Question

In each of the cases below, assume Division X has a product that can be sold either to outside customers or to Division Y of the same company for use in its production process. The managers of the divisions are evaluated based on their divisional profits.

	Case
		A		B
Division X:
Capacity in units		91,000		98,000
Number of units being sold to outside customers		91,000		74,000
Selling price per unit to outside customers	$	57	$	31
Variable costs per unit	$	24	$	16
Fixed costs per unit (based on capacity)	$	8	$	6
Division Y:
Number of units needed for production		24,000		24,000
Purchase price per unit now being paid to an outside supplier	$	51	$	32

Exercise 11A-3 (Algo) Part 2

2. Refer to the data in case B above. In this case, there will be no savings in variable selling costs on intracompany sales.

a. What is the lowest acceptable transfer price from the perspective of the selling division?

b. What is the highest acceptable transfer price from the perspective of the buying division?

c. What is the range of acceptable transfer prices (if any) between the two divisions? If the managers are free to negotiate and make decisions on their own, will a transfer probably take place?

Answer 1

1. Division X is the Seller. Division X does indeed have enough excess capacity to fulfill Division. Y’s requirements.

Therefore, there are no lost sales to the outside world, and the lowest acceptable price as far as the selling division is concerned is the variable cost of $20 per unit.

Transfer price for Seller = $16 + ($0/240,000)/ $16 + $0 = $16.

2. Division Y is the Buyer. Division Y can purchase a similar unit for $32 from an outside supplier, and $32 is the Buyer’s maximum price.

Transfer price for Buyer = Cost of buying from outside supplier = $32.

In this case, the requirements of the two divisions are compatible.

3. A transfer in the range of: $16 to $32 is plausible.

The transfer shall take place since division enough spare capacity = 98,000 – 74,000 = 24,000 to meet internal requirements of division Y.