7.(CPA adapted) Mar Company has two decentralized divisions, X and Y. Division X

Question

7.(CPA adapted) Mar Company has two decentralized divisions, X and Y. Division X has been purchasing certain component parts from Division Y at $75 per unit. Because Division Y plans to raise the price to $100 per unit, Division X desires to purchase these parts from external suppliers for $75 per unit. The following information is available:

Y's variable cost per unit: $70

Y's annual fixed costs: $15000

Y's annual production of these parts for X: 1,000 units

If Division X buys from an external supplier, the facilities Division Y uses to manufacture these parts will be idle. Assuming Division Y’s fixed costs cannot be avoided, what is the result if Mar requires Division X to buy from Division Y at a transfer price of $100 per unit?

a.It is suboptimal for the company as a whole because X should buy from external suppliers at $75 per unit.

b.It is more profitable for the company as a whole than allowing X to buy from external suppliers at $75 per unit.

c.It provides higher overall company operating income than a transfer price of $75 per unit.

d.It provides lower overall company operating income than a transfer price of $75 per unit.

Explanation / Answer

Variable cost for Division Y = $70/unit

Fixed cost is unavoidable

Supplier price = $75/unit

Division Y has no other alternative option i.e it remains idle if there is no transfer

It is beneficial for the company as a whole to transfer goods irrespective of the Transfer price

Hence option B is correct

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