Question

The Jordan Company manufacturers only one type of shoe and has two divisions, the Sole Division and the Assembly Division. The Sole Division manufactures soles and then "sells" them to the Assembly Division, which completes the shoes and sells them to retailers. The market price for the Assembly Division to purchase a pair of soles is $40. Fixed costs are per pair at 100,000 units.

Sole's costs per pair of soles are:
Direct materials	$8
Direct labor	$6
Variable overhead	$4
Division fixed costs	$2
Assembly's costs per completed pair of shoes are:
Direct materials	$10
Direct labor	$2
Variable overhead	$2
Division fixed costs	$18

Calculate and compare the difference in overall corporate net income between Scenario A and Scenario B if the Assembly Division sells 100,000 pairs of shoes for $120 per pair to customers.
Scenario A: Negotiated transfer price of $30 per pair of soles
Scenario B: Market-based transfer price

  

a) $1,000,000 of net income using Scenario B

b) $1,000,000 more net income under Scenario A

c) $200,000 of net income using Scenario A

d) None of the above is correct.

Answer 1

Answer. d) None of the above is correct.

Reason: There is no change in overall company net income in both scenario.

	Scenario A: Negotiated transfer price of $30 per pair of soles
			Sole Division	Assembly Division	Total
A	Sales		$3,000,000	$12,000,000	$15,000,000
B	Variable Cost
		Direct Materials	$800,000	$1,000,000	$1,800,000
		Direct Labor	$600,000	$200,000	$800,000
		Variable Overhead	$400,000	$200,000	$600,000
		Sole's purchase cost	$0	$3,000,000	$3,000,000
		Total (B)	$1,800,000	$4,400,000	$6,200,000
C	Contribution Margin (A-B)		$1,200,000	$7,600,000	$8,800,000
D		Fixed Cost	$200,000	$1,800,000	$2,000,000
	Net Income (C-D)		$1,000,000	$5,800,000	$6,800,000
	Scenario B: Market based transfer price
			Sole Division	Assembly Division	Total
A	Sales		$4,000,000	$12,000,000	$16,000,000
B	Variable Cost
		Direct Materials	$800,000	$1,000,000	$1,800,000
		Direct Labor	$600,000	$200,000	$800,000
		Variable Overhead	$400,000	$200,000	$600,000
		Sole's purchase cost	$0	$4,000,000	$4,000,000
		Total (B)	$1,800,000	$5,400,000	$7,200,000
C	Contribution Margin (A-B)		$2,200,000	$6,600,000	$8,800,000
D		Fixed Cost	$200,000	$1,800,000	$2,000,000
	Net Income (C-D)		$2,000,000	$4,800,000	$6,800,000