Question

The Assembly Division of SLOWCAR Company has offered to purchase 70,000 batteries from the Electrical Division (ED) for $110 per unit. The production costs per battery are $114. The Electrical Division has been selling 300,000 batteries per year to outside buyers for $138 each. Capacity is 350,000 batteries/year. The Assembly Division has been buying batteries from outside suppliers for $128 each. Should the Electrical Division manager accept the offer? Will an internal transfer be of any benefit to the company? Please show your work and the rationale for your answer.

Answer 1

• All working forms part of the answer
• Requirement1: Should ED manager accept the offer

The production cost for Electrical Division manager is $114 per battery.
The transfer price offer by Assembly Division is $110 per battery.

Hence, Electrical Division should not accept the offer because:

1.The transfer price is LESS THAN the production cost, and
2.Transfering 70000 units will lead to loss of contribution of 20000 units of normal sale, as maximum capacity is 350000 units only. If 70000 units are transferred, only 280000 units will be sold to outside market instead of 300000.

• Requirement 2: Will Internal Transfer will result in any benefit to the company.

The Net Benefit to company when there are no Internal transfer:

	Electrical division
	Normal Sale
Units of battery	300000
Sale price	$                       138.00
Sales Revenue	$         414,00,000.00
Production cost	$                       114.00
Total cost	$         342,00,000.00
Net Income	$           72,00,000.00

	Assembly Division
	If purchased from outside
Units purchased	70000
Units transferred	0
Purchase price	$                       128.00
Transfer price	$                                -
Purchase cost	$           89,60,000.00
Transfer cost	$                                -
Total cost	$           89,60,000.00

The Net Benefit (Loss) to Company = $ 7,200,000 - $ 8,960,000 = $ (1,760,000)

Net benefit when there is an internal transfer of 70000 units.

	Electrical division		Total
	Normal Sale	T/f to Assembly Division
Units of battery	280000	70000	350000
Sale price/Transfer price	$                     138.00	$                  110.00
Sales Revenue/Transfer revenue	$       386,40,000.00	$      77,00,000.00	$     463,40,000.00
Production cost	$                     114.00	$                  114.00
Total cost	$       319,20,000.00	$      79,80,000.00	$     399,00,000.00
Net Income	$         67,20,000.00	$      (2,80,000.00)	$        64,40,000.00

	Assembly Division
	If received from Electrical department
Units purchased	0
Units transferred	70000
Purchase price	$                  128.00
Transfer price	$                  110.00
Purchase cost	$                            -
Transfer cost	$      77,00,000.00
Total cost	$      77,00,000.00

The Net Benefit (Loss) to Company as a result of Internal Transfer = $ 6,440,000 – $ 7,700,000 = $ (1,260,000).

• Since the Net Loss has decreased from $1,760,000 to $1,260,000 as a result of Internal Transfer, the company has gained $ 500,000 as a result of Internal Transfer.