There are two key divisions in a major international organisation. Division Y makes the small component and Division Z makes the finished product, which incorporates one small component. Division Z normally purchases the small component from Division Y.

Details of the selling prices and costs for each product are:

	Small component £	Finished product £
Selling Price	66	106
Direct materials	19	10
Transfer price from Y	-	66
Direct labour @ £2 per hour	10	6
Variable overhead	5	4
Divisional Fixed Overheads	£950,000	£490,000
Outside sales (units)	100,000	25,000
Divisional investment	£13,600,000	£2,550,000

Division Z currently has a return on investment below the head office target of 15%. The transfer price of the small component is set at a competitive market price of £66.

After receiving an appeal from the Manager of Division Z to intervene, the Chief Executive asks you to consider a proposal for a ‘two-part tariff’ transfer price system.

You are required to:

1. Advise the Chief Executive on the appropriateness of the present transfer price system, with supporting calculations of its effects on the respective profitability and returns of each division.

2. To recommend a basis for the two-part tariff transfer price system, with supporting calculations and comment on its impact on the two divisions.

3. Comment on why you think the Chief Executive may be reluctant to intervene.

Answer rating: 100% (QA)

The present transfer price system involves Division Z purchasing the small component from Division Y for 66 Calculation of the profitability and return on investment ROI for both divisions under this ... View the full answer