Question

Everything Golf Inc. has several divisions, two of which transfer their products to other divisions. The Refining Division refines bubblygoo, a chemical that has excellent polymer properties that allows it to be used in the manufacturing of many lightweight metal objects. Refining then transfers the refined bubblygoo to the Clubs Division. The Clubs division processes the bubblygoointo the shaft of golf clubs and sells these shafts to golf club manufacturers at a price of $150 per shaft. Everything Golf currently requires the Refining division to transfer its total annual output of 400,000 barrels of bubblygoo to the Club division at total manufacturing cost plus 10%. Unlimited quantities of bubblegoo can be purchased and sold on the open market at $90 per barrel. While the Refinig division could sell all the bubblygoo it produces on the open market at $90 per barrel, it would incur a variable selling cost of $5 per unit to do so.

Gary Allen, manager of the Refining division, is unhappy with having to transfer the division’s entire output of bubblygoo to the Clubs division at 110% of cost. In a meeting with the management of Everything Golf, he protested, “Why should my division be required to sell bubblygoo to the Clubs Division at less than market price? For the year just ended in June, Clubscontribution margin was over $19 million on sales of clubs made from 400,000 barrels of bubblygoo, while Refining’scontribution on the transfer of the same number of units (400,000 barrels of bubblygoo) was just over $9 million. My division is subsidizing the profitability of the Clubs division. We should be allowed to charge market price for bubblygoo when we transfer it to the Clubs division.”

Detailed unit costs for both the Refining and Clubs divisions follow.

	Refining Division	Clubs Division
Transfer price from Mining division		$66
Direct material	$12	6
Direct labor	16	20
Manufacturing Overhead	32	25
Total cost per barrel	$60	$117

Manufacturing overhead cost in the Refining division is 25% fixed, 75% variable. In the Clubs division, it is 60% fixed and 40% variable.

Required:

1. Explain why cost-based transfer prices are not appropriate as a divisional performance measure.

2. Using the market price as the transfer price, determine thetotal contribution margins for both divisions for the last fiscal year. (Hint: set up each division’s revenues – variable expenses to find the per unit CM and then use the units to convert to total $ CM)

3. If Everything Golf. were to institute negotiated transfer prices and allow divisions to buy and sell on the open market, what price range for bubblygoo would be acceptable to both divisions. Explain your answer.

4. Which of the three types of transfer price – cost-based, market-based or negotiated, is most likely to elicit desirablemanagerial behavior at Everything Golf Inc. and thus benefit overall operations? Explain your answer.

Answer 1

	Units	400,000	barrels
	Refine division			Clubs Divisions
	Rate	Amount		rate	Amount
Sale Price	85	34,000,000		150	60,000,000
Transferred material				90	36,000,000
direct material	12	4,800,000		6	2,400,000
direct labor	16	6,400,000		20	8,000,000
Variable manufacturing ov.	8	3,200,000		15	6,000,000
Contribution		19,600,000			7,600,000
Fixed manufaction overhead	24	9,600,000		10	4,000,000
EBIT		10,000,000			3,600,000
answer:-1) cost bases tranger price model discourage the profit center concept of the entity. Division measure its performance with the profit it earns. Whearas in cost plus profit method a fixed percentage is added which may be not represent the center entreperneurship. And there much changes the profit benefit is merged in other unit for which item is trasnsferred. It discourages the cost control of both the transferor and transferree.
2) in the case of everthing Golf, if both the units sell and purchsae in the open market than the profit of refine division will be $10,000,000 EBIT whereas clubs division will be reduced to$ 3,600,000 EBIT. Contribution of clubs division will be 7,6000,000. whereas refine division will be 19,600,000
3) As per the negotiated transfer price , both the division should set the trsnger price $ 85. As the $85 is the net sale price per unit that refine division will fetch in the market
4)For the purpose of the overall benefit of the Everything Golf Inc , Refine division shold not go in the market as there will be an increased cost of $5 for selling expense per unit. Though it should charge the $85 net (90-5) from the Clubs division as per the market rate. Thus efficiency will be vest with the bothd divisions and overall profit of the Everything club will be maximum. There for Market based driven price or negotiated price is best for best developing managerial culture in the Units.