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Chapter 24: 27PGB (page 1367)

Question: Determining transfer pricing

The Hernandez Company is decentralized, and divisions are considered investment centers. Hernandez has one division that manufactures oak dining room chairs with upholstered seat cushions. The Chair Division cuts, assembles, and finishes the oak chairs and then purchases and attaches the seat cushions. The Chair Division currently purchases the cushions for \(32 from an outside vendor. The Cushion Division manufactures upholstered seat cushions that are sold to customers outside the company. The Chair Division currently sells 1,800 chairs per quarter, and the Cushion Division is operating at capacity, which is 1,800 cushions per quarter. The two divisions report the following information:

Chair Division Cushion Division

Sales Price per Chair \) 95 Sales Price per Cushion \( 34

Variable Cost (other than cushion) 56 Variable Cost per Cushion 12

Variable Cost (cushion) 32

Contribution Margin per Chair \) 7 Contribution Margin per Cushion $ 22

Requirements

1. Determine the total contribution margin for Hernandez Company for the quarter.

2. Assume the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its current sales price. What is the total contribution margin for each division and the company?

3. Assume the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its current variable cost. What is the total contribution margin for each division and the company?

4. Review your answers for Requirements 1, 2, and 3. What is the best option for Hernandez Company?

5. Assume the Cushion Division has capacity of 1,800 cushions per quarter and can continue to supply its outside customers with 1,800 cushions per quarter and also supply the Chair Division with 1,800 cushions per quarter. What transfer price should Hernandez Company set? Explain your reasoning. Using the transfer price you determined, calculate the total contribution margin for the quarter.

Short Answer

Expert verified

Answer

  1. The total contribution margin for the chair is $12,600 and for the cushion is $39,600.
  2. The total contribution margin when the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its current sales price for chairs is $9,000 and for cushions is $35,200.
  3. The total contribution margin when the Chair Division purchases the 1,800 cushions needed from the Cushion Division at the current variable cost for the chair is $48,600 and for cushion is $0.

By reviewing requirements 1, 2, and

  1. It can be concluded that the company shall purchase the 1,800 cushions needed from the Cushion Division at its current sales price, i.e., $44,200 total contribution margin less than requirements 1 and 3.
  1. The company should set the transfer price between $12 to $ 32, the variable cost range per cushion. The total contribution margin does not alter for the entire company when the transfer price changes, but it affects each division鈥檚 contribution margin. The total contribution margin is $88,200 that includes chair $12,600; cushion (external) $39,600; and cushion (internal) $36,000.

Step by step solution

01

Computing the total contribution margin-

Division

Units

x

Contribution margin per unit

=

Total contribution margin

Chair

1,800

x

$7

=

$12,600

Cushion

1,800

x

$22

=

$39,600

$52,200

02

Computing the total contribution margin when the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its current sales price- 

Division

Units

x

Contribution margin per unit

=

Total contribution margin

Chair

1,800

x

$5 ($7+$32-$34)

=

$9,000

Cushion

1,800

x

$22

=

$35,200

$44,200

03

 Step 3: Computing the total contribution margin when the Chair Division purchases the 1,800 cushions needed from the Cushion Division at current variable cost-

Division

Units

x

Contribution margin per unit

=

Total contribution margin

Chair

1,800

x

$27 ($7+$32-$12)

=

$48,600

Cushion

1,800

x

$0 ($22+$12-$34)

=

$0

$48,600

04

Determining the best option-

Division

Units

x

Contribution margin per unit

=

Total contribution margin

Chair

1,800

x

$7

=

$12,600

Cushion (external)

1,800

x

$22

=

$39,600

Cushion (internal)

1,800

x

$20

=

$36,000

$88,200

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Most popular questions from this chapter

Well-designed performance evaluation systems accomplish many goals. Consider the following actions, and state which goal is being achieved by the action:

a. Comparing targets to actual results

b. Providing subunit managers with performance targets

c. Comparing actual results with industry standards

d. Providing bonuses to subunit managers who achieve performance targets

e. Aligning subunit performance targets with company strategy

f. Comparing actual results of competitors

g. Taking corrective actions

h. Using the adage 鈥測ou get what you measure鈥� when designing the performance evaluation system

Zims, a national manufacturer of lawn-mowing and snow-blowing equipment, segments its business according to customer type: professional and residential. The following divisional information was available for the past year:

Net Sales Revenue Operating Income Average Total Assets

Residential \( 550,000 \) 65,280 $ 192,000

Professional 1,090,000 164,820 402,000

Management has a 26% target rate of return for each division.

Requirements

1. Calculate each division鈥檚 ROI. Round all of your answers to four decimal places.

2. Calculate each division鈥檚 profit margin ratio. Interpret your results.

3. Calculate each division鈥檚 asset turnover ratio. Interpret your results.

4. Use the expanded ROI formula to confirm your results from Requirement 1. What can you conclude?

What are two key performance indicators used to evaluate investment centers?

One subunit of Harris Sports Company had the following financial results last month:

Harris鈥擲ubunit X Actual Results Flexible Budget Flexible Budget Variance (F or U) % Variance (F or U)

Direct Materials \( 28,000 \) 25,900

Direct Labor 13,000 13,800

Indirect Labor 26,400 23,100

Utilities 12,300 11,300

Depreciation 25,000 25,000

Repairs and Maintenance 4,600 5,600

Total \( 109,300 \) 104,700

Requirements

1. Complete the performance evaluation report for this subunit. Enter the variance percent as a percentage of the budgeted amount rounded to two decimal places.

2. Based on the data presented, what type of responsibility center is this subunit?

3. Which items should be investigated if part of management鈥檚 decision criteria is to investigate all variances exceeding $2,500 or 10%?

4. Should only unfavorable variances be investigated? Explain.

Grandpa Jim鈥檚 Cookie Company sells homemade cookies made with organic ingredients. His sales are strictly Web based. The business is taking off more than Grandpa Jim ever expected, with orders coming from across the country from both consumers and corporate event planners. Grandpa decides to decentralize and hires a full-time baker who will manage production and product costs and a Web site designer/sales manager who will focus on increasing sales through the Web site. Grandpa Jim can no longer handle the business on his own, so he hires a business manager to work with the other employees to ensure the company is best utilizing its assets to produce profit. Grandpa will then have time to focus on new product development. Now that Grandpa Jim鈥檚 Cookie Company has decentralized, identify the type of responsibility center that each manager is managing
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