Question

The Parts Division of Nydron Corporation makes Part Y6P, which it sells to outside companies for $17.00 per unit. According to the cost accounting system, the costs of making one unit of Part Y6P consist of $7.00 for direct materials, $3.00 for direct labor, $4.50 for variable manufacturing overhead, and $1.20 for fixed manufacturing overhead. The Parts Division has enough idle capacity to make 1,000 units of Part Y6P each month. The Assembly Division of Nydron Corporation can use Part Y6P in one of its products. At present, the Assembly Division is purchasing an equivalent part from an outside supplier for $16.85 per unit. The Assembly Division needs 2,000 units of the part each month. It has been suggested that the Assembly Division buy Part Y6P from the Parts Division instead of buying the equivalent part from the outside supplier.

Answer 1

Lost outside sales = 1,000 units

Variable cost per unit = $7.00 per unit + $3.00 per unit + $4.50 per unit = $14.50 per unit

Contribution margin per unit = $17.00 per unit – $14.50 per unit = $2.50 per unit

From the perspective of the selling division, profits would increase as a result of the transfer if and only if:

Transfer price > Variable cost per unit + Opportunity cost per unit

Transfer price > Variable cost per unit + (Total contribution margin on lost sales ÷ Number of units transferred)

Transfer price > $14.50 per unit + [($2.50 per unit × 1,000 units) ÷ 2,000 units] = $15.75 per unit

From the perspective of the purchasing division, the transfer is financially attractive if and only if:

Transfer price < Cost of buying from outside supplier

Transfer price < $16.85 per unit

$15.75 per unit < Transfer price < $16.85 per unit.

Thanks