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- 20 Marks
Question
Anim Shoes Ltd produces and sells Ghana-made shoes with two main departments: production/sales and repairs departments. The production and sales department produces and sells 10,000 pairs of shoes each year. Due to the low quality of raw materials available in the country, the company includes an additional GH¢11 in the cost of a pair of shoes sold to cater for one-year after-sales repairs. On average, it is expected that a quarter of the total pairs of shoes sold would come back for repairs a year after sale. Repair works on a pair of shoes take 2 labour hours, and it is estimated that total repair cost on the quarter of shoes will be GH¢27,500.
In addition to providing repair services to the production and sales department, the repair department sometimes picks up offers from outside the company. Such external offers are billed at full cost and a margin on sales of 20%. The following is the breakdown of the average repair cost of a pair of shoes:
| Cost Item | Cost (GH¢) |
|---|---|
| Material | 2.50 |
| Labour (1.5 per hour) | 3.00 |
| Variable Overheads | 1.00 |
| Fixed Overheads | 2.30 |
Required:
i) Calculate the individual profits of the Production/Sales department, Repairs department, and Anim Ventures if repairs are done by the repairs department of Anim Ventures at either full cost plus 20% margin on sales or at marginal cost.
(8 marks)
ii) Pee Shoe Repairs has offered to repair each pair of shoes for Anim Ventures at GH¢10.00, a price which is cheaper than what the repairs department is offering. Should Anim Ventures accept this offer?
(5 marks)
iii) Identify THREE other factors Anim Ventures should consider in finalizing the decision in (ii) above.
(3 marks)
iv) Explain TWO principles of a good transfer pricing method.
(4 marks)
Answer
i) Profit Calculation:
- Full Cost plus 20% profit on sales:
| Cost Item | Production/Sales Dept (GH¢) | Repairs Dept (GH¢) | Anim Ventures (GH¢) |
|---|---|---|---|
| Sales | 27,500 | 27,500 | 27,500 |
| Cost | 27,500 | 22,000 | 22,000 |
| Profit | 0 | 5,500 | 5,500 |
- Marginal Costing Method:
| Cost Item | Production/Sales Dept (GH¢) | Repairs Dept (GH¢) | Anim Ventures (GH¢) |
|---|---|---|---|
| Sales | 27,500 | 16,250 | 27,500 |
| Cost | 16,250 | 22,000 | 22,000 |
| Profit | 11,250 | (5,750) | 5,500 |
ii) Should Anim Ventures accept Pee Shoe Repairs’ offer at GH¢10.00?
If Pee’s offer is accepted:
| Cost Item | Production/Sales Dept (GH¢) | Repairs Dept (GH¢) | Anim Ventures (GH¢) |
|---|---|---|---|
| Sales | 27,500 | 0 | 27,500 |
| Cost | 25,000 | 5,750 | 30,750 |
| Profit | 2,500 | (5,750) | (3,250) |
Decision:
No, Anim Ventures should not accept Pee Shoe Repairs’ offer because the entire organization would be worse off, with an overall loss of GH¢8,750 (GH¢5,500 + GH¢3,250).
iii) Additional Factors Anim Ventures Should Consider:
- Quality Standards: Pee Shoe Repairs’ ability to meet the quality standards required by Anim Ventures.
- Timely Delivery: The capability of Pee Shoe Repairs to provide timely after-sales repair services.
- Impact on In-House Repairs: Potential impact on the repairs department, including possible closure due to reduced workload and uncertain customer response if they discover the repair work is outsourced.
iv) Principles of a Good Transfer Pricing Method:
- Goal Congruence: The method should lead to optimal decisions for the entire organization, not just a specific division.
- Subunit Autonomy: If decentralization is favored, the transfer pricing method should support the autonomy of different subunits within the organization.
- Tags: Full Costing, Marginal Costing, Outsourcing, Profitability, Transfer Pricing
- Level: Level 2
- Uploader: Dotse