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BUSI 1005 Tutorial 10 – Responsibility Accounting and Transfer Pricing Question 1 Pella Company has several independent divisions. The company's Compressor Division produces a high-quality compressor that is sold to various users. The division's income statement for the most recent month, in which 500 compressors were sold, is given below: Total Unit Sales $125,000 $ Less cost of goods sold 75,000 150 Gross margin 50,000 100 Less selling and administrative expenses 30,000 60 Divisional net operating income $ 20,000 $ As shown above, it costs the division $150 to produce a compressor. This figure consists of the following costs: Direct materials $ 50 Direct labour: 4 hours x $15 60 Manufacturing overhead (50% fixed) : 4 hours x $10 40 Total cost $ The division has fixed selling and administrative expenses of $25,000 per month and variable selling and administrative expenses of $10 per compressor. The capacity of the division is limited to 2,500 hours per month. Another division of Pella Company, the Home Products Division, uses compressors as a component part of air-conditioning systems that it installs. The Home Products Division has asked the Compressor Division to sell it 120 compressors each month of a somewhat different design. The Compressor Division has estimated the following cost for each of the new compressors: Direct materials $ 60 Direct labour: 6 hours x $15 90 Manufacturing overhead: 6 hours x $10 60 Total cost $ All variable selling and administrative expenses could be avoided on the intracompany business. Required: a. Determine the lowest acceptable transfer price from the perspective of the Compressor Division for the new compressor.
b. Suppose the Home Products Division has found an outside supplier that will provide the new compressors for only $200 each. If the Compressor Division meets this price, what will be the effect on the profits of the company as a whole? c. Assume that the possibility of purchasing compressors externally for $200 no longer exists, but an external supplier has been found that can supply the compressors for $260. Armed with this information, the manager of the Home Products Division is able to negotiate a transfer price of $245. Calculate the impact on operating income of each division of this transaction. Question 2 Strutt Company, which manufactures robes, has enough idle capacity available to accept a special order of 10,000 robes at $8 a robe. A predicted income statement for the year without this special order is as follows: Per Unit Total Sales revenue $12.50 $1,250, Manufacturing costs: Variable 6.25 625, Fixed 1.75 175, 8.00 800, Gross profit 4.50 450, Marketing costs: Variable 1.80 180, Fixed 1.45 145, 3.25 325, Operating profit $ 1.25 $125, If the order is accepted, variable marketing costs on the special order would be reduced by 25 percent because all of the robes would be packed and shipped in one lot. However, if the offer is accepted, management estimates that it will lose sales of 2,000 robes at regular prices. Required – What is the net gain or loss from the special order?
Question 2 CM per unit for regular robes = $12.50 Sales^ – 6.25 Var Manufacturing^ – 1.80 Var^ Marketing^ = $4.45 2 marks CM per unit for special order = $8. Sales
Var Manufacturing - 1. Var Marketing = $0.40 2 marks Total CM on special order: 10,000 x $0.40 1 mark^ $4, Total CM lost on regular sales: 2,000 x $4.45 1 mark^ (8,900) Incremental operating income if special order is accepted ($4,900)
