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Chapter 24: Q22RQ (page 1355)
What does RI measure?
RI or Residual income measures excess of operating income over minimum acceptable income
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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.
XTreme Sports Company makes snowboards, downhill skis, cross-country skis, skateboards, surfboards, and inline skates. The company has found it beneficial to split operations into two divisions based on the climate required for the sport: Snow Sports and Non-snow Sports. The following divisional information is available for the past year:
Net Sales Revenue | Operating Income | Average Total Assets | ROI | |
Snow Sports | \(5,500,000 | \)990,000 | $4,100,000 | 24.1% |
Non-snow Sports | 8,500,000 | 1,530,000 | 6,100,000 | 25.1% |
XTreme鈥檚 management has specified a 13% target rate of return. Calculate each division鈥檚 profit margin ratio.
Interpret your results.
List the disadvantages of decentralization.
List the advantages of decentralization.
Explain the difference between a centralized company and a decentralized company.
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