Allied Company\'s Small Motor Division manufactures a number of small motors use

Question

Allied Company's Small Motor Division manufactures a number of small motors used in household and office appliances. The Household Division of Allied then assembles and packages such items as blenders and juicers.Both divisions are free to buy and sell any of their components internally or externally. The following costs relate to small motor LN233 on a per unit basis.
Fixed cost per unit $ 5
Variable cost per unit 8
Selling price per unit 30

Assuming that the Small Motor Division has excess capacity, compute the minimum acceptable price for the transfer of small motor LN233 to the Household Division.
Assuming that the Small Motor Division does not have excess capacity, compute the minimum acceptable price for the transfer of the small motor to the Household Division
Explain why the level of capacity in the Small Motor Division has an effect on the transfer price.

Explanation / Answer

(a) the minimum acceptable price for the transfer of small motor LN233 to the Household Division is any price above $8 because the company is incurring $8 in its variable cost so any price above its varaible cost will add to its net income. This is because fixed expense is not to be considered as it is not a relevant cost. Fixed costs are committed and hence not considerd in decision making and here the company has excess capacity so it can earn its fixed expense with the present capacity at which it is working and any contribution above its break even level will increase its net income. (b) If the small motor division does not have excess capacity and it is able to sell its product in the market, then the minimum transfer price should be the market price. Now if the company is unable to sell its product in the market then the company should transfer at any price above its variable cost the reason is same as explained in the first part. (c ) The level of capacity has an effect on the minimum price to sell. With excess capacity the company can offer a set minimum transfer price and any contribution earned will add to its net income. While a company which is running at breakeven level, it cannot set its transfer price below its selling price otherwise it will not be able to meet its required net profit of fixed expense.

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