Daily Energy Biscuits Limited is a well-known biscuit manufacturer in Northern India. The company has two divisions: Healthy Biscuits and Energetic Biscuits. Healthy Biscuits form the basic material for Energetic Biscuits. Mr. G. K. Rao is the manager of Healthy Biscuits Division and Mr. Akhil Gupta is the manager of Energetic Biscuits Division. Presently, Energetic Biscuits Division is buying Healthy Biscuits from outside market at a cost of Rs. 20 per pack. The company’ CMD, Mr. B. K. Atal, wants to develop a transfer pricing system that will instill goal congruence in the two division managers. Mr. Rao and Mr. Gupta each get a bonus of 10 per cent of the operating margins of their respective divisions.

The following information is available:

Details	Healthy Biscuits	Energetic Biscuits
Sales (market price)	Rs. 20.00 per pack of Biscuits	Rs. 40.00 per pack of Biscuits
Variable costs (excluding direct costs)	Rs. 5.00 per pack of Biscuits	Rs. 7.50 per pack of Biscuits
Fixed costs	Rs. 30,000 per month	Rs. 50,000 per month
Units sold to outside market	30,000 per month	8,000 per month
Capacity (in units)	40,000 per month	8,500 per month

A contribution margin income statement for each division and for the company in total, if the Energetic Biscuits Division buys Healthy Biscuits from outside suppliers at market price is given below. The bonuses of Mr. Rao and Mr. Akhil Gupta are also shown separately in the statement.

Details	Healthy Biscuits	Energetic Biscuits	Company Total
Operating Margin	Rs. 4,20,000	Rs. 50,000	Rs. 4,70,000
Bonus (10%)	Rs. 42,000	Rs. 5,000	Rs. 47,000
Operating income	Rs. 3,78,000	Rs. 45,000	Rs. 4,23,000

a.            If there are no cost savings associated with the Healthy Biscuits Division selling directly to the Energetic Biscuits Division, what is the (i) lowest transfer price and (ii) highest transfer price Linden should charge?

b.            Prepare contribution income statements for each division and the company as a whole using (i) the lowest and (ii) the highest transfer prices. Show both Mr. Rao’s and Mr. Gupta’s bonuses separately.

c.             What inferences do you draw on the basis of the details given in the case and calculations made by you in (b) above?

d.            How can the CMD of the Company, Mr. Atal, encourage the division managers to agree to an arrangement that will be acceptable to them and, at the same time, beneficial to the company as a whole? Explain your answer.

 

Answer rating: 100% (QA)

a To determine the lowest and highest transfer prices we need to consider the cost structure of both divisions Since there are no cost savings associated with the Healthy Biscuits Division selling dir... View the full answer