Question

Clear windowns manufacture windows for te home building industry. The window frames are produced in the frame division. The frames are then transferred to the glass division, where the glass and hardware are installed. The frame division can also sell frames directly to custom home builders,who install the glass and hardware. The two division run as autonomously as possible, subject to the groups current policy that the frame division must make internal sales first before selling outside the group and that the Glass division must always buy its frames frim the frame division. However this company policy together with the transfer price which is the frame division charges the Glass division, is currently under review. Details of the two division are given below.

The glass division

The glass divisions budget for the coming year shows that 35000 frames will be needed. An external supplier could supply these to the glass division for $80

The frame division

Frame division has the capacity to produce a total of 60000 frames per year. Details of the frame divisions budget which has just been prepared for the forthcoming year are as follows

Budgeted sales volume units 60000

selling price per unit $85

variable cost per unit for external sales of the frames $77

The variable cost for sales to the glass division of frames would be $3 per unit less compared to external sales due to cost saving on distribution and packaging

Maximum external demand for the frame is 30000 units per year

Q2.1 Assuming that the groups current policy could be changed, advice, using suitable calculations, the number of frames which the frame division should supply to the glass division in order to maximise group profits. Recommend the transfer price or prices at which these internal sales should take place after considering the perspective of the two division and the perspective of the group.

Q2.2 Explain why it may not be desirable for head office management to dictate transfer prices. when should headoffice management intervene in the transfer pricing process? 150 words

Answer 1

1.) For good transfer pricing, a negotiated transfer price must be established. A negotiated price is appropriate when the market prices are subject to rapid fluctuation.

> First let set up the minimum price which is equals to the sellers point of view; seller's incremental cost plus opportunity cost.

Variable cost ($77-$3) = $74

Loss contribution margin [(5,000 x 48)/35,000] = 1.14

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Total minimum price $75.14

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Total maximum price (from buyers point of view) $80

*** As a conclusion, Glass division can acquire to Frame division for profit maximization.

2.) It is not desirable for the head office to dictate transfer prices since every segment of the organization must create its own decision and they are more knowledgeable of their operation and they should permit a segment to operate as an independent entity and let achieve its goal while functioning in the best interest of the organization as a whole. If ever there are misunderstandings, here comes the head office to intervene.