Johnston Chemical Company manufactures a wide variety of industrial chemicals an
ID: 2589469 • Letter: J
Question
Johnston Chemical Company manufactures a wide variety of industrial chemicals and adhesives. It purchases much of its raw material in bulk from other chemical companies. One chemical, T-Bar, is prepared in one of Johnston’s own plants. T-Bar is shipped to other Johnston plants at a specified internal price.
The Johnston adhesive plant requires 10,000 barrels of T-Bar per month and can purchase it from an outside supplier for $150 per barrel. Johnston’s T-Bar unit has a capacity of 20,000 barrels per month and is presently selling that amount to outside buyers at $165 per barrel. The difference between the T-Bar unit’s price of $165 and the outside firm’s T-Bar price of $150 is due to short-term pricing strategy only; the materials are equivalent in quality and functionality. The T-Bar unit’s selling cost is $5 per barrel, and its variable cost of manufacturing is $90 per barrel.
For several years each unit of Johnston Chemical Company had been judged independently on the basis of its profit and return on investment. Top management had been working to gain effective results from a policy of decentralizing responsibility and authority for all decisions. However, goal congruence is also an important priority that the Company is emphasizing.
Diman Fong , a fresh MBA graduate from a renowned college was appointed as the manager of the adhesive plant unit and he is inexperience in the issue of transfer pricing and internal purchase. He came to you, as a management consultant for advice.
Suggested Considerations for Case Analysis:
Before you elaborate his setback and provide him with guidance, the following questions you need to raise and obtain his answer so as to lead him to resolve the problem.
Is there an outside supplier? If not, what happen to transfer price?
Is the seller’s variable cost less than the market price?
Is the selling unit operating at full capacity? (20 marks altogether)
(A) With the figures provided above, work out some detail as reference to advise Diman if his adhesive plant unit should purchase T-Bar inside or outside the Company? Given that Diman is new, his decision will likely start from the standpoint of the Company as a whole. (20 marks)
(B) When negotiate with T-Bar unit, what’s the most appropriate transfer price? (20 marks)
(C) If the T-Bar unit had a capacity of 30,000 barrels per month to deal with both internal and external sales, what will the situation be? (20 marks)
Explanation / Answer
Analysing this issue, we have reached certain points.
1. There is n outside supplier whose providing the barrels at the rate of 150 per barrel
2. There is a diiference the market price and the internal pricing.
3. the difference in presenting these, is due to short term pricing strategy.
As mentioned certain questions are raised.
(A) With the figures provided above, work out some detail as reference to advise Diman if his adhesive plant unit should purchase T-Bar inside or outside the Company? Given that Diman is new, his decision will likely start from the standpoint of the Company as a whole. (20 marks)
here, the decision can be affected by various factors, first of its not specific for the product as we need to think company as a whole and secondly to follow the startegy of goal congurance we require the capacity more than EOQ can only be achieved when we re getting the same product at a lesser rate.
While, analysing the process-
we can see that outside the product is sold at a lower price and it will save a cost for 1.50.000. Also the variable cost is presumed to be similar as there is no additional chnage in the product but the functionality and materila is same. While internal transfer pricing will let him to buy the barrels at a quite higher rate than the market price. Although the production unit of the plant is gaining the lead but from the buyer's persepctive the price is quite high at a difference of 10%.
(B) When negotiate with T-Bar unit, what’s the most appropriate transfer price?
the unit is working at below capacity , hence this means there is no opportunity cost of selling internally since no outside sales are forgone as a result of the transaction.
Transfer price-
Differential cost to selling division + Opportunity cost of selling internally
90 per barrel + 0
Opportunity cost is zero since no outside sales are forgone as a result of making this internal sale.
(C) If the T-Bar unit had a capacity of 30,000 barrels per month to deal with both internal and external sales, what will the situation be?
if the T bar unit has a capacity of producing above the capacity then it can fulfill the needs. and accordingly the fixed cost can be utilised to the fullest and also the selling cost can be submerged to the full. Also the goal congurence can be achieved well so that it can definitly meet the requirement of excessive demand.
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