Question

ABC Unicycle makes unicycles and has two divisions.  Each division is evaluated as a profit center.

The Wheel division, located in Nambia, produces unicycle wheels and can choose to sell wheels on either the open market at $30 per wheel, or sell them to the Assembly division.

The Assembly division, located in Elbonia, assembles unicycles and can choose to either buy wheels from the Wheel division or purchase wheels on the open market.

             Wheel            Assembly

Cost per unit                                                  Division          Division

Direct Labour                                                $2.00                 $6.00

Variable Materials                                           3.00                   7.00

Variable Overhead Costs                                4.00                   8.00

Fixed Overhead Costs*                                   5.00                   9.00

Other information

Maximum capacity                                        2,000              3,000

Current production volume                         1,800              2,600

Income tax rate                                               30%                10%

(* Fixed overhead costs are based on current production volumes)

The Assembly division would like to purchase an additional 400 wheels from the Wheel division. Total fixed costs would not be affected by the sale of these 400 wheels to the Assembly Division.

Required:

1. What is the likely range of transfer prices between the Wheel Division and Assembly Division?
2. What transfer price per unit would the Head Office prefer for the additional sale of 400 wheels, given that tax authorities will accept any of the following transfer prices
   1. Variable Cost
   2. Variable Cost +20%
   3. Market price

Answer 1

Solution :

Calculation showing contribution per unit of Wheel Division
Particulars	Amount ($)
Sales	30
Less : Direct Labour	2
Less : Variable Material	3
Less : Variable Overhead Costs	4
Contribution Per Unit	21
Solution to A.
Alrernative 1
If wheel division is willing to supply 400 wheels from the existing production capacity without increasing the production capacity to 100 %, then -
The Transfer price per unit will be $ 30.00 being the variable cost ($ 9 per unit) for producing unicycle wheel and the contribution lost on 400 units @ of $ 21 per unit by Wheel Division due to transfer to internal Division.
Alrernative 2
If wheel division is willing to supply 400 wheels by increasing the production capacity to 100 %, then -
The Transfer price per unit will be $ 19.5 being the variable cost ($ 9 per unit) for producing unicycle wheel and the contribution lost on 200 units @ of $ 10.5 {(200*21)/400} per unit by Wheel Division due to transfer to internal Division.
Solution to B
The Transfer Price that Head Office would prefer for the additional sale of 400 Wheels is the variable cost incurred for producing the Unicycle wheel.