Super Appliance Manufacturers Ltd has a wide range of manufacturing activities. The company
operates on a divisionalised basis with each division being responsible for its own manufacturing, sales
and marketing, and working capital management. Divisional chief executives are expected to achieve
a target of 20% return on sales.
A disagreement has arisen between two divisions which operate on adjacent sites. The Boiler division
has the opportunity to manufacture a geyser using a new heater element developed by the Electric
division. Currently there is no other source of supply for an equivalent heater in the required quantity
of 30 000 units a year, although a foreign manufacturer has offered to supply up to 10 000 units in the
coming year at a price of R9 each. Electric’s current selling price for the heater is R12. Although
Electric’s production line is currently operating at only 50% of capacity, sales are encouraging and
Electric confidently expects to sell 100 000 units in 2013, and its maximum output of 120 000 units in
201

Electric has offered Boiler’s requirements for 2013 at a transfer price equal to the normal selling price,
less the variable selling and distribution costs that it would not incur on this internal order. Boiler
responded by offering an alternative transfer price of the standard variable manufacturing cost plus a
20% margin on selling price. The two divisions have been unable to agree, so the corporate operations
director has suggested a third transfer price equal to the standard full manufacturing cost plus 15%.
However, neither divisional chief executive regards such a price as fair.
Electric’s 2013 budget for the production and sale of heaters, based on its standard costs for the
forecast 100 000 units sales, but excluding the possible sales to Boiler, is as follows:

les revenue (100 000 units @ R12 each) 1 200
Direct Manufacturing costs
Bought in materials 360
Labour 4230
Packaging 40
Indirect manufacturing costs
Variable overheads 10
Line production salaries 30
Depreciation
Capital equipment 150
Capitalised development costs 60
Total manufacturing costs 880
Sales and distribution costs
Salaries of sales force 50
Carriage 20
General overhead 50
Total costs 1 000
Profit 200

Notes:
1. The costs of the sales force and indirect production staff are not expected to increase up to
the current production capacity.
2. General overhead includes allocation of divisional administrative expenses and corporate
charges of R20 000 specifically related to this product.
3. Depreciation for all assets is charged on a straight-line basis using a five-year life span and no
residual value.
4. Carriage is provided by an outside contractor

Required:
a) Calculate each of the three proposed transfer prices and comment on how each might affect
the willingness of Electric’s chief executive to engage in inter-divisional trade.
b) Outline an alternative method of setting transfer prices which you consider to be appropriate
for this situation and explain why it is an improvement on the other proposals.