Comprehensive Illustration on Performance Management of Profit Centers

HAMLET PLC is a company specializing in the manufacture and sale of a range

of products for motorists. It is split into two profit center divisions: the battery
division (Division B) and the adaptor division (Division A). Division B sells one
product – portable battery. Division B has upgraded its portable battery so it can
also be used to rapidly charge mobile devices and laptops. The mobile device or
laptop must be attached to the battery using a special adaptor which is supplied
to the customer with the battery. Division B currently buys the adaptors from
Division A, which also sells them externally to other companies. The following
data are available for both divisions:

Division B has selling price for each portable battery, including adaptor Birr 180.
Variable costs of each units being assembled and sold include materials from
external suppliers for Birr 45; adaptor from Division A at Birr 13; and labour
costs of Birr 35. Annual fixed overheads are Birr 5,460,000. Annual production
and sales of portable batteries 150,000 units and the maximum annual market
demand for portable batteries 180,000 units as market share of B.

Division A has selling price per adaptor to Division B Birr 13 and selling price
per adaptor to external customers Birr 15. Costs per adaptor include material
costs of Birr 3, labour costs of Birr 4 and annual fixed overheads of Birr
2,200,000. Current annual production and sales capacity of adaptors for both
internal and external sales are 350,000 units; whereas, maximum annual
external demand for adaptors 200,000 units as market share of Division A.

In addition to the materials and labour costs above, Division A incurs a variable
cost of Birr 1 per adaptor for all adaptors it sells externally.

Currently, Head Office’s purchasing policy only allows Division B to purchase

the adaptors from Division A but Division A has refused to sell Division B any
more than the current level of adaptors it supplies to it. The manager of Division
B is unhappy. He has a special industry contact who he could buy the adaptors
from at exactly the same price charged by Division A if he were given the
autonomy to purchase from outside the group.

After discussions with both of the divisional managers and to ensure that the
managers are not demotivated, Head Office has now agreed to change the
purchasing policy for the next year to allow Division B to buy externally, provided
that it optimizes the profits of the group as a whole of HAMLET PLC. Considering
the discussion, for next year top management has reached on consensus to
change the transfer pricing system to optimize overall profit of the PLC.
 I. Based on the current transfer pricing system, what is the external sales
revenue of B and internal sales revenues of A?
II. Based on the current transfer pricing system, what is the total variable costs
and total fixed costs, as a whole for HAMLET PLC?
III. Based on the current transfer pricing system, which Division is more
profitable based on the Net Profit Margin ratio?
IV. Considering the discussion and reached consensus, the change in transfer
pricing approach is nearly from which method to which one?
V. As a whole of HAMLET PLC to optimize profit and influence the market by
using current production and sales of A, the appropriate business strategy
would be to buy the adaptors for B from A, after A has satisfied the maximum
demand of its external customers. Thus, if B uses the remaining capacity of
A for its current level 150,000, what is the profit of the PLC as a whole?
VI. Considering the designated transfer pricing of next year and both of the
divisions produce and sell at their full capacity and utilize the maximum
demand of their market share, at which B shall satisfy its remaining demand
(30,000units) for the adaptors from A at similar price (Birr 15 per unit) for
external customers, what will be the profit of Division B only?
VII. If negotiated consensus is reached by considering the existing facts and the
full capacity utilization strategy, what will be the fair transfer price between
the management of divisions to internally satisfy the only remaining demand
(30,000units) of B?