Question

Leather Ltd has been in business for many years making hand-made, high end, leather goods. One of its products is a designer jacket. There are two divisions involved in the production of jackets, the Cutting Centre and the Stitching Division. Budgeted production for both divisions is 500 jackets per year. The Cutting Centre specialises in cutting out the unique designs and currently only supplies to the Stitching Division, which expertly hand stitches the product to make a jacket of exceptional quality. The Stitching Division then sells the product to exclusive clients for £3,500 per jacket. The Cutting Centre incurs variable costs of £1,800 per jacket and fixed overheads of £100,000. The Stitching Division incurs further variable processing costs of £900 per jacket and fixed overheads of £50,000.

Required: (b) Calculate the budgeted annual profit for each division and the company as a whole if the cut leather is transferred to the Stitching Division at transfer price of £2,000.

(c) Assuming divisional performance is measured based on profit, discuss and explain the likely reaction of the divisional managers to an imposed transfer price of £2,000. (maximum word count 100 words)

(d) It has now come to light that the Cutting Centre could sell 300 units of cut designs to an external customer for £3,000 per unit. Discuss the effect that this will have on Leather Ltd’s profits and the willingness of each divisional manager to accept an imposed transfer price of £2,000 in each of the following scenarios separately: Scenario 1: The Cutting Centre capacity is sufficient to supply both the external customer and the Stitching Division. Scenario 2: A restricted supply of skilled labour means that the Cutting Centre has a maximum production capacity of 500 units.

Use calculations to support your answer. (maximum word count 120 words)

(e) If the Cutting Centre’s demand from external customers grows until it reaches a point where it is working at maximum capacity supplying goods to external customers at £3,000 a unit, calculate and explain the minimum transfer price that the Cutting Centre would charge, assuming other costs remain the same. (maximum word count 60 words)

Answer 1

ANSWER ; WORKING NOTES ;

Descripton                                         Cutting Unit                     Stitching unit              Leather Ltd

1. Budgeted production                        500 Nos                           500 Nos                      500 Nos

2. Fixed Cost    (In Pounds) 1,00,000