QUESTION TWO

$[25]$

Tap Co$.$ ?is a company specializing in the manufacture and sale of Taps. Each Tap consists of a main unit plus a set of Tap fittings. The company is split into two divisions, A and B$.$ ?Division A manufactures the tap and Division B manufactures sets of tap fittings, Currently, all of Division A$\text{'}$s sales are made externally. Division B$,$ ?however, sells to Division A as well as to external customers. Both of the divisions are profit centres.

The following data are available for both divisions:

$1$

Division A

Current selling price for each Tap

R$450$

Costs per Tap:

Fittings from Division B R$75$

Other materials from external suppliers $,$ ?R$200$

Labour costs R$45$

Annual fixed overheads R$7440000$

Annual production and sales of Taps $($units$)80000$

Maximum annual market demand for Taps $($units$)80000$

Division B

Current external selling price per set of fittings R$80$

Current price for sales to Division A R$75$

Costs per set of fittings:

Materials R$5$

Labour costs R$15$

Annual fixed overheads R$4400000$

Maximum annual production and sales of sets of fittings $($units$)$

$($including internal and external sales$)$

Maximum annual external demand for sets of fittings $($units$),180000$

Maximum annual internal demand for sets of fittings $($units$),80000$

The transfer price charged by Division B to Division A was negotiated some years ago between the previous divisional managers, who have now both been replaced by new managers.

Head office only allows Division A to purchase its fittings from Division B$,$ ?although the new manager of Division A believes that he could obtain fittings of the same quality and appearance for R$65$ ?per set, if he were given autonomy to purchase from outside the company. Division B makes no cost savings from supplying internally to Division A rather than selling externally.

Required:

$2\mathrm{.}1.$ ?Under the current transfer pricing system, prepare a profit statement showing the profit for each of the divisions and for Tap Co$.$ ?as a whole. Your sales and costs figures should be split into external sales and interdivisional transfers, where appropriate.

$(14)$

$2$

$2\mathrm{.}2.$ ?Head office is considering changing the transfer pricing policy to ensure maximization of company profits without demotivating either of the divisional managers. Division A will be given autonomy to buy from external suppliers and Division B to supply external customers in priority to supplying to Division A$.$ ?Calculate the maximum profit that could be earned by Tap Co$.$ ?if transfer pricing is optimized.

$(11)$