1.The company (PH) should not discontinue either of the units as the high profit witnessed in Construction is owing to the low profitability and losses that the prefabrication and construction division are witnessing. By discontinuing one or both of the divisions, the sourcing of the prefabricated components and relevant transportation would be from an outside vendor which may charge a higher price since it would not run the operations in loss (Heisinger, 2014). This premise is being made on the assumption that the operations of prefabrication and construction are efficient. It seems that the current crisis may be attributed to the transfer not being at arm’s length thereby lowering the revenue realisation. On the other hand, if there are efficiency issues with the prefabrication and construction, then the same should be fixed and only in the event of these issues not being fixed should an outside vendor be explored (Bhimani et. al., 2017).
2. The operating income for the various divisions is highlighted in the table below.
In the above computation, the revenues for prefabrication and transportation have been computed with the price of $ 60,000 and $ 90,000 per house respectively. The cost of goods sold has been adjusted for the transportation and construction based on the revenue of the respective previous divisions. It is apparent from the above computation that for 2008, all the three divisions are making profits.
3.If PH allowed the divisions to negotiate their own prices, then it may so happen that the optimum quantity may not be produced and also the transfer price may not be equal to the market price and may be above or lower the market price. This is because each of the division would be concerned with showing profits so as to highlight the need for the division to be continued. Hence, decision making may be driven by interests of the respective division rather than the organisation as a whole. This may have adverse impact on the business profitability in the long run (Drury, 2016).
4.If the transfer price forced is lower at $ 75,000 instead of $ 90,000, then there would be an adverse impact on the profits of the transportation division whereas the profitability of the construction division would increase. This is because there is underreporting of revenues for the transportation division along with lower cost of goods sold for the construction division. Under such a scenario, it is likely that the production quantity by construction would be lower than the optimum quantity so as minimise the losses (Emmauel & Otley, 2015).
Bhimani, A., Horngren, C.T., Datar, S.M. and Foster, G. (2017), Management and Cost Accounting 4th ed. Harlow: Prentice Hall/Financial Times
Drury, C. (2016) Cost and Management Accounting: An Introduction. 6th ed. New York: Cengage Learning
Emmauel, R.C. & Otley, T.D. (2015) Accounting for Management Control. 8th ed. London: Cengage Learning.
Heisinger, K.(2014) Essentials of Managerial Accounting 4th ed. London: Cengage Learning.