QUESTION 2 Transfer Pricing from the Viewpoint of the Entire

QUESTION 2 Transfer Pricing from the Viewpoint of the Entire Company Division A manufactures components for plasma TVs. The components can be sold either to Division B of the same company or to outside customers. Last year, the following activity was recorded in Division A: Selling price per component..$525 Variable cost per component Number of components: Produced during the year20,000 $390 Sold to outside customers.. Sales to Division B were at the same price as sales to outside customers. The components purchased by Division B were used in a TV set manufactured by that division. Division B incurred $900 in additional variable cost per TV and then sold the TVs for $1,800 each. Required: 1. Prepare income statements for last year for Division A, Division B, and the company as a whole. 2. Assume that Division A\'s manufacturing capacity is 20,000 components per year Next year Division B wants to purchase 5,000 components from Division A, rather than only 4,000 components as it did last year. (Components of this type are not available from outside sources.) From the standpoint of the company as a whole, should Division A sell the 1,000 additional components to Division B, or should it continue to sell them to outside customers? Explain

Solution

1. Income statement for the last year:

Division A

(1)

Division B

(2)

Whole company

(1+2)

$10,500,000

(20,000 units X $525 per unit)

$7,200,000

(4000 tv\'s X $1800 per tv)

$17,700,000

$7,800,000

(20,000 units X $390 per unit)

$5,700,000

[4000 units X ($525*+$900)]

C. Contribution (A - B)

*Division B\'s variable cost includes purchase cost of $525 per component.

2. Whether to sell additional components to division B or to outside customers by division A can be decided after going through INCREMENTAL ANALYSIS.

Calculation of net income when division A selling 5000 components to division A:

Division B

(5000 units)

(2)

Whole company

(1 + 2)

$10,500,000

(20000 X $525)

$9,000,000  

(5000 X $1800)

$7,800,000

(20,000 X $390)

$7,125,000

[5000 X ($525*+$900)]

Incremental analysis statement from the whole company point of view

Whole company

(4000 units)

Whole company

(5000 units)

C. Contribution

(A-B)

From above incremental analysis, we have determined that there is an increase in net profit by $375,000. Therefore it is advisable to sell additional components of 1000 units to Division B by Division A.

Hope this is useful and thank you!!!!!!!!!

	Division A (1)	Division B (2)	Whole company (1+2)
A. Sales revenue	$10,500,000 (20,000 units X $525 per unit)	$7,200,000 (4000 tv\'s X $1800 per tv)	$17,700,000
B. Variable cost	$7,800,000 (20,000 units X $390 per unit)	$5,700,000 [4000 units X ($525*+$900)]	$13,500,000
C. Contribution (A - B)	$2,700,000	$1,500,000	$4,200,000
D. Fixed cost	Nil	Nil	Nil
E. Net Income (C-D)	$2,700,000	$1,500,000	$4,200,000