The cost of manufacturing the parts is as follows: Based on a practical volume of 200,000 parts RM Direct materials 20 Direct Labour 4 Variable overhead 6 Fixed overhead* 10 Total Cost 40 Based on a practical volume of 200,000 parts Other costs incurred by the Mechanical Division are as follows: RM Fixed selling and administrative 500,000 Variable selling (per unit) 1 The part usually sells for between RM 56 and RM 60 in the external market. Currently, the Mechanical Division is selling it to external customers for RM 58. The division is capable of producing 200,000 units of the part per year; however, because of a weak economy, only 150,000 parts are expected to be sold during the coming year. The variable selling expenses are avoidable if the part is sold internally. The Engineering Division has been buying the same part from an external supplier for RM56. It expects to use 50,000 units of the part during the coming year. The manager of the Engineering Division has offered to buy 50,000 units from the Mechanical Division for RM 36 per unit
Required: I A. Define transfer price and, identify and describe the FIVE (5) different transfer pricing methods. (12 marks) B. Determine the minimum transfer price that the Mechanical Division would accept. (2 marks) W C. Determine the maximum transfer price that the manager of the Engineering Division would pay. Would the Engineering Division manager accept buying at RM58? Why or why not? (2 marks)
D. Should an internal transfer take place? Why or why not? If you were the manager of the Mechanical Division, would you sell the 50,000 components for RM 36 each? Explain. (5 marks) E. Suppose that the average operating assets of the Mechanical Division total RM 20 million and assuming that the 50,000 units are transferred to the Engineering Division for RM 42 each: i. Prepare income statement of Mechanical Division and calculate its operating income. (7 marks) ii. Compute the return on investment (ROI) for the coming year