Question

In each of the cases below, assume that Division X has a product that can be sold either to outside customers or to Division Y of the same company for use in its production process. The managers of the divisions are evaluated based on their divisional profits. Case A B Division X: Capacity in units 94,000 100,000 Number of units being sold to outside customers 94,000 80,000 Selling price per unit to outside customers $51 $25 Variable costs per unit $23 $13 Fixed costs per unit (based on capacity) $9 $6 Division Y: Number of units needed for production 20,000 20,000 Purchase price per unit now being paid to an outside supplier $47 $26

1-a. Refer to the data in case A above. Assume in this case that $1 per unit in variable selling costs can be avoided on intracompany sales.

1-b. If the managers are free to negotiate and make decisions on their own, will a transfer take place?

2-a. Refer to the data in case B above. In this case, there will be no savings in variable selling costs on intracompany sales. Determine the transfer price of the selling division.

Answer 1

PART – 1-a)

Relevant variable cost = Variable cost – Avoidable cost

                                     = $23 – $1

                                     = $22

Loss of contribution margin = Sale price – Variable cost

                                              = $51 – $23

                                              = $28

Transfer price = Relevant variable cost + Loss of contribution margin

                       = $22 + $28

                       = $50

Total transfer price for 20,000 units to Division Y = $50*20,000

                                                                                 = $1,000,000

PART – 1-b)

If managers are free to negotiate then transfer will not take place as the manager of Division B is getting purchase option at $47 from outside while the internal transfer from Division A will cost $50 which is costly. Thus, transfer will not take place.

PART – 2-a)

If there is no saving in the variable cost for intercompany transfer then there will be no loss of the contribution margin and thus the transfer price will be equal to the variable cost only.

Thus,

Transfer price = $13

Total transfer price for 20,000 units to Division B = $13*20,000

                                                                                = $260,000