Question

Mike is a manufacturing supplier. Mike’s products are both bought in and purchased internally from its manufacturing division Manuf. The transfer price used by Manuf to sell internally its products to Mike is set by head office and is currently under some discussion. The current policy is for Manuf to sell internally at its variable cost plus 30% margin. Manuf argues however that it should be calculated as full cost plus margin, and even offers to reduce the margin to 10% in this case. Manuf has provided the following information to enable a price comparison between the two possible pricing strategies:

a)      Steel: each product needs 0.4 kg of steel in the final product, knowing that it loses 5% of the steel put in. Steel costs $4,000 per tonne.

b)      Other materials are bought in and have a list price of $3 per kg, although Manuf enjoys a 10% volume discount; each products consumes 0.1 kg of such materials.

c)      The labour time required to make one product is 0.25 hours, paid $10 per hour.

d)     Variable overheads are absorbed at the rate of 150% of labour rates, and fixed overheads are 80% of the variable overheads.

e)      Delivery is made by an outsourced distributor that charges Manuf $0.50 per product.

Required:

a)      Calculate the price that Manuf would charge for its product under the existing policy based on the variable cost   

b)      Calculate the price that Manuf would charge for its product if the new policy based on the full cost would be implemented   

c)      Comment on the 1) general implications of setting a transfer price within a business ; 2) advise on the adequacy of changing the transfer price for this specific case

d)     Mike is using the price information in its annual budgeting process, built in an incremental approach. Explain 2 alternative budgeting techniques that Mike might consider implementing, given the critiques you raise of the traditional budgetary process   

  

Answer 1

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