Question

The following question presents hypothetical data concerning transfer of cotton between departments as part of the Cotton On Group's production processes. The textile department produces cotton for use by various other production departments within the Cotton On Group. The costs incurred by the textile department to produce cotton are provided below:

	Cost per square metre
Direct materials	$2.10
Direct labour	$0.50
Variable overhead	$0.25
Fixed overhead	$0.15

The textile department can also sell cotton to external customers for $5.00 per square metre. Sales staff from the textile department are paid a sales commission of $0.10 per square metre for sales to external customers. No sales commissions are paid for transfers to internal customers.

Required

1. Provide and discuss three examples which illustrate how cost-plus pricing could be used to set the internal transfer price for cotton and how these prices impact departmental profitability.
2. Measure and discuss the internal transfer price for cotton if the general transfer price rule is used in the following situations:
   1. The textile department has infinite capacity .
   2. The textile department has no spare capacity .
   3. The textile department has capacity to produce 50,000 metres, internal demand is 40,000 metres and external demand is 17,000 metres .

Answer 1