Discuss the short-term and long-term issues

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Reference no: EM132985120

Question

Amber Company has three divisions which operate as autonomous profit centres. The Bubbles Division manufactures premium soap which it sells to external customers for $4 per cake. Its main raw materials are caustic soda, which it purchases from the Chemo Division, and glycerine, which it purchases from the Oils Division.

The Chemo Division manufactures a high grade caustic soda for internal transfer, and also sells this to external customers at a rate of $4 per kg. There is an established market for caustic soda, and the Chemo Division can sell all the caustic soda that it can manufacture.

The Oils Division also operates in a well- developed competitive market. It currently sells its glycerine for $6 per litre. However, the external market is limited, so the Oils Division operates with excess capacity. Currently, about 70 percent of the output of Glycerine is sold to the Bubbles Division.

The following costs relate to the two products that are transferred:

	Oils Division Glycerine Per litre	Chemo Division Caustic Soda Per kg
Direct material	$ 2.50	$1.00
Direct labour	0.40	0.50
Variable overhead	0.60	0.40
Fixed overhead	1.50	1.40
Total Cost	$5.00	$3.30

Required:
a) State the general transfer pricing rule, and use it to calculate transfer prices for the Chemo Division and the Oils Division.

b) Bubbles Division has just discovered that it can purchase glycerine from an overseas source at $3.90 per litre, and has told the Oils Division that unless it lowers its transfer price, it will no longer purchase its product. The manager of the Oils Division has said that he cannot supply glycerine at this price, as he needs to cover his overheads and meet his profit target

Discuss the short-term and long-term issues that need to be considered by these two divisions, and by the company as a whole in resolving this issue.

c) "There is no need to use transfer pricing systems in divisionalised companies, as these only result in internal transactions which cancel each other out."

Do you agree with this statement? Provide arguments to explain your answer.

Reference no: EM132985120

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