a)
i) The transfer price of GH¢750 proposed by the MIS division is based on cost plus 150% from which it can be deduced that the total cost of a consulting day is (100/250) x GH¢750 = GH¢300. This comprises GH¢240 (80%) variable cost and GH¢60 (20%) fixed cost. In this instance, the transfer price should be set at marginal costs plus opportunity cost. It is assumed in this situation that transferring internally would result in the MIS division having a lost contribution of GH¢750 – GH¢240 = GH¢510 per consulting day. The marginal cost of the transfer of services to the HR division is GH¢190 (GH¢240 external variable costs less GH¢50 saving due to use of internal video-conferencing equipment). Adding the opportunity cost of GH¢510 gives a transfer price of GH¢700 per consulting day. This is equivalent to using the market price as a basis for transfer pricing where the transfer price is set at the external market price (GH¢750) less any costs avoided (GH¢50) by transferring internally.

ii) There is in effect no external market available for one of the required pairs of consultants within the MIS division and therefore opportunity cost will not apply and transfers should be made at the variable cost per consulting day of GH¢190. The other pair of consultants, who would otherwise be 100% utilized in providing consulting services to external clients, should be charged at a rate of GH¢700 per day which represents marginal cost plus opportunity cost.

iii) The lost contribution from the major client amounts to GH¢264,000/(2 x 240) = GH¢550 less variable costs of GH¢240 = GH¢310 per consulting day. Thus, in this instance, the transfer price should be the contribution foregone of GH¢310 plus internal variable costs of GH¢190, making a total of GH¢500 per consulting day.

Alternative

Cost Analysis:
Let X represent the cost
X + 1.5X = 750
2.5X = 750
X = 300

Variable cost = 80% of 300 = GH¢240
Fixed cost = 20% of 300 = GH¢60

i) Where there is no spare capacity, transfer price should be at market price. With the use of internal facilities and savings in variable cost, transfer price should be market price less savings, i.e., GH¢750 – GH¢50 = GH¢700.

ii) Where one team is idle, the fully engaged team will transfer at adjusted market price while the idle team will transfer at adjusted variable cost.
Fully engaged: GH¢750 – GH¢50 = GH¢700
Idle: GH¢240 – GH¢50 = GH¢190
Total = GH¢890

For the two teams:

iii) Where there is an offer from an outside customer, the transfer price should be the opportunity cost.
Offer price = GH¢264,000 / 480 hours = GH¢550, adjusted by savings of GH¢50, giving GH¢500 per consulting day.

Marks Allocation for Part a:

Analysis = 4 marks
i) = 3 marks
ii) = 3 marks
iii) = 4 marks
Total for part a = 14 marks

b) Limitations of negotiated transfer prices:

Suboptimal pricing: The transfer price which is the final outcome of negotiations may not be close to the transfer price that would be optimal for the organization as a whole since it can be dependent on the negotiating skills and bargaining powers of individual managers.
(2 marks)

Potential conflict: They can lead to conflict between divisions, which may necessitate the intervention of top management to mediate. The measure of divisional profitability can be dependent on the negotiating skills of managers who may have unequal bargaining power.
(2 marks)

Time-consuming process: They can be time-consuming for the managers involved, particularly where large numbers of transactions are involved.

(2 marks)