MANAGERIAL ACCOUNTING
CASE NO. 2 - GREENWICH PLC CASE STUDY
I Problem Statement
Greenwich plc has three independent divisions; the North Division, Essex Division and Swansea Division. The Swansea Division produces product X and X100 of which the North Division buys from an external supplier at P900 and Essex Division at P1, 900per unit.
A mediator has been appointed by the head office to agree the purchasing Products X and X100. In his mediation between divisions, he found out contents of the original agreement and recommended a revision.
Ergo, the following questions are needed to be answered, to wit:
- How much is the increase or decrease in profits for the three divisions and the company if the head office agreement is imposed on managers and what are the problems faced by mediator in this situation?
- What are the implications of the following transfer pricing policies?
- Transfer price = cost plus a mark-up for the selling division
- Transfer price = standard cost plus a mark-up for the selling division.
- Transfer price = incremental cost
- Transfer price = price negotiated by the managers
II Areas of Consideration
The issue of transfer pricing occurs when an independent unit sells or buys from another independent unit within the same business conglomerate.Since independent unit managers have the authority to decide on how they run their business operations, they deal with external suppliers and customers as well as its affiliated divisions. The following information is relevant to solve divisional profit under the original and revised agreement.
Product | X | X100 |
Direct materials | £200 | £300 |
Direct labour | £200 | £300 |
Variable overhead | £300 | £600 |
Total Variable Cost | £700 | £1200 |
Transfer price | £1,000 | £2,000 |
Annual Volume(Capacity) | 3,000 units | 1,000 units |
III Alternative Courses of Action
The mediator was tasked to compute the increase in profit under the original agreement and the revised agreement.
Hence, the analysis for the original agreement (Alternative 1)
[pic 1]
Under the original agreement, North and Essex division (both buying divisions) contracted to purchase 3,000 and 1,000 units respectively from Swansea (selling division). External sales were 1,000 units for both Product X and X100. Sales are quoted at its market price of 900 and 1900 for product X and X100. North division registered total sales of P3, 600,000 and Essex division of P3, 800,000. The artificial price used to record the inter-divisional transfer is the transfer price used to evaluate divisional performance. Swansea charging North at a transfer price of P3, 000,000 and Essex of P2, 000,000.00. Swansea recorded total variable production cost of P2, 100,000 for product X and P1, 200,000 for Product X100 for the 3,000 and 1,000 units respectively. North and Essex total variable production cost were P700, 000 and P1, 200,000 respectively. Swansea division has total profit after external sales of P1, 700,000; North division has a decrease in income of 100,000 and Essex an increase of 600,000. Greenwich as company registered total sales of P7 400,000, a no effect on inter-divisional transfers, and total variable production cost of P5, 200,000 leaving a divisional income for the company of P2, 200,000. There is no opportunity cost at this agreement since the selling division is operating at its maximum capacity of 4,000 units annually.
Analysis for the revised agreement (Alternative 2)[pic 2]
Under the revised agreement, North and Essex division (both buying divisions) contracted to purchase 2,000 and 500 units respectively from Swansea (selling division). External sales were 2,000 units for Product X and 1500 units for X100. Sales are quoted at its market price of 900 and 1900 for product X and X100. North division registered total sales of P3, 600,000 and Essex division of P3, 800,000. The artificial price used to record the inter-divisional transfer is the transfer price used to evaluate divisional performance. Swansea charging North at a transfer price of P2, 000,000 and Essex of P1, 000,000.00. Swansea recorded total variable production cost of P1, 400,000 for product X and P600,000 for Product X100 for the 2,000 and 500 units respectively. North and Essex total variable production cost were P1, 400, 000 and P1, 800,000 respectively. Swansea division has total profit after external sales of P1, 000,000; North division has a increase in income of 200,000 and Essex an increase of 1,000,000. Greenwich as company registered total sales of P7 400,000, a no effect on inter-divisional transfers, and total variable production cost of P5, 200,000 leaving a divisional income for the company of P2, 200,000.There is an opportunity cost at this agreement since the selling division is not operating at its maximum capacity of 4,000 units annually. Computation of opportunity cost is as follows: