Question : 34) Bedtime Bedding Company manufactures pillows. The Cover Division makes : 1217117

 

34) Bedtime Bedding Company manufactures pillows. The Cover Division makes covers and the Assembly Division makes the finished products. The covers can be sold separately for $5.00. The pillows sell for $6.00. The information related to manufacturing for the most recent year is as follows:

 

Cover Division manufacturing costs

$6,000,000

Sales of covers by Cover Division

4,000,000

Market value of covers transferred to Assembly

6,000,000

Sales of pillows by Assembly Division

7,200,000

Additional manufacturing costs of Assembly Division

1,500,000

 

Required:

Compute the operating income for each division and the company as a whole. Use market value as the transfer price. Are all managers happy with this concept? Explain.

Answer:

 

Cover

Assembly

Company

Revenue:

 

 

 

   External

 $ 4,000,000

$7,200,000

$11,200,000

   Internal

6,000,000

0

0

      Total

$10,000,000

$7,200,000

$11,200,000

Cost of goods:

 

 

 

   Incurred

$ 6,000,000

$1,500,000

$ 7,500,000

   Transferred-in

0

6,000,000

0

      Total

$ 6,000,000

$7,500,000

$ 7,500,000

 

 

 

 

Operating income

$ 4,000,000

$ (300,000)

$ 3,700,000

 

The Assembly manager is probably not happy because the division is showing a loss. The manager would probably argue for a transfer price at something less than market price. However, since the market is open and competitive, the market price can be justified. The division needs to either increase its price or reduce its costs if it expects to show a profit.

 

35) DesMoines Valley Company has two divisions, Computer Services and Management Advisory Services. In addition to their external customers, each division performs work for the other division. The external fees earned by each division in 20X5 were $200,000 for Computer Services and $350,000 for Management Advisory Services. Computer Services worked 3,000 hours for Management Advisory Services, who, in turn, worked 1,200 hours for Computer Services. The total costs of external services performed by Computer Services were $110,000 and $240,000 by Management Advisory Services.

 

Required:

a.Determine the operating income for each division and for the company as a whole if the transfer price from Computer Services to Management Advisory Services is $15 per hour and the transfer price from Management Advisory Services to Computer Services is $12.50 per hour.

 

b.Determine the operating income for each division and for the company as a whole if the transfer price between divisions is $15 per hour.

 

c.What are the operating income results for each division and for the company as a whole if the two divisions net the hours worked for each other and charge $12.50 per hour for the one with the excess? Which division manager prefers this arrangement?

 

36) Better Food Company recently acquired an olive oil processing company that has an annual capacity of 2,000,000 liters and that processed and sold 1,400,000 liters last year at a market price of $4 per liter. The purpose of the acquisition was to furnish oil for the Cooking Division. The Cooking Division needs 800,000 liters of oil per year. It has been purchasing oil from suppliers at the market price. Production costs at capacity of the olive oil company, now a division, are as follows:

 

Direct materials per liter

$1.00

Direct processing labor

0.50

Variable processing overhead

0.24

Fixed processing overhead

0.40

   Total

$2.14

 

Management is trying to decide what transfer price to use for sales from the newly acquired company to the Cooking Division. The manager of the Olive Oil Division argues that $4, the market price, is appropriate. The manager of the Cooking Division argues that the cost of $2.14 should be used, or perhaps a lower price, since fixed overhead cost should be recomputed with the larger volume. Any output of the Olive Oil Division not sold to the Cooking Division can be sold to outsiders for $4 per liter.

 

Required:

a.Compute the operating income for the Olive Oil Division using a transfer price of $4.

 

b.Compute the operating income for the Olive Oil Division using a transfer price of $2.14.

 

c.What transfer price(s) do you recommend? Compute the operating income for the Olive Oil Division using your recommendation.

37) Explain what transfer prices are, and what are the four criteria used to evaluate them?

 

38) Briefly explain each of the three methods used to determine a transfer price.