Question

Exercise 11A-2 Transfer Pricing from the Viewpoint of the Entire Company [LO11-5]

Division A manufactures electronic circuit boards. The boards can be sold either to Division B of the same company or to outside customers. Last year, the following activity occurred in Division A:

Selling price per circuit board	$	194
Variable cost per circuit board	$	119
Number of circuit boards:
Produced during the year		20,100
Sold to outside customers		14,500
Sold to Division B		5,600

  
Sales to Division B were at the same price as sales to outside customers. The circuit boards purchased by Division B were used in an electronic instrument manufactured by that division (one board per instrument). Division B incurred $270 in additional variable cost per instrument and then sold the instruments for $620 each.

Required:

1. Prepare income statements for Division A, Division B, and the company as a whole.

2. Assume Division A’s manufacturing capacity is 20,100 circuit boards. Next year, Division B wants to purchase 6,600 circuit boards from Division A rather than 5,600. (Circuit boards of this type are not available from outside sources.) From the standpoint of the company as a whole, should Division A sell the additional 1,000 circuit boards to Division B or continue to sell them to outside customers?

Answer 1

Income Statement for Division A , Division B and Company as Whole
	Division A	Division B	Total Company
Sales	$3,899,400	$3,472,000	$6,285,000
	(20100 UnitX $194)	(5600 UnitX $620)	(14500 UnitX$194) +(5600X620)
Expenses:
Added by the division	$2,391,900	$1,512,000	$3,903,900
	(20100Unit X $119)	(5600 UntiX$270)
Transfer Price Paid		1086400
		(5600X$194)
Total Expenses	$2,391,900	$2,598,400	$3,903,900
Net Operating Income	$1,507,500	$873,600	$2,381,100

Req 2:
Contribution earned by DIV A
Selling price per unit	$194.00
Less: variable cost per unit	$119.00
Contribution per unit earned by Div A	$75.00
Contribution earned by DIV B
Selling price per unit	$620.00
Less: Cost added per unit	$270.00
Less: Transfer price of Div A	$119.00
Contribution earnedper unit by Div B	$231.00

The Division A must sell additional 1000 units to Division B as it will increase the overall profit of company by $ 231,000 (231*1000)