Question - Goody Ltd has two divisions: the Component Division and Electronix Division. The Component Division manufactures a special component where there is no external market price as it is only sold internally to Electronix Division.

The estimated unit costs of manufacturing the special component are as follows:

Direct materials $30.00

Direct labour 7.50

Variable overheads 15.00

Fixed allocated overheads 9.00

The Electronix Division will use 30,000 components per year.

Two Jobs: X and Y will have to be forgone if the special components are produced. The costs of the two jobs are as follows:

Job X Job Y

Revenues $780,000 $450,000

Variable manufacturing $585,000 $315,000

Fixed allocated overheads $60,000 $90,000

Required:

(a) Assume that the special component displaces other potential jobs in Component Division. Briefly explain how the Component Division should set the transfer price of the special component produced for the Electronix Division.

(b) Calculate the minimum transfer price that the Component Division should charge if the two Jobs X and Y have to be given up to produce the special components for the Electronix Division.

(c) If the Component Division can produce the special components without displacing any work for the external customers, what is the minimum transfer price that should be charged to the Electronix Division?

(d) The manager of Component Division offered to supply the special component at full cost plus the division's average mark-up of 30%. Calculate the transfer price. What do you think of this transfer pricing scheme suggested by the manager of Component Division?

(e) The manager of Electronix Division refuses to pay the average mark-up as he had found a supplier who has offered to supply at $60 per unit. He offers to pay Component Division's variable costs plus a lump sum of $112,500 to help cover fixed costs and provide some profits. Should the Component Division accept this last offer? Explain your answer.