Reference no: EM132954633

StrictlyFans manufactures and delivers desktop fans for homes and offices in Garnet. The company sells through its website and uses commercial logistics firms to deliver its products. The markets for its products are highly competitive. The company has traditionally relied on the high quality of its designs to drive demand for its products.

The company is divided into two divisions (components and assembly), plus a head office that provides design, administrative and marketing support. The manufacturing process involves:

• the components division is making the housing components and electrical components for the desktop fan. This is an intricate process as it depends on the specific design of the desktop fan and so serves as a significant source of competitive advantage for StrictlyFans.
• the assembly division is assembling the various components into a finished desktop fan ready for shipment. This is a simple process.
• The finance director (FD) of StrictlyFans is currently overloaded with work due to changes in financial accounting policies that are being considered at the board level. As a result, she has been unable to look at certain management accounting aspects of the business and has asked you to review the transfer pricing policy between the components and assembly divisions.

The current transfer pricing policy at StrictlyFans is as follows:

• market prices for electrical components are used as these are generic components for which there is a competitive external market; and
  prices for housing components are based on total actual production costs to the component's division are used as there is no external market for these components since they are specially designed for StrictlyFans's products.
  Currently, the components division produces only for the assembly division to meet overall demand without the use of external suppliers for housing and electrical components. If the components division were to sell its electrical components externally, additional costs of $269,000 would arise for transport, marketing and bad debts.
• The FD is considering two separate changes within StrictlyFans: one to the transfer pricing policy and a second one to the divisional structure.
• First, the transfer pricing policy for housing components would change to use variable cost to the components division. The FD wants to know the impact of the change in transfer pricing policy on the current results of the two divisions and the company. (No change is proposed to the transfer price of the electrical components.)
• Second, as can be seen from the divisional performance report, the two divisions are currently treated as profit centres. The FD considers splitting the components division into two further separate divisions: an electrical components division and a housing components division. If the board agrees to this proposal, then the housing components division will be treated as a cost centre only, charging its total production cost to the assembly division. The electrical components and assembly divisions will remain as profit centres.
• The FD needs to understand the impact of this proposed new divisional structure on divisional performance assessment and the company. She has asked that, to keep the discussion on the new divisional structure simple, you use the existing transfer pricing policy to do illustrative calculations. She stated that she would reallocate head office costs to the two new components divisions in proportion to their cost of sales.

REQUIRED:

Problem 1: Evaluate the current system of transfer pricing at StrictlyFans from the Electrical Components and the Housing Components perspective.

Problem 2: Advise the finance director (FD) on the impact of changing the transfer pricing policy for housing components as suggested by the FD.

Problem 3: Evaluate the impact of the change in the proposed divisional structure on the profit in the housing division and the electrical division as directed by the FD.