Johnson Corp. has two divisions, Division A and Division B. Division B has asked

Question

Johnson Corp. has two divisions, Division A and Division B. Division B has asked Division A to supply it
with 5,000 units of part WD26 this year to use in one of its products. Division A has the capacity to produce 25,000
units of part WD26 per year. Division A expects to sell 21,000 units of part WD26 to outside customers this year at
a price of $20.00 per unit. To fill the order from Division B, Division A would have to cut back its sales to outside
customers. Division A’s variable manufacturing cost (direct labor + direct material + variable overhead) for part
WD26 is $12.00 per unit. The variable selling cost when selling to outside customers is $2.00 per unit. This
variable selling cost would not have to be incurred on sales of the parts to Division B.
10.1 Calculate Division A’s minimum acceptable transfer price.
10.2 Baker Inc. has approached Division B and has offered to sell 5,000 units of the part for $18 per unit. . Division
B can either purchase the part from Baker Inc. or transfer it from Division A. How much does the overall profit of
Johnson Inc. increase or decrease, if Division B accepts Baker’s offer and declines to transfer any units from
Division A.

Explanation / Answer

10.1 SOLUTION-

Calculation of Division A’s minimum acceptable transfer price-

For all units variable cost must be considered (5000 *12 ) =    $60000

Add- Contribution for 1000units must be considered because this is opportunity cost for company if it is not transferred it would be sold = [(20 - 12-2) * 1000 = 6000$

note: contribution for 4000 units is not considered because this is spare capacity of a company as company's maximum capacity to sell is 21000 units.

so Minimum acceptable transfer pricing would be (60000+6000) = 66000$

10.2 SOLUTION:

A) Impact on overall profit of Johnson Inc if Division B accepts Baker’s offer-

Division B have to purchase 5000 units from Baker Inc. at the rate of 18 per unit , if company produce this unit in house than company able to produce it at 12$ per unit.

so there is a loss of (6 * 4000) = 24000$

as 4000 units capacity will be spare.

B) Impact on overall profit of Johnson Inc if Division B does not accepts Baker’s offer-

There is no impact on company's overall profit it will continue to tranfer its units from one division to another as shown in 10.1 part.

NOTE: In 10.2 as complete details of selling price of final product is not given so solution given is based on details given only.

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