Exercise 11A-2 Transfer Pricing from the Viewpoint of the Entire Company [LO11-5

Question

Exercise 11A-2 Transfer Pricing from the Viewpoint of the Entire Company [LO11-5]

Division A manufactures electronic circuit boards. The boards can be sold either to Division B of the same company or to outside customers. Last year, the following activity occurred in Division A:

  
Sales to Division B were at the same price as sales to outside customers. The circuit boards purchased by Division B were used in an electronic instrument manufactured by that division (one board per instrument). Division B incurred $290 in additional variable cost per instrument and then sold the instruments for $620 each.

Required:

1. Prepare income statements for Division A, Division B, and the company as a whole.

2. Assume Division A’s manufacturing capacity is 21,500 circuit boards. Next year, Division B wants to purchase 7,200 circuit boards from Division A rather than 6,200. (Circuit boards of this type are not available from outside sources.) From the standpoint of the company as a whole, should Division A sell the additional 1,000 circuit boards to Division B or continue to sell them to outside customers?

Selling price per circuit board $ 185 Variable cost per circuit board $ 111 Number of circuit boards: Produced during the year 21,500 Sold to outside customers 15,300 Sold to Division B 6,200

Explanation / Answer

1)

2)Since the Division A is selling the circuit board at the market price (at which it is selling to outside customers)

so there will no loss on selling the additional circuit to division B rather to outside customer.

Also The overall profit will increase by selling additional circuit to division B

By selling Additional 1000 units to B.

Additional profit to A:0

Addtional profit to B: 1000[620-185-290] = 145000 contribution

Overall company profit $145000 increases.

so Division A shall sell the circuit to B

Income statement A B Total sales 3977500     [21500*185] 3844000   [6200*620] 7821500 less:variable cost -2386500    [21500*111] -1147000    [6200*185] -3533500 Additional variable cost -1798000     [6200*290] -1798000 contribution margin 1591000 899000 2490000

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