Question

Garcon Inc. manufactures electronic products, with two operating divisions, Consumer and Commercial. Condensed divisional income statements, which involve no intracompany transfers and which include a breakdown of expenses into variable and fixed components, are as follows:

Garcon Inc.

Divisional Income Statements

For the Year Ended December 31, 20Y2

1		Consumer Division	Commercial Division	Total
2	Sales:
3	14,400 units × $144 per unit	$2,073,600.00		$2,073,600.00
4	21,600 units × $275 per unit		$5,940,000.00	5,940,000.00
5	Total sales	$2,073,600.00	$5,940,000.00	$8,013,600.00
6	Expenses:
7	Variable:
8	14,400 units × $104 per unit	$1,497,600.00		$1,497,600.00
9	21,600 units × $193* per unit		$4,168,800.00	4,168,800.00
10	Fixed	200,000.00	520,000.00	720,000.00
11	Total expenses	$1,697,600.00	$4,688,800.00	$6,386,400.00
12	Income from operations	$376,000.00	$1,251,200.00	$1,627,200.00

*$150 of the $193 per unit represents materials costs, and the remaining $43 per unit represents other variable conversion expenses incurred within the Commercial Division.

The Consumer Division is presently producing 14,400 units out of a total capacity of 17,280 units. Materials used in producing the Commercial Division’s product are currently purchased from outside suppliers at a price of $150 per unit. The Consumer Division is able to produce the materials used by the Commercial Division. Except for the possible transfer of materials between divisions, no changes are expected in sales and expenses.

	Required:
1.	Would the market price of $150 per unit be an appropriate transfer price for Garcon Inc.? Explain.
2.	If the Commercial Division purchases 2,880 units from the Consumer Division, rather than externally, at a negotiated transfer price of $115 per unit, how much would the income from operations of each division and the total company income from operations increase?
3.	Prepare condensed divisional income statements for Garcon Inc. based on the data in Requirement 2.
4.	If a transfer price of $126 per unit is negotiated, how much would the income from operations of each division and the total company income from operations increase?
5a.	What is the range of possible negotiated transfer prices that would be acceptable for Garcon Inc.?
5b.	Assuming that the managers of the two divisions cannot agree on a transfer price, what price would you suggest as the transfer price?

Answer 1

1.Since there is spare capacity in the consumer division, the acceptable tranfer prices are variable cost per unit - market price per unit
i.e. $104-$150
The transfer price should be set in between the two. However, $150 is an appropriate price
2.Income will increase as follows:
Consumer Division = (115-104)*2880 = $31,680
Commercial Division = (150-115)*2880 = $100,800
Company = $132,480
Garcon Inc.
Divisional Income Statements
For the Year Ended December 31, 20Y2
1		Consumer Division	Commercial Division	Total
2	Sales:	$2,404,800.00	$5,940,000.00	$8,344,800.00
6	Expenses:
7	Variable:	$1,797,120.00	$4,068,000.00	$5,865,120.00
10	Fixed	200,000.00	520,000.00	720,000.00
11	Total expenses	$1,997,120.00	$4,588,000.00	$6,585,120.00
12	Income from operations	$407,680.00	$1,352,000.00	$1,759,680.00
4.Income will increase as follows:
Consumer Division = (126-104)*2880 = $63,360
Commercial Division = (150-126)*2880 = $69,120
Company = $132,480
5a. Acceptable price $104-$150
5b. Will suggest midpoint i.e. $127 as transfer price