Yisivikelo (Pty) Ltd (Yisivikelo) is a divisionalised company that manufactures insulating panels for cold rooms. These...

 

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Yisivikelo (Pty) Ltd (Yisivikelo) is a divisionalised company that manufactures insulating panels for cold rooms. These panels are considered to be the finest panels available on the market. Two divisions are involved in manufacturing these panels: The Ukushisa Division and Iphaneli Division. Ukushisa Division Ukushisa Division (Ukushisa) manufactures high density polystyrene sheets. All sheets are of identical size. These sheets are the insulating material used to form the interior of the panels that are manufac- tured by the Iphaneli Division (Iphaneli). Ukushisa has the capacity to manufacture 33 000 polystyrene sheets per annum. External demand for these sheets is only 9 500 sheets. As the sheets are of unusual density, only two customers (both graphic design artists) purchase the polystyrene. Even if Ukushisa dropped their selling price, they would not be able to sell more sheets, and their two customers would not pay more for the sheets than the current selling price. Besides, as the high density polystyrene gives rise to Iphaneli's competitive advantage (i.e. the high level of insulation), Yisivikelo is not keen to market the polystyrene sheets, more widely. Financial information relating to the production of polystyrene sheets in the Ukushisa is as follows: Selling price per unit (9 500 sheets sold externally) Variable production costs Fixed production costs * Net profit per unit Investment in operating assets 325 130 90 105 3 900 000 * Fixed costs per sheet is based on total fixed costs of R2 970 000 divided by full capacity of 33 000 sheets. Iphaneli Division Iphaneli receives the high density polystyrene sheets from Ukushisa. These sheets are transferred from Ukushisa to Iphaneli at the full manufacturing cost per sheet (R220). Iphaneli builds a protective shell around each of these sheets, and sells the completed panels to a number of cold room specialists in the building industry. As Iphaneli is the only provider of insulating panels of this grade, the price they charge affects the number of panels that can be sold. The first 15 000 panels are sold to Iphaneli's "crown jewel" customers at a price per panel of R520 each. Iphaneli could sell a further 12 000 panels to smaller operators, if this price is reduced to R395 per panel for the remaining panels. Panels sold to smaller operators do not need to be as neatly finished as those supplied to crown jewel customers, and Iphaneli can save R10 of finishing costs (included in variable costs below) on all panels supplied to smaller operators. The first 15 000 panels can always be sold for R520 per panel, regardless of whether any additional panels are sold or not. Financial information relating to the production of panels in Iphaneli is as follows: Per panel (the first 15 000 panels) R Selling price Variable production costs (excluding transfer price) Transfer price Fixed production costs ** Profit per unit Per sheet R 520 190 220 18 92 Per panel (additional panels up to 12 000) R Investment in operating assets 4 576 000 ** Fixed costs per unit is based on total fixed costs of R486 000 divided by full capacity of 27 000 panels. 395 180 220 18 -23 As both divisions are investment centres, Yisivikelo has recently begun using return on investment (ROI) and residual income (RI) in order to evaluate divisional performance. (Management's bonuses are based on RI only. ROI is only used to compare divisional performance.) Yisivikelo has a weighted average cost of capital (WACC) of 17%. Other manufactures of polystyrene sheets have an average ROI of 18%, and other panel manufacturers a ROI of 19%. Shortly after Yisivikelo announced the changes to the performance evaluation method of the company, the divisional manager of Ukushisa (Vuyani Nkosi) and the divisional manager of Iphaneli (Sizwe Tau) had the following argument: Vuyani: "Look - I think that it's unfair that Ukushisa doesn't earn any profit on the sheets we transfer to Iphaneli. To sustain the capacity that Ukushisa has, I have a large investment in assets, and substan- tial fixed costs and this has a huge impact on my ROI. I think that we should transfer sheets to you at our current market price of R325 per sheet. That will result in a good indication of the profits we earn for the firm in total." Sizwe: "No way! That is completely unreasonable. At the moment we're covering the bulk of your division's fixed costs! From a relevant costing perspective, all it costs you to make the sheets is your variable cost! We're doing you the favour already. I think that the transfer price should be Ukushisa's variable cost." Vuyani: "Sizwe, you're dreaming. You guys wouldn't exist if it wasn't for our sheets. If you are not prepared to give me market price for our sheets, I'm not prepared to sell them to you. We can last longer than you can." Sizwe: "Fine - let's see what Bon has to say about this." The matter was duly escalated to Bonang Khumalo, Yisivikelo's head office accountant. REQUIRED (a) Determine the respective number of polystyrene sheets and number of panels that should be sold externally in order to optimize profits for the firm. Calculate the optimum profit to the firm under this plan. (i) Profit; ROI, and (iii) RI (f) (b) Suggest a suitable transfer price (or range of transfer prices), based on relevant costing principles, that will result in profit being maximised for the firm. Briefly explain your answer. (c) Comment on the appropriateness of the current transfer price. In support of your comments you should calculate the: at the current transfer price for each division separately, and for the firm in total. (d) Comment (briefly) on Vuyani's suggestion that the transfer price should be the current market price (R325 per sheet). (e) Comment (briefly) on Sizwe's suggestion that the transfer price should be the vari- able cost per sheet (R130 per sheet). Suggest a transfer pricing method that will result in profit being optimized, and which supports meaningful performance evaluation and divisional autonomy. Ex- plain. TOTAL Marks 10 5 24 4 4 3 50 Yisivikelo (Pty) Ltd (Yisivikelo) is a divisionalised