Question

Managerial Accounting (Transfer price question)

Love Inc. manufactures a line of men's colognes and aftershave lotions. The manufacturing process is basically a series of mixing operations, with the addition of certain aromatic and coloring ingredients. The finished product is packaged in a company-produced glass bottle and packed in cases of six bottles. There are two areas (perfume production and bottle manufacture) have evolved over the years almost independently;in fact, a rivalry has developed between management personnel as to which division is more important to the company. As the new controller, you are responsible for determining a proper transfer value to use in crediting the bottle production profit center and in debiting the perfume packaging profit center.

At you request, the bottle division's general manager has asked certain other bottle manufacturers to quote a price for the quantity and sizes of bottles that the perfume division needs. These competitive prices are as follows:

Volume (equivalent cases)*	Total price	Price per case
2,000,000	$4,000,000	$2.00
4,000,000	$7,000,000	$1.75
6,000,000	$10,020,000	$1.67

*An "equivalent case" represents six bottles.

An analysis of the bottle plant indicates that it can produce bottles at the following costs:

Volume (equivalent cases)	Total cost	Cost per case*
2,000,000	$3,200,000	$1.60
4,000,000	$5,200,000	$1.30
6,000,000	$7,200,000	$1.20

*The analysis indicates that these costs represent fixed costs of $1.2 million and variable costs of $1.00 per equivalent case.

The perfume production division has the following costs in addition to the bottle costs:

Volume ( Cases)	Total cost	Cost per case
2,000,000	$16,400,000	$8.20
4,000,000	$32,400,000	$8.10
6,000,000	$48,420,000	$8.07

After analysis, the marketing research department has given you the following price demand relationship for the finished product:

Sales volume (cases)	Total sales revenue	Sales price per case
2,000,000	$25,000,000	$12.50
4,000,000	$45,600,000	$11.40
6,000,000	$63,900,000	$10.65

a) Love Inc. has used market-based transfer prices in the past. Using current market prices and costs and assuming a volume of 6 million cases, calculate the income for (1) the bottle division, (2) the perfume division, and (3) the company.

b) Are these production and sales levels the most profitable volumes for (1) the bottle division, (2) the perfume division, and (3) the company? Explain your answer.

Answer 1