Performance Evaluation - Transfer Pricing Question

Blackwater Company manufactures windows for the home building industry. The window frames are produced in the Frame Division. The frames are then transferred to the Glass Division, where the glass and hardware are installed. The company's best-selling product is a 1 x 1.2 metre, double-paned window. The standard cost of the window is detailed as follows:

                                            Frame Division            Glass Division

Direct material                            $30                          $60*

Direct labour                               40                           30

Variable overhead                       60                           60

Total standard cost                      $130                       $150

*Not including the transfer price for the frame.

The Frame Division can also sell frames directly to custom home builders, who install the glass and hardware. The sales price for a frame is $160. The Glass Division sells its windows for $380. The markets for both frames and finished windows exhibit perfect competition.

REQUIRED -

1. Assume that there is no excess capacity in the Frame Division.

(a) Use the general rule to calculate the transfer price for window frames.

(b) Calculate the transfer price if it is based on standard variable cost with a 10 per cent markup.

2. Assume that there is excess capacity in the Frame Division.

(a) Use the general rule to calculate the transfer price for window frames.

(b) Explain why your answers to requirements l(a) and 2(a) differ.

(c) Suppose that the predetermined fixed overhead rate in the Frame Division is 125 per cent of direct labour cost. Calculate the transfer price if it is based on standard absorption cost plus a 10 per cent markup.

(d) Assume the transfer price established in requirement 2(c) is used. The Glass Division has been approached by the management of a commercial construction company with a special order for 1000 windows at $310 each. From the perspective of the Blackwater Company as a whole, should the special order be accepted or rejected? Explain your answer.

(e) Assume the same facts as in requirement 2(d). Would an autonomous Glass Division manager accept or reject the special order? Why?

3. Independent of requirements 1 and 2, assume that the Frame Division has limited capacity and can only supply half of the required 200 units of the double-paned window to the Glass Division. To supply all of the 200 units to the Glass Division, the Frame Division would have to forgo production and sales of 150 units of another product to external customers. These external sales typically yield a contribution of $80 per unit. Use the general rule to calculate the transfer price, and explain the likely decision the two divisions will make about the transfer.

REQUIRED READING -

Emmanuel, Otley and Merchant, Chapter 11, Interdependence and Transfer Pricing.

Anthony and Govindarajan, Chapter 6, Transfer Pricing.