Question

15-36. Evaluate Profit Impact of Alternative Transfer Decisions

Amazon Beverages produces and bottles a line of soft drinks using exotic fruits from

Latin America and Asia. The manufacturing process entails mixing and adding juices and

coloring ingredients at the bottling plant, which is a part of Mixing Division. The finished

product is packaged in a company-produced glass bottle and packed in cases of 24 bottles

each.

Because the appearance of the bottle heavily influences sales volume, Amazon developed

a unique bottle production process at the company’s container plant, which is a part of Con-

tainer Division. Mixing Division uses all of the container plant’s production. Each division

(Mixing and Container) is considered a separate profit center and evaluated as such. As the

new corporate controller, you are responsible for determining the proper transfer price to use

for the bottles produced for Mixing Division.

At your request, Container Division’s general manager asked other bottle manufacturers

to quote a price for the number and sizes demanded by Mixing Division. These competitive

prices follow:

Volume Total Price Price per Case

400,000 equivalent cases a . . . . . . $2,880,000 $7.20

800,000 . . . . . . . . . . . . . . . . . . . . .   5,000,000 6.25

1,200,000 . . . . . . . . . . . . . . . . . . .   6,480,000 5.40

a An equivalent case represents 24 bottles.

Container Division’s cost analysis indicates that it can produce bottles at these costs:

Volume Total Cost Cost per Case

400,000 equivalent cases . . . . . . $2,400,000 $6.00

800,000 . . . . . . . . . . . . . . . . . . . .   4,000,000    5.00

1,200,000. . . . . . . . . . . . . . . . . . .   5,600,000    4.67

These costs include fixed costs of $800,000 and variable costs of $4 per equivalent case.

These data have caused considerable corporate discussion as to the proper price to use in the

transfer of bottles from Container Division to Mixing Division. This interest is heightened

because a significant portion of a division manager’s income is an incentive bonus based on

profit center results.

Mixing Division has the following costs in addition to the bottle costs:

Volume Total Cost Cost per Case

400,000 equivalent cases . . . . . . $1,800,000 $4.50

800,000 . . . . . . . . . . . . . . . . . . . .   2,600,000 3.25

1,200,000. . . . . . . . . . . . . . . . . . .   3,400,000 2.83

The corporate marketing group has furnished the following price–demand relationship

for the finished product:

Total Sales Sales Price

Sales Volume Revenue per Case

400,000 equivalent cases . . . . . . $ 8,000,000 $20

800,000 . . . . . . . . . . . . . . . . . . . . 14,400,000 18

1,200,000. . . . . . . . . . . . . . . . . . . 18,000,000 15

Required

a. Amazon Beverages has used market price–based transfer prices in the past. Using the

current market prices and costs and assuming a volume of 1.2 million cases, calculate

operating profits for:

(1) Container Division.

(2) Mixing Division.

(3) Amazon Beverages.

b. Is this production and sales level the most profitable volume for:

(1) Container Division?

(2) Mixing Division?

(3) Amazon Beverages?

Explain.

Answer 1