Materials used by the Industrial Division of LeMaster Manufacturingare currently
ID: 2433926 • Letter: M
Question
Materials used by the Industrial Division of LeMaster Manufacturingare currently purchased from outside suppliers at a cost of $120per unit. However, the same materials are available from theMaterials Division. The Material Division has unused capacity andcan produce the materials needed by the Industrial Division at avariable cost of $95 per unit. Assume that a transfer price of $110has been established and that 40,000 units of materials aretransferred, with no reduction in the Materials Division's currentsales.a. How much would LeMaster Manufacturing's total income fromoperations increase?
b. How much would the Industrial Division's income from operationsincrease?
c. How much would the Materials Division's income from operationsincrease?
d. If the negotiated price approach is used, what would be therange of acceptable transfer prices and why?
Explanation / Answer
If the transferhas no effect on fixed costs, then from the selling division'sstandpoint, the transfer price must cover both the variable costsof producing transferred units and any opportunitycosts.
Seller'sperspective:
Transfer price > Variable cost + (Total contributionmargin of lost sales / Number of units transferred)
IndustrialDivision MaterialsDivision Total Savings from transfer from material division ($120 - $110) x $40,000 $400,000 $400,000 Profit from internal transfer ($110 - $95) x 40,000 $600,000 $600,000 Total $400,000 $600,000 $1,000,000