QUESTION 1 [43 MARKS]

Kasko (Pty) Ltd (“Kasko”) produces flour and bread from two separate divisions namely; the flour
division, and the bakery division. Both divisions are profit centres. The company was established in
1989 in Durban. The financial year end of Kasko is 31 July.

Performance evaluation

Each division has one manager responsible for overseeing its operations. Kasko determines the bonus
of each manager using the following formula: Bonus = Profit after tax (PAT) x 20%. If the profit after
tax of the division is negative (i.e., the division makes a loss) no bonus will be paid. The bonuses are
only payable if the manager of the division is in the employ of Kasko at the end of the financial year.
Bonuses are paid at the end of September.

Fixed costs

The following are the fixed costs incurred by Kasko (the company as a whole). The costs are currently
allocated to each division based on the revenue of each division.

Fixed costs Notes R

Water and electricity 1 700 000
Indirect labour 2 550 000
Depreciation 3 345 000
Sales and marketing costs 4 247 500
Other manufacturing overheads 765 000
2 607 500
Notes

1. Water and electricity refers to actual municipal water and electricity expense. Upon research of the
water and electricity needs of each division, management determined that 63% of the water and
electricity expensed was actually used by the bakery division.

2. The indirect labour relates to the salaries of two bakers who work in the bakery division and are
paid R200 000 and R350 000 each per annum.

3. Depreciation relates to the total depreciation of machinery in both divisions. Information about the
cost and useful life of machinery in each division is readily available.

4. Sales and marketing costs are incurred by the head office in the Durban CBD in relation to selling
and advertising both flour and bread.

Transfer pricing between the flour and bakery divisions

Flour is the main ingredient in the production of bread, the only product of the bakery division. The
bakery division currently buys its flour from an external supplier at a price of R16 per kilogram. The
bakery division is currently considering buying its flour from the flour division. As such, management
has decided to implement a transfer pricing scheme but are unsure how this could be determined.
 TUTORIAL QUESTION 1 2022

Flour Division

The flour division only produces cake flour. There are currently no abnormal losses in the production
process. The cost structure per unit (i.e., 1 kilogram of flour) is as follows:

Cost per unit Notes R

Wheat 2,8
Additives 0,7
Direct labour 1 ?
Packaging and branding 2 0,7
Manufacturing overheads 3 4
Commission on sales 1,3

1. All resources used in the production of flour are sufficiently available and may be assumed to not
be constrained except for direct labour which is limited to 25 000 hours per annum. The labourers
take 3 minutes per unit on average and are paid R25 per hour. No overtime is possible because of
labour law restrictions.

2. Flour is packaged in small branded plastic pouches made from laminated several plastic layers.
This makes a barrier against factors like sunlight, air, moisture and germs. The packaging will not
be required if the flour is transferred internally.

3. Manufacturing overheads are mixed in nature. Fixed manufacturing overheads are allocated to
products (units) based on the number of labour hours. Management has correctly determined the
fixed manufacturing overhead rate to be R20 per hour.

There is heightened competition in the industry and as such, consumers are very sensitive to price
changes. The prices set usually influence the demand levels. Management of the flour division
estimated the following demand levels at different prices per unit.

Selling price R10 R11,5 R12 R13,5 R14

Demand 520 000 500 000 440 000 380 000 300 000

Bakery Division

The bakery division produces white loaves of bread and sell them for R18 each. The demand is
expected to be 340 000 loaves of bread for the year ending 31 July 2022 (FY2022). The cost structure
for one loaf of bread is expected to be as follows:

Cost per loaf Notes R

Flour 1 ?
Labour 2 ?
Eggs, milk, salt and sugar 2
Other ingredients 1,2
Fixed costs ?

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 TUTORIAL QUESTION 1 2022

1. One loaf of bread requires 500 grams of flour.

2. The bakery division uses wage labourers who are paid R25 per hour. Each loaf of bread on average
requires 6 minutes of the labourers’ time. This amount excludes the salaries of the two bakers.

REQUIRED [43 MARKS]

MARKS
Ignore any VAT implications Sub- Total
total
(a) Recommend an appropriate range of transfer prices per kilogram of flour
between the flour and bakery divisions. Structure your solution as follows:

• Calculation of the minimum transfer price the flour division should charge 13
the bakery division.
• Calculation of the maximum transfer price the bakery division will be willing 6
to pay for the flour.
Communication skills – layout and structure 1 20

(b) Critically evaluate the current performance evaluation system implemented by

Kasko (Pty) Ltd. 10

Please ignore the information under the heading Fixed costs ONLY

Communication skills – logical argument and clarity of expression 1 11

(c) Critically comment on the current allocation of the fixed costs to each division
of Kasko (Pty) Ltd. 9 9

(d) Discuss the objectives of an ideal transfer pricing system. 3 3

TOTAL 43

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