Question

Silicon Industries is a decentralized company with two divisions: mining and processing. They are both evaluated as profit centres. The mining division transfers raw diamonds to the processing division. The processing division is currently operating at 1 million kg below its capacity, while the mining division is operating at full capacity. The mining division can sell raw diamonds externally at $75 per kilogram. The unit cost of 1 kg of polished diamonds produced by the processing division is as follows: Raw diamonds $75, Direct materials $10, Direct labour ($20/hour) $30, Variable manufacturing overhead $20, Fixed manufacturing overhead $50, Total unit cost $185 The processing division has just received an order from International Diamonds Co. for 300,000 kg of polished diamonds at a price of $175 per kilogram. Silicon has a policy that prohibits selling any product below total cost. The total cost of a kilogram of raw diamonds in the mining division is $60, of which 25% is company fixed costs. Requirements (a) Would Silicon as a whole benefit if the raw diamonds were transferred to the processing division at $60 per kilogram to fill the order from International Diamonds? Show all calculations. (b) Briefly explain whether anything is wrong with Silicon's policy that no product should be sold below total cost. (c) Calculate the minimum and maximum transfer prices that could be used. (d) Recommend an appropriate transfer price for raw diamonds sold by the mining division to the processing division. Explain your answer. (e) If the mining division was not operating at full capacity, would your answer in part (d) be different?

Answer 1

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Part a	Yes
Raw Diamond Cost	Variable only	$         45
Direct Material		$         10
Direct Labor		$         30
Variable Manufacturing Cost		$         20
Total Cost		$       105
Sale Price		$       175
Part b
Yes, Since total cost is $ 185, however relevant cost is only $105.
Policy of not below total cost is not good for taking decision about acceptance of order.
Relevant cost actually should be considered
Part c
Minimum Transfer Price	60*75%	$         45
Maximum Transfer Price	Sale to external	$         75
Part d
Appropriate Transfer price		$         45
Part e	Yes
Relevant Variablce Cost		$         45
Add: Lost contribution	75-45	$         30
Appropriate Transfer Price		$         75