Question

Case Study
Me-n-U is a very successful hamburger chain located in Florida. One of the main reasons why customers love this burger chain is because of the freshness and the unique taste of the hamburger patties offered by this food establishment.
Me-n-U buys its hamburger patties from a special farm called Lux Living Farm located in Vermont. The cows on this farm receive daily massages and are fed beer instead of water. They are also allowed to roam free over 100 acres of land. These factors contribute to the tenderness of the meat.   Worried that this farm will sell its beef to another customer, Me-n-U bought the farm so it would have exclusive rights and access to all of the wonderful beef. In the past, Lux Living Farm charged Me-n-U $25 per pound:

Variable cost per pound $10
Fixed cost per pound $ 10
Markup 5   
Total price = $25

Questions:
1. How should the sale from Lux Living Farm to its parent company, Me-n-U be reported on the consolidated income statement and the stand-alone income statements?
2. What price should be set?
3. Do you agree with the decision in buying the farm? Why or why not?

Incorporate managerial accounting concepts such as opportunity costs, sunk cost, and out-of-pocket costs in your answers. Also, think about how your answers will impact non-controlling interest if present.

Answer 1

Ans 1.

In consolidated financial statement, all the inter-company transactions are completely removed and hence, no such sale and purchase should be reported. In stand-alone financials, sales shall be reported at $25 per pound of beef sold, i.e., at actual transaction price.

Ans 2.

The minimum transfer price, acceptable for Lux Living Farm would be opportunity cost which is $25 per pound, i.e., the market price for the beef produced. It is also mentioned that Lux Living Farm could sell its products to outside customers, if  Me-n-U does not take over.

However, if Lux Living Farm has the option of selling it products to outside customers as well as it has surplus capacity, then, the minimum transaction price would be variable / out of pocket cost, i.e., $10 per pound of beef.

Ans 3.

The decision to take over the Farm is justified as, Lux Living Farm is the primary source for the supply of Me-n-U. Also, if Lux Living Farm supplies to outsiders, then, business interest of Me-n-U will be endangered. Hence, it is wise decision to take over the Farm.

Non-controlling interest would not be affected if the transfer price is set at $25., i.e., at opportunity cost. Any price, less that this would impact the interest of the non-controlling interest adversly.