ZazziCyclesGroupis a divisionalised organisation that makes and sells bicyclesin Italy.

Production of partsand assembly takes place inthe MilanDivision (design and manufacturing).

The finished products are then transferred for sale to the TurinDivision (sales and marketing).

The TurinDivision incurs fixed costs of70,000 per month. They sell the bikes for250per bike.

In May, the MilanDivision produced2,000bikes.The costs of productionfor the Milan divisionin Maywere as follows:

Variable costs

()

Labour

22per bike

Aluminium

60per bike

Paint

4per bike

Rubber

9per bike

Fixed costs

Electricity

50,000

Insurance

20,000

Management salaries

100,000

Notes:

Fixed costs areto beallocated evenly across production.

(a) Calculate:

(i)The variable costof production per bike.

(ii)The full costof production per bike.

(iii)The full cost of production per bike plus a 25% mark-up.

(b)Calculate theprofit or lossreportedby each divisionwhen theyuse:

(i) The variable cost as transfer price from Milan to Turin.

(ii) The full cost as transfer price from Milan to Turin.

(iii) The full cost plus 25% mark-up as transfer price from Milan to Turin.

Assume that the Turin Division sells all the units produced by the Milan Division in the same month.

(c)Atpresent,management bonuses of 30% are paid on reported divisional profits.Choice of transfer price is not made by the Group, but is devolved to the divisions.

Given this information, suggest:

(i) Which transferpricethe manager ofeach division would prefer.

(ii) The issues that may arise in deciding on a transfer priceand ways of avoiding these.