Question 2

(a) Although the general rule for transfer prices is the outlay cost plus opportunity cost, many companies instead use negotiated prices to price their goods and services. Critically explain when it is appropriate to use negotiated transfer price.

(b) Kendall Corporation has two divisions: Phoenix and Tucson. Phoenix currently sells a condenser to manufacturers of cooling systems for RM520 per unit. Variable costs amount to RM380, and demand for this product currently exceeds the division's ability to supply the marketplace.

Kendall is considering another use for the condenser, namely, integration into an enhanced refrigeration system that would be made by Tucson. Related information about the enhanced system are as follows: Selling price of refrigeration system: RM1,285 Additional variable manufacturing costs required: RM820 Transfer price of condenser: RM490

Top management is anxious to introduce the enhanced system; however, unless the transfer is made, an introduction will not be possible because of the difficulty of obtaining condensers in the quality and quantity desired. The company uses responsibility accounting and ROI when measuring divisional performance, and awards bonuses to divisional management.

Required: (i) Evaluate the reaction of Phoenix's divisional manager to the decision to transfer condensers to Tucson. Show computations to support your answer. (6 marks)

(ii) Evaluate Tucson's divisional management reaction to the RM490 transfer price. Show computations to support your answer.

(iii) Assume that a lower transfer price is desired. Determine the parties that should be involved in setting the new price?

(iv) From a contribution margin perspective, evaluate whether Kendall will benefit more if it sells the condensers externally or transfers the condensers to Tucson. Show relevant computation to support your answer.