Question

Problem 15-44 (Algo) Analyze Transfer Pricing Data (LO 15-2)

Elsinore Electronics is a decentralized organization that evaluates divisional management based on measures of divisional contribution margin. Home Audio (Home) Division and Mobile Electronics (Mobile) Division both sell electronic equipment, primarily for video and audio entertainment. Home focuses on home and personal equipment; Mobile focuses on components for automobile and other, nonresidential equipment. Home produces an audio player that it can sell to the outside market for $72 per unit. The outside market can absorb up to 89,000 units per year. These units require 3 direct labor-hours each.

If Home modifies the units with an additional hour of labor time, it can sell them to Mobile for $81 per unit. Mobile will accept up to 77,000 of these units per year.

If Mobile does not obtain 77,000 units from Home, it purchases them for $84 each from the outside. Mobile incurs $36 of additional labor and other out-of-pocket costs to convert the player into one that fits in the dashboard and integrates with the automobile’s audio system. The units can be sold to the outside market for $204 each.

Home estimates that its total costs are $1,090,000 for fixed costs, $14.40 per direct labor-hour, and $7.20 per audio player for materials and other variable costs besides direct labor. Its capacity is limited to 375,000 direct labor-hours per year.

Required:

Determine the following:

a. Total contribution margin to Home if it sells 89,000 units outside.

b. Total contribution margin to Home if it sells 77,000 units to Mobile.

(c) & (d). The costs to be considered in determining the optimal company policy for sales by Home.

The annual contributions and costs for Home and Mobile under the optimal policy.

Answer 1

A)	To outside market
		Particular		Amount
		Sales	89,000*72	6,408,000
	Less:	Direct Labour hour	3*89,000*14.40	3,844,800
	Less:	Material and other variable cost	7.20*89,000	640,800
		Contribution		1,922,400
	Direct Labour Hours at 89,000 units are 2,67,000 hours (89,000*3) i.e. less than maximum capacity of 3,75,000.
B)	To Mobile Division
		Particular		Amount
		Sales	77,000*81	6,237,000
	Less:	Direct Labour hour	4*77,000*14.40	4,435,200
	Less:	Material and other variable cost	7.20*77,000	554,400
		Contribution		1,247,400
	Direct Labour Hours at 77,000 units are 3,08,000 hours (77,000*4) i.e. less than maximum capacity of 3,75,000.
C)		Particular		Amount
		Incremental contribution if sold to outside market	1,922,400-1,247,000	675,000
	Less:	Incremental cost if sold to outside market	77,000*3	231,000
		Incremental contribution		444,000
	The costs to be considered in determining the optimal company policy for sales by Home are incremental Direct Labour hour cost of 14.40 per hour per unit and incremental cost that Mobile Division will have to incur if purchased from outside market i.e. 3 (84-81).
	It is advisable in the overall interest of the Company to purchase audio players for Mobile Division from outside market due to overall increment in Contribution of the Company.
D)		Particular	Home	Mobile
		Sales	6,408,000	15,708,000
			(89,000*72)	(77,000*204)
	Less:	Direct Labour hour	3,844,800	2,772,000
			(89,000*3*14.4)	(77,000*36)
	Less:	Material and other variable cost	640,800	6,468,000
			(89,000*7.2)	(77000*84)
		Contribution	1,922,400	6,468,000