Question

Amazon Beverages produces and bottles a line of soft drinks using exotic fruits from Latin America and Asia. The manufacturing process entails mixing and adding juices and coloring ingredients at the bottling plant, which is a part of Mixing Division. The finished product is packaged in a company-produced glass bottle and packed in cases of 24 bottles each.

Because the appearance of the bottle heavily influences sales volume, Amazon developed a unique bottle production process at the company’s container plant, which is a part of Container Division. Mixing Division uses all of the container plant’s production. Each division (Mixing and Container) is considered a separate profit center and evaluated as such. As the new corporate controller, you are responsible for determining the proper transfer price to use for the bottles produced for Mixing Division.

At your request, Container Division’s general manager asked other bottle manufacturers to quote a price for the number and sizes demanded by Mixing Division. These competitive prices follow.

Volume	Total Price			Price per Case
460,000 equivalent casesa	$	3,588,000		$	7.80
920,000		6,256,000			6.80
1,380,000		8,280,000			6.00

^a An equivalent case represents 24 bottles.

Container Division's cost analysis indicates that it can produce bottles at these costs.

Volume	Total Cost			Cost per Case
460,000 equivalent cases	$	2,976,000		$	6.47
920,000		5,092,000			5.53
1,380,000		7,208,000			5.22

These costs include fixed costs of $860,000 and variable costs of $4.60 per equivalent case. These data have caused considerable corporate discussion as to the proper price to use in the transfer of bottles from Container Division to Mixing Division. This interest is heightened because a significant portion of a division manager’s income is an incentive bonus based on profit center results.

Mixing Division has the following costs in addition to the bottle costs.

Volume	Total Cost			Cost per Case
460,000 equivalent cases	$	1,860,000		$	4.04
920,000		2,660,000			2.89
1,380,000		3,460,000			2.51

The corporate marketing group has furnished the following price–demand relationship for the finished product:

Sales Volume	Total Sales Revenue			Sales Price per Case
460,000 equivalent cases	$	9,476,000		$	20.60
920,000		17,112,000			18.60
1,380,000		21,528,000			15.60

Required:

a. Amazon Beverages has used market price–based transfer prices in the past. Using the current market prices and costs and assuming a volume of 1.38 million cases. Calculate operating profits for Container Division, Mixing Division, Amazon Beverages. (Enter your answers in thousands of dollars.)

b-1. Calculate operating profits for Container, Mixing and Amazon Beverages for volumes of 460,000, 920,000 and 1,380,000 cases. (Enter your answers in thousands of dollars.)

b-2. Which volume of production is the most profitable for Container, Mixing and Amazon Beverages?

Answer 1

a.

1.38 million cases			('000)
Particulars	Container Division	Mixing Division	Amazon Beverages
(i) Sales	8280	21528	21528
(ii) Costs	6348	11740	9808
	(1380*4.6)	(8280+3460)	(6348+3460)
(iii) Operating Profit (i-ii)	1932	9788	11720

b.1.

Container Division			('000)
Particulars	460000 cases	920000 cases	1380000 cases
(i) Sales	3588	6256	8280
(ii) Costs	2116	4232	6348
	(460*4.6)	(920*4.6)	(1380*4.6)
(iii) Operating Profit (i-ii)	1472	2024	1932

Mixing Division			('000)
Particulars	460000 cases	920000 cases	1380000 cases
(i) Sales	9476	17112	21528
(ii) Costs	5448	8916	11740
	(3588+1860)	(6256+2660)	(8280+3460)
(iii) Operating Profit (i-ii)	4028	8196	9788

Amazon Beverages			('000)
Particulars	460000 cases	920000 cases	1380000 cases
(i) Sales	9476	17112	21528
(ii) Costs	3976	6892	9808
	(2116+1860)	(4232+2660)	(6348+3460)
(iii) Operating Profit (i-ii)	5500	10220	11720

b.2. Volume of 920000 cases is more profitable for container division.
Volume of 1380000 cases is more profitable for mixing division.
Volume of 1380000 cases is more profitable for Amazon Beverages.