Question

Kelowna Company has two divisions, A and B. Division A manufactures 12,000 units of product per month. The cost per unit is calculated as follows.

Variable costs	$	10
Fixed costs		20
Total cost	$	30

Division B uses the product created by Division A. No outside market for Division A’s product exists. The fixed costs incurred by Division A are allocated headquarters-level facility-sustaining costs. The manager of Division A suggests that the product be transferred to Division B at a price of at least $30 per unit. The manager of Division B argues that the same product can be purchased from another company for $26 per unit and requests permission to do so.

Required

1. a-1. How much would the division gain or lose if Division B were to purchase the product from the outside company for $26 per unit?

2. a-2. Is it in the best interest of Kelowna Company for Division B to purchase the product from an outside company?

Answer 1

Dear, the main thing to talk about is fixed cost here, which was being allocated from head-quarters that means it will continue to occur even if the division shuts.

1) In this case if the company purchases from outside , the fixed cost will still occur so, it will cost the company at $ 46 i.e 26+20 but it was being transferred from division A at $30 so it will be a loss to the company of $16 per unit.

2) As it is clarified from the above point, it is not in favour of company to purchase from outside rather they should continue their production of Division A.