Question

Case Study 3:       

SSHA Holdings Pty Ltd owns two business units; Rotor Electrics in Nauru and Green Acres in Australia. Each business unit is treated as a profit center by SSHA Holdings. Rotor Electrics manufactures electric motors in Nauru, which it sells in the International market for AUS$220 per unit. Green Acres Ltd. makes ride-on mowers using electric motors similar to those manufactured by Rotor Electrics Ltd. Currently, Green Acres buys these similar electric motors from an Australian supplier (external supplier that is not part of the SSHA Holdings group) for $220. Both companies pay 10% sales commission only when they sell their products to external customers.

The unit selling prices and relevant costs are given below.

	Rotor Electrics Amounts per motor	Green Acres Amounts per ride-on mower
Selling Price per unit	$220	$2100
Production Cost per unit	$100	$1100 (including the electric motors purchased at $220)
Selling Expenses (10% sales commission)	$22	$210

Requirements

1. Calculate the profits made by (1) Rotor Electrics business unit (per motor), (2) Green Acres business unit (per refrigerator), and (3) SSHA Holdings Ltd (as a whole group), when Rotor Electrics sells to external customers and Green Acres buys from an external supplier

2. SSHA Holdings management decides that Rotor Electrics must sell its electric motors to Green Acres. The managing director is aware of the 20% tax rate in Nauru compared to Australia’s 30% tax rate and decides to set a transfer price that will minimize SSHA Holdings overall income tax.

To achieve this tax minimization goal, the managing director sets a transfer selling price of AUS$400 per motor for Rotor Electrics to sell to Green Acres.

Using this new transfer selling price for Rotor Electrics, calculate the profits made by (1) Rotor Electrics business unit (per motor), (2) Green Acres business unit (per refrigerator), and (3) SSHA Holdings Ltd (as a whole group). You should ignore any other transfer costs (such as exchange rate fluctuations) in your answer.

3. The managing director cannot see why the current performance measures (Profit and Return on Investment) for each manager should be changed (the managing director does not consider whether the new arrangement will affect bonuses or future promotion prospects for the managers of each company). Using your answers to requirement 1 and 2 above, explain;

a. Whether the Rotor Electrics manager and the Green Acres manager would both support the decision to transfer the electric motors from Rotor Electrics to Green Acres at AUS$400. Describe (using your calculations) the impact of the new transfer selling price on the performance for Rotor Electrics and for Green Acres.                                                                                               

b. Whether the $400 transfer price is a goal congruent transfer price given the managing director’s decision to retain the same performance measures.   

c. Whether there is an alternative recommendation you would make to the managing director using any of the information you have prepared when answering requirements 1, 2, or 3

Answer 1

				SSHA HOLDINGS
	1 AND 2)	ASSUMUNG GREEN ACRES PURCHASES MOTOR FROM ROTOR ELECTRICS
				UNIT 1	UNIT 2
				ROTOR ELECTRICS	GREEN ACRES
				MOTOR	REFRIGERATOR
		SELLING PRICE	$	220	2100
		LESS:PRODUCTION COST	$	-100	-1100
		LESS:SELLING EXPENSE	$		-210	(10% OF SALES)
		PROFIT PER UNIT		120	790
	3)	SSHA HOLDINGS LTD (AS A WHOLE GROUP) WHEN ROTOR ELECTRIC SELLS TO EXTERNAL CUSTOMERS AND GREEN ACRES BUYS FROM EXTERNAL SUPPLIER
				UNIT 1	UNIT 2
				ROTOR ELECTRICS	GREEN ACRES
				MOTOR	REFRIGERATOR
		SELLING PRICE	$	220	2100
		LESS:PRODUCTION COST	$	-100	-1100
		LESS:SELLING EXPENSE	$	-22	-210	(10% OF SALES)
		PROFIT PER UNIT		98	790
		PROFITS BY SSHA HOLDINGS		=	98+790
					$888 PER UNIT
2)		ROTOR ELECTRICS SELLINGS ITS PRODUCT TO ELECTRIC MOTORS
				UNIT 1	UNIT 2
				ROTOR ELECTRICS	GREEN ACRES
				MOTOR	REFRIGERATOR
		SELLING PRICE	$	400	2100
		LESS:PRODUCTION COST	$	-100	-1280	(1100-220+400)		880
		LESS:SELLING EXPENSE	$		-210	(10% OF SALES)
		PROFIT PER UNIT		300	610
		PROFIT BY SSHA HOLDINGS LTD
				IN $	(SALE OF FINAL PRODUCT)
		SALE PRICE OF REFREIGERATOR		2100
		LESS: PRODUCTION COST OF ROTOR		-100
		LESS: PRODUCTION COST OF REFRIGETOR		-880	(1100-220)
		LESS: SELLING EXPENSE OF REFRIGETOR		-210
		PROFIT BY SSHA HOLDINGS LTD		910