The Spanish Watch Company has two divisions and manufactures one type of watch. The two divisions are the production Division and the Package & Delivery Division. The production Division manufactures watches and then sells them to the Package & Delivery Division, which packs the watches and sells them to retailers. The market price for the Package & Delivery Division to purchase this watch is £40.   Production’s cost per watch are: £ Direct materials 6 Direct labour 7 Variable overhead 5 Division fixed cost 2     Package & Delivery’s cost per watch are: £ Direct materials 9 Direct labour 3 Variable overhead 4 Division fixed cost 16       Notes: Fixed costs shown above are per pair for 100,000 units.       Required:   a) Assume the transfer price for a watch is 160% of full costs of the Production Division and 100,000 watches are produced and sold to the Package & Delivery Division. What is the Production Division's operating income?                                                                                            b) If the Package & Delivery Division purchases 100,000 watches from production departments and sells to retailers at a price of £150 per watch, what is the operating income of Spanish Watch Company?                                                                                            c) If Production Division has excess capacity to produce 100,000 watches which it cannot sell externally, must it negotiate a transfer price below £40 per watch internally? If the production division cannot negotiate the appropriate transfer price with internal package and delivery division, what is the consequence of this? Explain.

Question

The Spanish Watch Company has two divisions and manufactures one type of watch. The two divisions are the production Division and the Package & Delivery Division. The production Division manufactures watches and then sells them to the Package & Delivery Division, which packs the watches and sells them to retailers. The market price for the Package & Delivery Division to purchase this watch is £40.

 

Production’s cost per watch are:

£

Direct materials

6

Direct labour

7

Variable overhead

5

Division fixed cost

2

 

 

Package & Delivery’s cost per watch are:

£

Direct materials

9

Direct labour

3

Variable overhead

4

Division fixed cost

16

 

 

 

Notes: Fixed costs shown above are per pair for 100,000 units.

 

 

 

Required:

 

a) Assume the transfer price for a watch is 160% of full costs of the Production Division and 100,000 watches are produced and sold to the Package & Delivery Division. What is the Production Division's operating income?

                                                                                    

 

 

 

b) If the Package & Delivery Division purchases 100,000 watches from production departments and sells to retailers at a price of £150 per watch, what is the operating income of Spanish Watch Company?

                                                                                    

 

 

 

c) If Production Division has excess capacity to produce 100,000 watches which it cannot sell externally, must it negotiate a transfer price below £40 per watch internally? If the production division cannot negotiate the appropriate transfer price with internal package and delivery division, what is the consequence of this? Explain.

                                                                               

 

 

d) Calculate and compare the difference in overall corporate net income between Scenario A and Scenario B if the Production Division sells 100,000 watches to retailers for £120 per watch.

 

a. Scenario A: Negotiated transfer price of £30 per watch.

 

b. Scenario B: Market-based transfer price of £40 per watch.

Explain fully.

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