Question

Liverpool Company has two divisions and manufactures one type of watch.. The two divisions are the production Division and the Package & Delivery Division. The production Division manufactures watches and then sells them to the Package & Delivery Division, which packs the watches and sells them to retailers. The market price for the Package & Delivery Division to purchase this watch is £40.

Production’s cost per watch are:	£
Direct materials	6
Direct labour	7
Variable overhead	5
Division fixed cost	2

Package & Delivery’s cost per watch are:	£
Direct materials	9
Direct labour	3
Variable overhead	4
Division fixed cost	16

Notes: Fixed costs shown above are per pair for 100,000 units.

d) Calculate and compare the difference in overall corporate net income between Scenario A and Scenario B if the Production Division sells 100,000 watches to retailers for £120 per watch.

1. Scenario A: Negotiated transfer price of £30 per watch.

2. Scenario B: Market-based transfer price of £40 per watch.

Explain fully.

Answer 1

Scenario A Negotiated transfer price of £30 per watch

Particulars	Production division	Package & delivery division	Total
Revenue	3,000,000	12,000,000	15,000,000
Less: Costs
Direct material	600,000	900,000	1,500,000
Direct labor	700000	300,000	1,000,000
Variable overhead	500,000	400,000	900,000
Division fixed cost	200000	1,600,000	1,800,000
Purchase from production division	-	3,000,000	3,000,000
Net income	1,000,000	5,800,000	6,800,000

Scenario B Market-based transfer price of £40 per watch.

Particulars		Production division	Package & delivery division	Total
Revenue		4,000,000	12,000,000	16,000,000
Less: Costs
Direct material		600,000	900,000	1,500,000
Direct labor		700000	300,000	1,000,000
Variable overhead		500,000	400,000	900,000
Division fixed cost		200000	1,600,000	1,800,000
Purchase from production division		-	4,000,000	4,000,000
Net income		2,000,000	4,800,000	6,800,000

The profits under both these scenarios are same . the overall corporate profit remains same.

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