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 th 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.

1. Calculate Division A's minimum acceptable transfer price.

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.

Answer 1

Answer:

1. $13.50

2. Decrease in Profit : $ 22,500

Explanation:

Minimum Transfer Price = Variable Costs - Internal Savings + Opportunity Cost

       = $12.00 + $2.00 - $2.00 + 1,000/4,000 × ($20.00 - ($12.00 + $2.00))

       = $12.00 + $1.50

       = $13.50

Maximum Transfer Price can never be more than what the receiving division (Division B can purchase externally)

Maximum Transfer Price = $18.00

Division B will incur more costs when it accepts Baker's offer and declines to transfer any units from Division A. Hence decrease in Profit)

Decrease in Profit = 5,000 units × ($18.00 - $13.50)

                              = $ 22,500