Case Study Question :

Seaside Equipment Limited (SE) have two divisions: Fishing Reel Division and Fishing Rod Division. SE manufactures a variety of equipment and accessories sold to amateurs who are interested in fishing as a hobby. The equipment and accessories are distributed through retailers throughout Singapore and other parts of Asia. The fishing reels are either sold to retailers or transferred internally to the Fishing Rod Division. The Fishing Rod Division requires the fishing reels to assemble its finished products that are sold to external customers. SEs board of directors have delegated decision-making authority to managers of both Fishing Reel and Fishing Rod divisions and the managers are rewarded based on his divisions profits that they are able to control. Until recently, the fishing reels have been transferred to the Fishing Rod Division for a transfer price of $26.00 per reel, which is equal to variable cost plus a 30% mark-up. William Zhang, manager of the Fishing Reel Division, has just informed Kate Manton, manager of the Fishing Rod Division, that he has increased the transfer price to $32, as this is equal to the current market price he can sell his reels for in the external market. Kate is furious about this decision and has decided to buy the reels in the external market for $28. She is not completely happy with this decision as, although these reels are of reasonable quality, they are not up to the standard of the reels provided by the Fishing Reel Division. Information relating to the manufacture and sale of the reels is as follows:

Direct Materials $10

Direct Labour $4

Variable Overhead $3

Fixed factory Overhead Allocated $2

Selling and Administration (40% is fixed) $5

Note that if the reels are transferred, instead of sold on the external market, $1.00 in selling and administration costs will not be incurred.

Required:

(a) Identify and explain two (2) reasons why it is necessary for Seaside Equipment Limited to determine a Transfer Price for the fishing reels.

(b) Identify and explain the three (3) factors that have created a transfer pricing problem at SE.

(c) What is the optimal sourcing decision for the reels from the viewpoint of Seaside Equipment Limited as a whole if the Fishing Reel Division has spare capacity to produce reels for the Fishing Rod Division? Your answer should be supported with complete and properly labelled calculations. State any assumptions you make.

(d) Given your answer to part c), do you believe that the new transfer price of $32 is appropriate? Explain your answer fully. In your answer, you must refer to: (I) The behaviours likely to occur if this transfer price is used; (ii) The impact of these behaviours on the companys interests as a whole.

(e) Assume the Fishing Reel Division does NOT have any spare capacity to satisfy the Fishing Rod Divisions demand for the fishing reels. From the perspective of SE as a whole, determine the optimal sourcing decision for the reels. You must explain your answer fully. Marks will be awarded for complete and properly labelled calculations to support your answer. State any assumptions you make.