Question

Kelowna Company has two divisions, A and B. Division A manufactures 12,000 units of product per month. The cost per unit is calculated as follows.

Variable costs	$	10
Fixed costs		20
Total cost	$	30

Division B uses the product created by Division A. No outside market for Division A’s product exists. The fixed costs incurred by Division A are allocated headquarters-level facility-sustaining costs. The manager of Division A suggests that the product be transferred to Division B at a price of at least $30 per unit. The manager of Division B argues that the same product can be purchased from another company for $26 per unit and requests permission to do so.

1. a-1. How much would the division gain or lose if Division B were to purchase the product from the outside company for $26 per unit?

Answer 1

If the units are not produced by Division A, it would not incur any Variable cost. But the fixed cost will be incurred. Total fixed cost incurred by division A = $20 X 12,000 = $240,000

Division A will lose $240,000