Bath Co is a company specialising in the manufacture and sale of baths. Each bath consists of a main unit plus a set of bath fittings. The company is split into two divisions, A and B. Division B manufactures the bath and Division A manufactures sets of bath fittings, which are both sold externally and transferred to Division B. Both of the divisions are treated as profit centres. The following data is available for both divisions: Division A Division B External selling price of items £80 £450 Transfer price £75 Internal standard variable costs per item £20 £245 Annual fixed costs £4,400,000 £7,440,000 Annual production capacity 200,000 80,000 Maximum external demand 180,000 80,000 The transfer price charged by Division A to Division B was negotiated some years ago between the previous divisional managers, who have both now been replaced by new managers. Head Office only allows Division B to purchase its fittings from Division A, but Division A must give priority to division B requirements before selling externally. The new manager of Division B believes he could obtain fittings of the same quality and appearance for £65 per set, if he was given the autonomy to purchase from outside the company. Required: (a) Under the current transfer price system, prepare a profit statement showing the profit for each of the divisions and for Bath Co as a whole. (b) Head Office is considering changing the transfer pricing policy to ensure maximisation of company profits without de-motivating either of the divisional managers. Division B will be given autonomy to buy from external suppliers (at £65 per set of fittings) and Division A to supply external customers in priority to supplying to Division B if either division wishes. Calculate the range for a negotiated transfer price which will maximise company profits and indicate whether transfers will take place or not. Calculate the profit achieved by the company overall.
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Bath
Bath Co is a company specialising in the manufacture and sale of baths. Each bath consists of a main unit plus a set of bath fittings. The company is split into two divisions, A and B. Division B manufactures the bath and Division A manufactures sets of bath fittings, which are both sold externally and transferred to Division B. Both of the divisions are treated as profit centres.
The following data is available for both divisions:
|
|
Division A |
Division B |
|
External selling price of items |
£80 |
£450 |
|
Transfer price |
£75 |
|
|
Internal |
£20 |
£245 |
|
Annual fixed costs |
£4,400,000 |
£7,440,000 |
|
Annual production capacity |
200,000 |
80,000 |
|
Maximum external demand |
180,000 |
80,000 |
The transfer price charged by Division A to Division B was negotiated some years ago between the previous divisional managers, who have both now been replaced by new managers. Head Office only allows Division B to purchase its fittings from Division A, but Division A must give priority to division B requirements before selling externally. The new manager of Division B believes he could obtain fittings of the same quality and appearance for £65 per set, if he was given the autonomy to purchase from outside the company.
Required:
(a) Under the current transfer price system, prepare a profit statement showing the profit for each of the divisions and for Bath Co as a whole.
(b) Head Office is considering changing the transfer pricing policy to ensure maximisation of company profits without de-motivating either of the divisional managers. Division B will be given autonomy to buy from external suppliers (at £65 per set of fittings) and Division A to supply external customers in priority to supplying to Division B if either division wishes. Calculate the range for a negotiated transfer price which will maximise company profits and indicate whether transfers will take place or not. Calculate the profit achieved by the company overall.
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