Question
In: Accounting
CLUK is a producer of sports nutrition drinks and has two divisions, D1 and D2. Division...
CLUK is a producer of sports nutrition drinks and has two divisions, D1 and D2. Division D1 manufactures recyclable plastic containers which it sells to both Division D2 and also external customers. Division D2 makes high protein drinks which it sells to the retail trade in the containers that it purchases from Division D1.
You have been provided with the following budget information for Division D1:
|
$ |
|
|
Selling price to retail customers per 1,000 containers |
130 |
|
Variable costs per container |
0.04 |
|
Fixed Costs per annum |
2.4 million |
|
Net Assets |
4.0 million |
|
Production capacity |
40,000,000 containers |
|
Retail demand for containers |
38,000,000 containers |
|
Demand for containers from Division D2 |
20,000,000 containers |
You have been provided with the following budget information for Division D2:
|
$ |
|
|
Selling per container of protein drink |
0.50 |
|
Variable costs per drink (excluding container) |
0.15 |
|
Cost per container (from Division D1) |
At transfer price |
|
Fixed Costs |
1,750,000 |
|
Net assets |
12,650.000 |
|
Sales volume of protein drinks in containers |
20,000,000 |
Transfer Pricing Policy
Division D1 is required to satisfy the demand of Division D2 before selling containers externally. The transfer price for a container is full cost plus 20%.
Performance Management Targets
Divisional performance is assessed on Return on Investment (ROI) and Residual Income (RI). Divisional managers are awarded a bonus if they achieve the annual ROI target of 25%. CLUK has a cost of capital of 7%.
Required:
REQUIRED:
- Produce a three-page PowerPoint presentation to incorporate the following tasks:
- SLIDE 1
Using Excel, produce a profit statement for each division detailing sales and costs, separating external sales and inter-divisional transfers. You are advised to produce this statement in a Excel spreadsheet first and then copy this information into the PowerPoint slide
- SLIDE 2
Using Excel, calculate the ROI for division D1 and division D2. Copy this information into Slide 2 of the PowerPoint presentation
- SLIDE 3
Provide a brief commentary on the divisionalised profit statements and ROI results shown in slides 1 and 2
[40 MARKS]
- The directors of CLUK are planning to expand the operations of the company and together with the divisional managers, have agreed to purchase a new machine that would increase annual production capacity to 50,000,000 cans at Division D1.
The purchase of this machine will increase the net assets of Division D1 by $500,000. Assume that there is no impact on unit variable costs or fixed costs resulting from this purchase. Inter-divisional transfers will be priced at opportunity cost.
You are required to produce a report to the directors critically discussing the issues and implications of the Transfer Pricing Policy on this investment and divisional profits. You should support your answer with suitable analysis and revised profit statements (these should be included as appendices to your report). Your report should be produced in a Word document containing no more than 1,000 words (+/- 10%).
Solutions
Expert Solution
| a | ||||||
| SLIDE 1 | ||||||
| Particulars | Division D1 | Division D2 | ||||
| Sale to outside | Transfer D2 | |||||
| Selling Price per unit | 0.13 | - | 0.5 | |||
| Transfer Price (#NOTE 1) | - | 0.12 | - | |||
| Variable Cost per unit | 0.04 | 0.04 | 0.15 | |||
| Contribution per unit | 0.09 | 0.08 | 0.35 | |||
| Total Unit (D1 capacity limited to 40Million) | 20000000 | 20000000 | 20000000 | |||
| Total Contribution (unit* contribution per unit) | 18,00,000 | 16,00,000 | 70,00,000 | |||
| Total contribution of D1 | 34,00,000 | |||||
| Total Fixed Cost | 24,00,000 | 17,50,000 | ||||
| Net Profit | 10,00,000 | 52,50,000 | ||||
| #NOTE 1 | ||||||
| Transfer Price Calculation | ||||||
| Prticulars | Amount | |||||
| Total Variable Cost(40000000*.04) | 16,00,000 | |||||
| Total Fixed Cost | 24,00,000 | |||||
| Total cost (VC + FC ) | 40,00,000 | |||||
| Profit @ 20% on TC | 8,00,000 | |||||
| Price ( Total cost + Profit) | 48,00,000 | |||||
| Total Units | 4,00,00,000 | |||||
| Transfer Price | 0.12 | |||||
| SLIDE 2 | ROI of Divisions | |||||
| Particulars | Division D1 | Division D2 | ||||
| Total Profit | 10,00,000 | 52,50,000 | ||||
| Net Asset | 40,00,000 | 1,26,50,000 | ||||
| ROI ( Total Profit/ Net asset) | 25% | 41.5% = 42% | rounded to 42% | |||
| SLIDE 3 | Brief Commentary | |||||
| Here in Division D1, the limiting factor is production capacity. Under the policy, Division D1 should meet the requirment of Division D2 and after that only sell the product in market. Transfer price is 0.12 which is less than market price. This will lead to decrease the profit of D1 and reduce cost of D2. So as per the Divisionalised profit statement and ROI, the loss for the manager D1 and benefit for manager D2.It may cause conflict. So finally it is better to allocate the transfer price to D1 along with outside selling price as a fair decision. Both divisions are profitable while comparing with market which have a ROI of 7% only. But Division D2 is more profitable than D1 having higher ROI. So more concentrate on Division D2. | ||||||
| b | ||||||
| * | If the capacity raised to 50000000 from 40000000 | |||||
| The incremental contribution will be | ||||||
| (Selling price - Variable cost)* incremental units | ||||||
| (0.13-0.04)*10000000 = | 9,00,000 | |||||
| Purchase of Machine for $5,00,000 will lead to increase in contribution by 900000 | ||||||
| * | If Transfer price policy changed to Opportunity Cost from Cost Plus 20% | |||||
| Variable cost | 0.04 | |||||
| Opportunity Cost (.13-.04) | 0.09 | |||||
| 0.13 | ||||||
| Previous Transfer price | 0.12 | |||||
| Revised Profit Statement | ||||||
| Particulars | Division D1 | |||||
| Sales to external (30000000*0.13) | 39,00,000 | |||||
| Sales to Division D2 (20000000*0.13) | 26,00,000 | |||||
| Total Sales | 65,00,000 | |||||
| Less: Variable cost (50000000*0.04) | 20,00,000 | |||||
| Contribution | 45,00,000 | |||||
| Less: Fixed Cost | 24,00,000 | |||||
| Profit | 21,00,000 |
ekkarill92 answered 2 years ago