Question

Charlotte Manufacturing makes and distributes small prefabricated homes in kits. The kits contain all pieces needed to assemble the home. All that is required is that the builder erects the home on a foundation.

Charlotte Manufacturing is organized into two divisions: the manufacturing division and the sales division. Each division is evaluated on the basis of its reported profits. The transfer price between the manufacturing division, where the kits are made, and the selling division, which sells the kits, is variable cost plus 6 %, a total of about $63,600. The selling price per kit is about $71,600 and selling and distribution costs are about $3,500 per home kit.

The total costs that do not vary in proportion with volume at Charlotte Manufacturing amount to about $5,500,000 per year: about $4,125,000 in manufacturing and about $1,375,000 in the selling division. The company is currently operating at capacity, which is dictated by the machinery in the manufacturing division. Each kit requires about 44 hours of machine time, and the total available machine time is

11, 000 hours per year. Charlotte Manufacturing is making and selling about 2,750 kits per year. Increasing the plant capacity is not a viable option in the foreseeable future.

Willie Scott is the firm's salesperson. Willie has been approached a number of times recently by people wanting to buy cottages to erect on recreational properties. The cottages would be made by modifying the existing home product. The modification process would begin with a completed home kit. The manufacturing division would then incur additional materials and labor costs of $2,200 and eight

hours of machine time to convert a home kit into a cottage kit.

Willie is proposing that the company split the sales division into two divisions: home sales and cottage sales. The new divisional structure would have no effect on existing administrative, personnel, or selling costs.

Requirement

Suppose the new division is created. Discuss the issues in choosing a transfer price in this situation. What transfer price for each of the two products, home, and cottage kits, would you recommend and why? (If you feel that the appropriate transfer price for each product can be within a range, specify the range.)

Answer 1

TOTAL MACHINE HOURS	11000
EACH REQUIRE	44 HOURS
EXISTING PRODUCTION	11000/44
	250
TOTAL	63600	PER KIT
VARIABLE COST (63600/106%)	60000	240
CONTRIBUTION CHARGED	3600	14.4
MACHINE HOURS	11000	44
PER MACHINE HOUR	0.327272727
EXISTING VARIABLE COST	240
ADDITIONAL LABOR AND MATERIAL COST	2200
CONTRIBUTION LOSS ON 8 MACHINE HOURS	2.618181818
TOTAL VARIABLE COST	2442.618182
CHARGE CONTRIBUTION 6% AS PER EXISTING POLICY	146.5570909
TRANSFER PRICE	2589.175273