Question

E10-19 (Algo) Determining Minimum, Maximum, Negotiated Transfer Prices [LO 10-6]

Shaw is a lumber company that also manufactures custom cabinetry. It is made up of two divisions: Lumber and Cabinetry. The Lumber Division is responsible for harvesting and preparing lumber for use; the Cabinetry Division produces custom-ordered cabinetry. The lumber produced by the Lumber Division has a variable cost of $3.40 per linear foot and full cost of $4.40. Comparable quality wood sells on the open market for $10.20 per linear foot.

Required:
1. Assume you are the manager of the Cabinetry Division. Determine the maximum amount you would pay for lumber.
2. Assume you are the manager of the Lumber Division. Determine the minimum amount you would charge for the lumber if you have excess capacity. Repeat assuming you have no excess capacity.
3. Assume you are the president of Shaw. Determine a mutually beneficial transfer price assuming there is excess capacity.

Answer 1

Ans:

1.The maximum price the manager of the Cabinetry Division (the buyer) should pay is $10.20, the amount that could purchase the lumber in the open market.

2.If the Lumber Division has excess capacity, the minimum price equals the variable costs, i.e. $3.40.If the Lumber Division does not have excess capacity, the minimum price is the selling price in the open market i.e. $10.20.

3. A mutually benefit transfer price is between the minimum ($3.40) and maximum ($10.20). If it were set at $4.40, the divisions would receive benefits equally from internal transfer. The selling division makes $3.40 above variable costs ($4.40 - $3.40), whereas the buying division saves $3.40 in the open market price ($10.20 - $4.40).

Hope this helped ! Let me know in case of any queries.