Reference no: EM132904120

Question - Rosan Limited has two departments which are referred to as the Denika department and the McKlmon department. The company is now thinking of restructuring so that the two departments will become profit centres which the managers of the departments given more autonomy. The individual salaries of the managers would be linked to the profits of their respective departments.

The Denika department sells 20,000 electronic boards to appliance dealers and computer stores for $500 each. A critical part to complete the electronic board is currently made by the McKlmon department and supplied to the Denika Department for free. Under the proposed changes stated above to create the profit centres, the McKlmon department would charge the Denika Department for the parts provided at the price that it currently charges its external customers. In addition to the part supplied by the McKlmon department, the Denika department incurs variable cost of $100 per unit and Fixed costs of $200,000 per year to supply product for its customers.

The McKlmon department has two sources of work; the work needed to satisfy the parts for the Denika Department and the work required to satisfy sales of 30,000 parts to its external customers. Its external customers are charged at full cost plus 40 per cent for a similar part supplied to the Denika department. The details of the budget for the next year for the McKlmon Department revealed standard costs of making the part;

*Fixed overheads per unit are based on a production capacity of 50,000 units (or 150,000 labour hours)

Budgets have been produced for each department on the assumption that the McKlmon Department will produce 20,000 for the Denika Department and that the transfer price for this work will be calculated in the same way as the price charged to external customers. However, the manager of the Denika Department has now stated that she intends to purchase the parts from another company, Maryam Limited, because they have offered to supply the parts for $195 each which is less than the price that the McKlmon Department would charge.

Required -

1. Calculate the individual profits of the Danika Department and the McKlmon Department, and Rosan Limited as a whole if;

2. (i) The parts are sold by the McKlmon Department to Danika Department at full cost plus 40 per cent;

(ii) The parts are sold by the McKlmon Department to Danika Department at variable cost;

(iii) The parts are purchased externally from Maryam Limited

3. Explain, with reasons, why the transfer price proposed in the budget 'full cost plus' pricing model may not be appropriate for Rosan Limited, and state what you will recommendation.

4. What would be the best transfer price to use if the Danika department was located as a separate legal entity in another country where the corporate tax rate was higher than that of the country in which Rosan Limited and its McKlmon department were located, and why?