Question

AAB Company has two divisions, Brown and Green. Brown makes a product W1 which is used by Green to manufacture W2. Brown can also process W1 further and sell it to outsiders for $30/unit.

Brown’s variable cost to make a unit of W1 is $20 and the further processing cost if sold to outsiders is $5/unit.

Green’s cost to process W1 into W2 is $6/unit and Green can sell all the W2 it can produce for $40/unit.

Required: Answer the following independent questions.

1. If Brown is operating below capacity, what is the lowest transfer price that Brown will accept to sell W1s to Green?

2. If Brown is operating at full capacity (can sell all of the W1s produced to outsiders), what is the lowest transfer price that Brown will accept to sell W1s to Green?

Brown can make 500,000 units of W1 but can only sell 300,000 of the W2s resulting from further processing to outsiders. The transfer price for Brown to sell units to Green is set by AAB at $22 per unit. Green will take as many units of W1 as Brown can deliver and has no other source for W1.

3. Calculate the contribution margin of Brown and Green in this scenario.

4. Recalculate the contribution margin of Brown and Green if the transfer price is set at $20 per unit. What difference does it make to the various parties (AAB, Brown and Green) whether the transfer price is $22 or $20? Explain your answer.

Answer 1

Difference to various parties in the last part is as follows:-

For Brown:-

If transfer price is 22 $ then contribution per unit = $ 3.8

If transfer price is 20 $ then contribution per unit = $ 3

Loss of contribution = 0.8

For Green:-

If transfer price is 22 $ then contribution per unit = $ 12

If transfer price is 20 $ then contribution per unit = $ 14

Additional Contribution = $ 2

For further calculation please refer uploaded notes;