Review Exercises 1. During the current year, Division A of Galloway Company incu

Question

Review Exercises

1.   During the current year, Division A of Galloway Company incurred the following manufacturing costs for 5,000 units of a component part:

Total

Per Unit

Variable costs

$200,000

$40

Fixed costs

  40,000

  8

a. Compute the advantage/disadvantage to the company as a whole (in terms of next year’s operating income) if there are no alternative uses for Division A’s facilities, and if Division B purchases 5,000 units of this part from an external supplier at a price of (1) $43 per unit (2) $36 per unit.

b.            Compute the advantage/disadvantage to the company as a whole (in terms of next year’s operating income) if there are alternative uses for Division A’s facilities by other Galloway operations that would otherwise require additional outlay costs of $26,000, and if Division B purchases 5,000 units of this part from an external supplier at a price of (1) $43 per unit (2) $36 per unit.

2.   Empire Company has two divisions. Division A is located in the United States where the income tax rate is 40%. Division K is located in Korea where the income tax rate is 30%. Division A produces an intermediate product at a variable cost of $100 per unit, and transfers the product to Division K where it is finished and sold for $500 per unit. Variable cost in Division K is $80 per unit. Fixed costs are $75,000 per year in Division A and $90,000 per year in Division K. Assume 1,000 units are transferred annually and the minimum transfer price allowed by the U.S. tax authorities is the variable cost. Also assume operating income in each country is equal to taxable income.

a. What transfer price should be set for Empire to minimize its total income taxes? Show your calculations.

b.            If Empire desires to minimize its total income taxes, calculate the amount of tax liability in each country.

Explanation / Answer

1)

a) Fixed costs are irrelevant because they remain the same whether Division B buysinternally or externally

b)   

46000

2)

a) To minimize its total income taxes, the company should report no operating income inthe U.S., the country with the higher income tax rate. This outcome occurs if the transfer price is set at full cost $100 + ( 75000/1000) = $175 per unit.

b)

1 2 Advantage ( Disadvantage ) as above -15000 20000 Before Considering alternative use of facilities 26000 26000 Advantage from Alternative use of facilities( Next Year operating Income ( Advantage /( Disadvatage ) to the company as a whole) 11000

46000

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