May 2013 Exam Pink PLC has several divisions which supply materials to each other.

The Brown division has offered to supply the Blue division material x at a cost of 20 per kg. The Brown division calculates the transfer price based on full cost plus 25% profit mark up. It also sells material x to external customers at the same price of 20 per kg. The full cost has been estimated as 75% variable and 25% fixed. If Brown transferred the materials internally to Blue they would make savings of 2.50 per kg of variable packing cost. Required: (a) Evaluate the transfer prices at which Brown should charge Blue if the groups objective is to maximise profit across the whole group for the following three scenarios: (i) (ii) (iii) Brown has an external market for all the material x it can produce at 20 per kg. (3 marks) Brown has the capacity to produce 10,000kgs and has an external market for 5,000kgs. (6 marks) Blue has found an external supplier that will supply as much material x as it requires for 16 per kg. Brown is still charging Blue 20 per kg. Discuss whether Blue should buy externally and show the range of transfer prices at which Brown could sell to Blue. (6 marks)

(b)

Examine the main issues that could arise from transfer pricing decisions in multi divisional companies. (10 marks) (Total: 25 marks)