Question

Setting Transfer Prices --Market Price versus Full Cost Ardmore, Inc., manufactures heating and air conditioning units in its six divisions. One division, the Components Division, produces electronic components that can be used by the other five. All the components produced by this division can be sold to outside customers; however, from the beginning, about 70 percent of its output has been used internally. The current policy requires that all internal transfers of components be transferred at full cost. Recently, Cynthia Busby, the new chief executive officer of Ardmore, decided to investigate the transfer pricing policy. She 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 her inquiry, she gathered some information concerning Part 4CM, used by the Small AC Division in its production of a window air conditioner, Model 7AC. The Small AC Division sells 10,000 units of Model 7AC each year at a unit price of $58. Given current market conditions, this is the maximum price that the division can charge for Model 7AC. The cost of manufacturing the air conditioner is computed as follows: Part 4CM $6.45 Direct materials 23.00 Direct labor 15.00 Variable overhead 3.50 Fixed overhead 6.50 Total unit cost $54.45

Answer 1

Page 0 Date: _Page No 1. Calculation of contribution Margins & Components Division - Part 4CM (per unit) & 6.45 Transfer Variable - Price cost Direct Direct Variable Material Labor overhead $2.75 $ 0.80 $ 1.10 $ 4.65 Contribution Marin $ 1.80 Total contribution = 10000 units X $1.80 $ 18000 * Small AC Division Model TAC (per unit) $ 58 - Sales Price Variable cost Part 4cm Direct Material Direct Labor variabh overhead $6.45 $23.00 $ 15.00 $ 3.50 $ 47.95 contribution $ 10.05 Total contribution 10000 unit x $10.05 $100500

Page ② Date: | 1 Page no: - & Company has a n (Per unit) Contribution Contribution - Total Margin of component Division Margin of Small AC Division contribution Margin $1.80 $10.05 $11.85 Total contribution & $11.85 x 10000 = $ 118500

Page ② Date:_/_Page No.: 2. Minimum and maximum Transfer Prices per unit * Minimum Transter Pric : Since all be sold and there Minimum the to is Tronster 10000 units & Port 44M could outside buyers at $12 per unit no spare capacity as well, Price : Morket price - $12 Minimum Transfer priu = $12 per unit Maximum Since the part from Maximum willing to Transfer Price small ac division could also buy the external suppliers at & 12 per unit, Transter price that the division would be offer is $12 Maximum Transtor pris & 12 per unit