Question

Chic Cycle ?Inc., has two? divisions, A and? B, which manufacture expensive bicycles. Division A produces the bicycle? frame, and division B assembles the rest of the bicycle onto the frame. There is a market for both the subassembly and the final product. Each division has been designated as a profit center. The transfer price for the subassembly has been set at the? long-run average market price. The following data are available for each? division:

Selling price for final product		$290
Long-run average selling price for intermediate product		175
Incremental cost per unit for completion in division B		160
Incremental cost per unit in division A		120
The manager of division B has made the following? calculation:
Selling price for final product		$290
Transferred-in cost per unit (market)	$175
Incremental cost per unit for completion	$160	$335
Contribution (loss) on product		$(45)

a. Should transfers be made to division B if there is no unused capacity in division? A? Is the market price the correct transfer? price? Show your computations. Begin by calculating the gain or loss if transfers are made to division B when there is no unused capacity in division A. What is the minimum transfer price?

b. Assume that division? A's maximum capacity for this product is 1,000 units per month and sales to the intermediate market are now 750 units. Assume that for a variety of? reasons, division A will maintain the ?$175 selling price indefinitely. That? is, division A is not considering lowering the price to outsider buyers even if idle capacity exists. Should 250 units be transferred to division? B? At what transfer? price?

c. Suppose division A quoted a transfer price of ?$130 for up to 250 units. What would be the contribution to the company as a whole if a transfer were? made? As manager of division? B, would you be inclined to buy at ?$130?? Explain. The contribution to the company as a whole if a transfer were made would be ?$--- per unit.
Complete the table below using the transfer price of $130 to compute the contribution margin to division B.

Selling price for final product		?
Trnasferred in cost per unit (in market)	?
Incremental cost per unit for completion	?	?
Contribution margin (loss) on product		?

As manager of division? B, would you be inclined to buy at $130??

Answer 1

a. If there is no unused capacity in division A, then no transfers should be made to division B, as by doing so company looses $45 per unit in comparision to selling it as an intermediate product.

Further, If there is no unused capacity in division A, market price is the correct transfer price as the division A looses an opportunity of selling the product in market at market price by transferring it to division B.

Computation showing loss if transfers are made to division B when there is no unused capacity in division A is as below:

Therefore, minimum transfer price is market price of intermediate product i.e. $175

b. In case of unused capacity of 250 units is available at division A, 250 units should be transferred to division B. Furthe, these units should be transferred at cost to division A i.e. $120 per unit. By doing so division B will generate an incremental profit of $10 per unit. Calculations are as below:

Kindly note that if the product is transferred at higher price by division A to division B, it will not impact the overall profit to the company as a whole.

c. In case of transfer price of $130, contribution to the company as a whole for 250 units would be $10 per unit. Calculations are as below:

Total contribution = 10 X 250 = $2,500

It is clear from the above table, that contribution margin to division B at $130 transfer cost would be 0, therefore as a manager of division B, I would not be inclined to buy at $130.