company that manufactures insulating panels for cold rooms. These panels are considered to be the finest panels available on the market. Two divisions are involved in manufacturing these panels: The Ukushisa Division and Iphaneli Division. Ukushisa Division Ukushisa Division (Ukushisa) manufactures high density polystyrene sheets. All sheets are of identical size. These sheets are the insulating material used to form the interior of the panels that are manufac- tured by the Iphaneli Division (Iphaneli). Ukushisa has the capacity to manufacture 33 000 polystyrene sheets per annum. External demand for these sheets is only 9 500 sheets. As the sheets are of unusual density, only two customers (both graphic design artists) purchase the polystyrene. Even if Ukushisa dropped their selling price, they would not be able to sell more sheets, and their two customers would not pay more for the sheets than the current selling price. Besides, as the high density polystyrene gives rise to Iphaneli's competitive advantage (i.e. the high level of insulation), Yisivikelo is not keen to market the polystyrene sheets, more widely. Financial information relating to the production of polystyrene sheets in the Ukushisa is as follows: Selling price per unit (9 500 sheets sold externally) Variable production costs Fixed production costs * Net profit per unit Investment in operating assets 325 130 90 105 3 900 000 * Fixed costs per sheet is based on total fixed costs of R2 970 000 divided by full capacity of 33 000 sheets. Iphaneli Division Iphaneli receives the high density polystyrene sheets from Ukushisa. These sheets are transferred from Ukushisa to Iphaneli at the full manufacturing cost per sheet (R220). Iphaneli builds a protective shell around each of these sheets, and sells the completed panels to a number of cold room specialists in the building industry. As Iphaneli is the only provider of insulating panels of this grade, the price they charge affects the number of panels that can be sold. The first 15 000 panels are sold to Iphaneli's "crown jewel" customers at a price per panel of R520 each. Iphaneli could sell a further 12 000 panels to smaller operators, if this price is reduced to R395 per panel for the remaining panels. Panels sold to smaller operators do not need to be as neatly finished as those supplied to crown jewel customers, and Iphaneli can save R10 of finishing costs (included in variable costs below) on all panels supplied to smaller operators. The first 15 000 panels can always be sold for R520 per panel, regardless of whether any additional panels are sold or not. Financial information relating to the production of panels in Iphaneli is as follows: Per panel (the first 15 000 panels) R Selling price Variable production costs (excluding transfer price) Transfer price Fixed production costs ** Profit per unit Per sheet R 520 190 220 18 92 Per panel (additional panels up to 12 000) R Investment in operating assets 4 576 000 ** Fixed costs per unit is based on total fixed costs of R486 000 divided by full capacity of 27 000 panels. 395 180 220 18 -23 As both divisions are investment centres, Yisivikelo has recently begun using return on investment (ROI) and residual income (RI) in order to evaluate divisional performance. (Management's bonuses are based on RI only. ROI is only used to compare divisional performance.) Yisivikelo has a weighted average cost of capital (WACC) of 17%. Other manufactures of polystyrene sheets have an average ROI of 18%, and other panel manufacturers a ROI of 19%. Shortly after Yisivikelo announced the changes to the performance evaluation method of the company, the divisional manager of Ukushisa (Vuyani Nkosi) and the divisional manager of Iphaneli (Sizwe Tau) had the following argument: Vuyani: "Look - I think that it's unfair that Ukushisa doesn't earn any profit on the sheets we transfer to Iphaneli. To sustain the capacity that Ukushisa has, I have a large investment in assets, and substan- tial fixed costs and this has a huge impact on my ROI. I think that we should transfer sheets to you at our current market price of R325 per sheet. That will result in a good indication of the profits we earn for the firm in total." Sizwe: "No way! That is completely unreasonable. At the moment we're covering the bulk of your division's fixed costs! From a relevant costing perspective, all it costs you to make the sheets is your variable cost! We're doing you the favour already. I think that the transfer price should be Ukushisa's variable cost." Vuyani: "Sizwe, you're dreaming. You guys wouldn't exist if it wasn't for our sheets. If you are not prepared to give me market price for our sheets, I'm not prepared to sell them to you. We can last longer than you can." Sizwe: "Fine - let's see what Bon has to say about this." The matter was duly escalated to Bonang Khumalo, Yisivikelo's head office accountant. REQUIRED (a) Determine the respective number of polystyrene sheets and number of panels that should be sold externally in order to optimize profits for the firm. Calculate the optimum profit to the firm under this plan. (i) Profit; ROI, and (iii) RI (f) (b) Suggest a suitable transfer price (or range of transfer prices), based on relevant costing principles, that will result in profit being maximised for the firm. Briefly explain your answer. (c) Comment on the appropriateness of the current transfer price. In support of your comments you should calculate the: at the current transfer price for each division separately, and for the firm in total. (d) Comment (briefly) on Vuyani's suggestion that the transfer price should be the current market price (R325 per sheet). (e) Comment (briefly) on Sizwe's suggestion that the transfer price should be the vari- able cost per sheet (R130 per sheet). Suggest a transfer pricing method that will result in profit being optimized, and which supports meaningful performance evaluation and divisional autonomy. Ex- plain. TOTAL Marks 10 5 24 4 4 3 50

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a To optimize profits for the firm we need to determine the respective number of polystyrene sheets and panels that should be sold externally Lets calculate the optimum profit to the firm under this p... View the full answer