FINANCIAL ACCOUNTING
10th Edition
ISBN: 9781259964947
Author: Libby
Publisher: MCG
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Transcribed Image Text:The Fruity Bakers specialize in making delicious cakes. Their trademark fruit cake is
made in Division X (the supplying division) and sold to external customers for them
to decorate, or it can be enjoyed plain. It is also transferred to Division Y (the
receiving division) where it is iced and decorated to be sold as a luxury wedding cake.
Fruity Bakers are currently trying to decide what the optimum price to sell the cakes
from Division X to Y should be in order to motivate the managers of both divisions.
The following data shows the costs incurred by Division X to make a fruit cake and
by Division Y to ice and decorate the wedding cake:
$/unit
Division X
Variable costs
22
Fixed overhead
9
31
Division Y
Variable costs
33
Fixed overhead
8.
41
Plain fruit cakes can be sold and purchased externally for $35.
Wedding cakes can be sold for $80.
Instructions:
1. Should the company make the fruit cakes internally or buy them in?
2. What non-financial factors should also be taken into consideration?
3. What would be the implication of using the following transfer pricing policies?
a. Variable cost plus 30%
b. Variable cost only
c. The external market price
d. Full cost plus 5%
Transcribed Image Text:Question 1: True / false
(A1)
1. Internal transfers should be preferred when there is an external market for the
transferred item because there will be more control over quality and delivery.
2. The transfer price will determine how profits will be shared between the two
divisions.
3. Residual income as a measure of performance enables fair comparisons to be
made between the performances of different divisions in the company.
4. When a transfer price is based on cost because there is no eternal market for the
transferred item, at least one of the divisional managers is likely to consider the
transfer price as 'unfair.
5. ROI is usually measured as divisional operating profit before deducting
depreciation as a percentage of the division's capital employed.
6. Residual income is calculated after deducting both depreciation on non-current
assets and notional interest on the division's capital employed.
7. Performance reports allow comparisons between actual performance and budget
expectations.
8. Residual income is the amount of profit left after subtracting expenses of a
particular investment center.
9. Like ROI, residual income is a performance measure displayed as a ratio.
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