Wood Inc. manufactures wood poles. It has two divisions, Harvesting and Sawing, which are both evaluated as profit centres. The Harvesting Division is responsible for all the harvesting operations and transfers logs to the Sawing Division, which transforms the logs into poles for external customers. Sawing can produce 10,000 poles per year. The Sawing Division is currently producing at full capacity, after management decided a year ago to manufacture a higher-demand wood pole, Pole-S, that can be sold readily. The manager of the Sawing Division suggests that the maximum price the division can pay for logs transferred from Harvesting is $61.50 per log. The following information supports this suggestion:
Price that external customers are willing to pay for one unit of Pole-S $122.0.0
Costs per unit:
Direct labour …………………………………………..$35.00
Variable overhead ……………………………………….4.50
Fixed overhead …………………………………………..8.50
Direct materials (other than logs) …………………………2.50
Total cost per unit ………………………………………50.50
Target profit margin …………………………………….10.00
Total cost and margin ………………………………….$60.50
Maximum transfer price for one log ……………………$61.50
The manager of the Harvesting Division disagrees with the proposed transfer price of $61.50. The division is operating at full capacity and can sell all the logs it produces to external customers for $75. Moreover, the director says: “For each unit of Pole-S my direct labour cost is $40.50, variable overhead is $9.50, and fixed overhead is $15. I cannot spend $65 to cut trees and sell them for $61.50.”
REQUIRED
A. Determine whether it would be beneficial for the company as a whole if logs were transferred to the Sawing Division at the suggested price of $61.50 per log. Show all your calculations.
B. Explain the impact of transferring the logs to the Sawing Division at $61.50 on the performance of each division and specifically on each manager.
C. Determine the minimum and the maximum transfer price that could be used to account for the transfer of logs from the Harvesting Division to the Sawing Division. Recommend an appropriate transfer price. Justify your recommendation?
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