Mimosa Company Ltd manufactures dashboard instruments for heavy construction machinery. The firm is based in Brisbane, but operates several divisions in Australia, New Zealand, the Philippines, Malaysia and Indonesia.
The Wellington division manufactures complex electrical panels that are used in a variety of the firm’s instruments. There are two basic types of panels.
§The high-density panel (HDP) is capable of many functions and is used in the most sophisticated instruments, such as tachometers and pressure gauges.
§The low-density panel (LDP) is much simpler and is used in less-complicated instruments.
Although there are minor differences among the different high-density panels, the basic manufacturing process and production costs are the same. The high-density panels require considerably more skilled labour than the low-density panels, but the unskilled labour needs are about the same. Moreover, the cost of direct materials in the high-density panel is much higher than that of the low-density panel. Production costs are summarised as follows. Note that all amounts are in Australian currency.
Unskilled labour (0.5 hour @ $20)
LDP (0.5 hour @ $40)
HDP (1.5 hours @ $40)
Total variable cost
Theannual fixed overheadin the Wellington division is$1 000 000. There is a limited supply of skilled labour available in the area, and the division must constrain itsproduction to 40 000 hoursof skilled labour each year. This has been a troublesome problem for Jane Davis, the division manager. The LDP line seems to have unlimited demand, with eachLDPselling for$45.Business also has increased in recent years for the HDP, and Davis estimates the division could now sell anywhere upto 6 000 unitsper year at a priceof $145.
In the Philippines, Mimosa operates its Manila division. This division is a recent acquisition of Mimosa, and it was formerly a successful Philippines company. The division’s main product is a sophisticated tachometer used in heavy-duty cranes, bulldozers and backhoes. The instrument, designated as TCH–320, has the following production costs.
Unskilled labour (0.5 hour @ $9)
Skilled labour (3 hours @ $17)
Total variable cost
The cost of purchased components includesa $145control pack currently imported from Japan. Fixed overhead in the Manila division is about $800,000 per year. Both skilled and unskilled labour is in abundant supply. The TCH–320 sells for $270.
Basil Santos, the manager of the Manila division, recently attended a high-level corporate meeting in Wellington. In a conversation with Jane Davis, it was apparent that Wellington’s high-density panel might be a viable substitute for the control pack currently imported from Japan and used in Manila’s TCH–320. Upon returning to Manila, Santos asked his chief engineer, Sam Ferreira, to look into this matter. Ferreira obtained several HDP units from Wellington, and a minor project was mounted to determine whether the HDP could replace the Japanese control pack.
Several weeks later, the following conversation occurred in Santos’ office.
There’s no question that Wellington’s HDP unit will work in our TCH–320. In fact, it could save us some money.
That’s good news. If we can buy our components within the company, we’ll help Wellington’s bottom line without hurting ours. Also, it will look good to the senior management at the head office if they see us working hard to integrate intoMimosa’s overall production program.
I’ve also been worried about the reliability of supply of the control pack. I don’t like being dependent on such a critical supplier that way.
I agree. Let’s look at your figures on the HDP replacement.
I got together with the controller’s people, and we worked up some numbers. If we replace the control pack with the HDP from Wellington, we’ll avoid the $145 control pack cost we’re now incurring. In addition, we’ll save $5.50 on the basic raw materials. There is one catch, though. The HDP will require some adjustments in order to use it in the TCH–320. We can make the adjustments here in Manila. I’m guessing it will require an additional two hours of skilled labour to make the necessary modifications. I don’t think variable overhead would be any different. Then there is the cost of transporting the HDPs to Manila. This may be $4.50 per unit.
Sounds good. I’ll give Jane Davis a call and talk this over. We can use up to 10 000 of the HDP units per year, given the demand for the TCH–320. I wonder what kind of a transfer price Wellington will want?
i. Draw a simple diagram depicting the two divisions and the flow of their products. Also show the two alternatives that the Manila division has in the production of its TCH–320. (3 marks)
ii. From the perspective of Mimosa’s top management, should any of the TCH–320 units be produced using the HDP? If so, how many? (18 marks)
iii. Suppose Wellington transfers 10 000 HDP units per year to Manila. From the perspective of Mimosa’s top management, what effect will the transfer price have on the company’s profit? (4 marks)
iv. What is the minimum transfer price that the Wellington division would find acceptable for the HDP? Explain. (5 marks)
v. What is the maximum transfer price that the Manila division would find acceptable for the HDP? (6 marks)
vi. As the corporate controller for Mimosa, recommend a transfer price. (4 marks)
Show all workings clearly.
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