Question

Johnston Chemical Company manufactures a wide variety of industrial chemicals and adhesives. It purchases much of its raw material in bulk from other chemical companies. One chemical, T-Bar, is prepared in one of Johnston’s own plants. T-Bar is shipped to other Johnston plants at a specified internal price. The Johnston adhesive plant requires 10,000 barrels of T-Bar per month and can purchase it from an outside supplier for $150 per barrel. Johnston’s T-Bar unit has a capacity of 20,000 barrels per month and is presently selling that amount to outside buyers at $165 per barrel. The difference between the T-Bar unit’s price of $165 and the outside firm’s T-Bar price of $150 is due to short-term pricing strategy only; the materials are equivalent in quality and functionality. The T-Bar unit’s selling cost is $5 per barrel, and its variable cost of manufacturing is $90 per barrel.Required: (a) From the perspective of Johnson as a whole, should the Mixing division purchase T-Bar from the T-Bar division within Johnson or from the external supplier? Use calculations to support your answer. (b) If internal transfer of T-Bar within Johnson was demanded by Johnson management for competitive reasons, what would the ideal transfer price be considering all of the different transfer-pricing options available to Johnson? Explain your answer with calculations. (c) How would your answer to (b) change, if at all, if the T-Baar division had capacity to make 30,000 barrels of T-Bar per month and external customers’ demand was for 20,000 barrels?

Answer 1

a) The mixing division is better to purchase from outside since the cost per barrel is less that is $150 which is less than $165.

b) If the internal transfer of T-bar within Johnston was demanded by Johnston management for competitive reasons, its production cost can be taken as the ideal transfer price i. e., $90

It can also have transfer price of (revenue less cost) that is (165-95) =$50

c) If the T-bar division had capacity to make 30,000 barrels of T-bar per month and external customer's demand was for 20,000 barrels, it is okay to have a internal transfer price and sale to the adhesive mixing division since 10,000 barrels are left with the Johnston chemical company.