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Managerial Accounting: The Corners...

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Maryanne M. Mowen + 2 others
ISBN: 9781337115773

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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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Setting Transfer Prices—Market Price versus Full Cost

Lansing Electronics Inc. manufactures a variety of printers, scanners, and fax machines in its two divisions: the PSF Division and the Components Division. The Components Division produces electronic components that can be used by the PSF Division. All the components this division produces can be sold to outside customers. However, from the beginning, nearly all of its output has been used internally. The current policy requires that all internal transfers of components be transferred at full cost.

Recently, Cam DeVonn, the chief executive officer of Lansing Electronics, decided to investigate the transfer pricing policy. He was concerned that the current method of pricing internal transfers might force decisions by divisional managers that would be suboptimal for the firm. As part of his inquiry, he gathered some information concerning Component Y34, which is used by the PSF Division in its production of a basic scanner, Model SC67.

The PSF Division sells 40,000 units of Model SC67 each year at a unit price of $42. Given current market conditions, this is the maximum price that the division can charge for Model SC67. The cost of manufacturing the scanner follows:

Chapter 11, Problem 45P, Setting Transfer PricesMarket Price versus Full Cost Lansing Electronics Inc. manufactures a variety , example  1

The scanner is produced efficiently, and no further reduction in manufacturing costs is possible.

The manager of the Components Division indicated that she could sell 40,000 units (the division’s capacity for this part) of Component Y34 to outside buyers at $12 per unit. The PSF Division could also buy the part for $12 from external suppliers. She supplied the following details on the manufacturing cost of the component:

Chapter 11, Problem 45P, Setting Transfer PricesMarket Price versus Full Cost Lansing Electronics Inc. manufactures a variety , example  2

Required:

  1. 1. Compute the firmwide contribution margin associated with Component Y34 and Model SC67. Also, compute the contribution margin earned by each division.
  2. 2. Suppose that Cam DeVonn abolishes the current transfer pricing policy and gives divisions autonomy in setting transfer prices. Can you predict what transfer price the manager of the Components Division will set? What should be the minimum transfer price for this part? The maximum transfer price?
  3. 3. CONCEPTUAL CONNECTION Given the new transfer pricing policy, predict how this will affect the production decision of the PSF Division manager for Model SC67. How many units of Component Y34 will the manager of the PSF Division purchase, either internally or externally?
  4. 4. Given the new transfer price set by the Components Division and your answer to Requirement 3, how many units of Y34 will be sold externally?
  5. 5. CONCEPTUAL CONNECTION Given your answers to Requirements 3 and 4, compute the firmwide contribution margin. What has happened? Was Cam’s decision to grant additional decentralization good or bad?

1.

To determine

Calculate the contribution margin of Component Y34 and Model SC67. Also, calculate the contribution margin earned by the division.

Explanation

Contribution margin can be defined as the amount obtained after deducting the variable expense from sales revenue. It means the amount of sales left after covering the variable expenses.

The following table represents the contribution margin:

 Component Y34 ($)Model SC67 ($)Company ($)
Sales1 (A)260,0001,680,0001,940,000
Variable expenses2 (B)160,000920,0001,080,000
Contribution margin (AB)100,000760,000860,000

Table (1)

Therefore, the contribution margin for Component Y34, Model SC67 and division are $100,000, $760,000 and $860,000 respectively.

Working Notes:

1. Calculation of sales under Component Y34:

Sales=Number of units×Selling price per unit=40,000 units×$6.5=$260,000

Hence, the amount of sales under Component Y34 is $260,000.

Calculation of sales under Model SC67:

Sales=Number of units×Selling price per unit=40,000 units×$42=$1,680,000

Hence, the amount of sales under the Model SC67 is $1,680,000

2.

To determine

Predict the transfer price of the component division. Also, calculate minimum transfer and maximum transfer.

3.

To determine

Calculate the number of units that the PSF division manager will purchase either internally or externally.

4.

To determine

Determine the number of units of Component Y34 to be sold externally.

5.

To determine

Calculate firm-wide contribution margin. Also, describe whether the decision by C was good or bad.

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