Sandstone Industrial Resources Company (SIPC) has several divisions. However, only two are involved in the internal transfer of products. The Mining Division refines a material called toldine, which is then transferred to the Metals Division. The toldine is processed into an alloy by the Metals Division, and the alloy is sold to customers at $150 per unit. The Mining Division is currently required by SIPC to transfer its total yearly output of 400 000 units of toldine to the Metals Division at total actual manufacturing cost plus 10 per cent. Unlimited quantities of toldine can be purchased and sold on the open market at $90 per unit. While the Mining Division could sell all of the toldine it produces at $90 per unit on the open market, it would incur a variable selling cost of $5 per unit. Brian Jones, manager of the Minng Division, is unhappy with having to transfer the entire output of toldine to the Metals Division at 110 per cent of cost. In a meeting with the management of SIRC, he said:
Why should my division be required to sell toldine to the Metals Division at less than market price? For the financial year that has just ended, Metals’ was over $79 million on sales of 400 000 units, while Mining’s contribution was just over $5 million on the transfer of the same number of units. My division is subsidising the profitability of the Metals Division. We should be allowed to charge the market price for toldine when transferring to the Metals Division.
The following table shows the detailed unit cost structure for both the Mining and Metals divisions during the most recent year:
Mining DivisionMetals Division
Transfer price from Mining Division…………………-…………………………$66
Direct material……………………………………..$12………………………………6
Direct labour………………………………………..16…………………………..20
Manufacturing overhead……………………………32*………………………….25′
Total cost per unit………………………………….$60………………………..$117
Required:
1. Explain why transfer prices based on actual costs are not appropriate as the basis for divisional performance measurement.
2. Using the market price as the transfer price, determine the for both the Mining Division and the Metals Division.
3. If SIPC were to introduce the use of negotiated transfer prices and allow divisions to buy and sell on the open market, determine the price range for toldine that would be acceptable to both the Mining Division and the Metals Division. Explain your answer.
4. Use the general transfer-pricing rule to calculate the lowest transfer price that would be accruable to the Mining Division. Is your answer consistent with your conclusion in requirement 3? Explain
5. Identify which one of the three types of transfer prices (cost-based, market-based) is most likely to elicit desirable management behavior at SIRC. Explain your answer.
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