Question

Question 5

Division A, which is operating at capacity, produces a component that currently sells in a competitive market for $44 per unit. At the current level of production, the fixed cost of producing this component is $12 per unit and the variable cost is $17 per unit. Division B would like to purchase this component from Division A. The price that Division A should charge Division B for this component is:

Multiple Choice

• $17 per unit.

• $29 per unit.

• $36 per unit.

• $44 per unit.

• $61 per unit.

Selected data from Division A of Green Company are as follows:

Sales	$	620,000
Average investment	$	198,400
Operating income	$	99,200
Minimum rate of return		18	%

Division A's residual income (RI) is:

Multiple Choice

• $63,488.

• $30,256.

• $27,776.

• $17,856.

• $292,144.

Answer 1

Question 5

Answer - The price that Division A should charge Division B for this component is $44 per unit

Explanation - As Division A is operating at full capacity and produces a component that is selling in a competitive market for $44 per unit. In a competitive market, if the division is working at capacity, then products are transferred at market price but If the division has idle capacity, then transfer price is on the variable cost of production.

If it provides this component below this price to division B, it is opportunity loss for division A because it is working at full capacity.

Hence, Tranfer Price (At Full Capacity) = Variable Price + Opportunity Loss = $17 + ( $44 - $17) = $44
                                

Division A's residual income (RI)

Minimum Required Operating Income = Average Operating Assets x Minimum Rate of Return
                                          = $198400 x 18%
                                                 = $35,712

Residual income = Actual Operating Income - Minimum Required Operating Income
                            = $99,200 - $35,712
                            = $63,488