Question

Johnson Furnace Mfg., manufactures residential furnaces. Currently the Electric Components Division is selling its entire capacity of 40,000 electric motors in the external market. The following information is available from the Electric Components Division regarding the selling price and the cost to manufacture and distribute one motor in the external market:

External selling price per motor............................................ $90

Direct material cost per motor ............................................ $28

Direct labor cost per motor ………………………….……. $12

Variable manufacturing overhead per motor ……………... $ 4

Allocated fixed manufacturing overhead costs per motor..... $16

Variable marketing and distribution cost per motor……….. $ 8

The Furnace Division has been purchasing 12,000 motors annually in the external market for $88 per motor. Seventy five percent of the variable marketing and distribution cost will not be incurred by the Electric Components Division on internal transfers.

1. If the Furnace Division wants to purchase 12,000 motors from the Electric Components Division, what would be the minimum transfer price per motor.

2. What would be the maximum transfer price per motor?

3. What would be the total impact on overall company profitability if the two divisions negotiate a transfer price of $85 and the motors are transferred internally?

Answer 1

Answer 1:

Minimum transfer price per motor: $ 84

Calculation:

Material cost	$                  28.00
Labor cost	$                  12.00
Variable manufacturing O/H	$                    4.00
Fixed manufacturing O/H	$                        -
Variable marketing costs (8*25%)	$                    2.00
Add: Contribution lost (90-28-12-4-8)	$                  38.00
Minimum Transfer price	$                  84.00

Answer 2:

Maximum transfer price per motor: $ 88

Explanation:

This is because the amount paid by Furnace department in external market is $ 88.

Answer 3:

Total impact on overall company profitability if the two divisions negotiate a transfer price of $85 and the motors are transferred internally = $ 48,000.

Calculation:

Benefit to Electric division: $ 1 * 12000 = $ 12,000

Benefit to Furnace department = $ 3 * 12000 = $ 36,000.

Total benefit = 12000 + 36000 = $ 48,000.

In case of any doubt, please comment.