3. As shown in part (1) above, the Electrical Division would insist on a
transfer price of at least $7.50 for the fitting. Would the Brake Division
make any money at this price? Again, the fixed costs are not relevant in
this decision since they would not be affected. Once this is realized, it is
evident that the Brake Division would be ahead by $6.00 per brake unit
if it accepts the $7.50 transfer price.
Selling price of the brake units ... $50.00
Less:
Purchased parts (from outside vendors) ... $22.50
Electrical fitting X52 (assumed transfer price) ... 7.50
Other variable costs ... 14.00 44.00
Brake Division contribution margin ... $ 6.00
In fact, since there is a positive contribution margin of $6, any transfer
price within the range of $7.50 to $13.50 (= $7.50 + $6.00) will improve
the profits of both divisions. So yes, the managers should be able to
agree on a transfer price.
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