Your firm operates a boutique motel with three operating departments, accommodation (ACC), food and beverage (F & B), and gift shop (GS). The following issues have arisen and you are required to report to the Board of Management on the matters raised and the explanations requested.
All three operating areas use hand made chocolates produced by F & B. Market purchase price of $5.00 has been used as the transfer price in the past and the following data has been drawn from last years activities. Over the year 50,000 chocolates are produced, 60% are used for functions organised by F & B, 20% by ACC and the balance are sold to external customers through the GS.
F & B's unit costs are:
- Variable costs $3.50
- Fixed costs $2.00
Required:
a) Should the current policy of market transfer price be continued, why? If you disagree, what is your recommendation for the transfer price?
b) What effect, if any, does maximum capacity have on the minimum transfer price?
c) If GS was able to purchase 2,000 units from an outside supplier for $3.00 per unit. The units would have to be packaged before sale which would cost $0.50 per unit. The demand by external customers will not change.
Should the organisation allow GS to purchase the units externally? Why or why not?
d) Suppose that GS has the choice of:(i) Cutting the selling price for external sales from $6.00 to $4.00 which would guarantee additional sales of 100 units per month of chocolates in GS, or (ii) Maintain the current position.Which option should be chosen?
e) What other considerations should management factor into the decision making process in regard to purchasing from external sources or cutting the selling price?