Question

Forward Ltd has two divisions: Parts Division and Assembly Division. Currently, Parts Division produces oil filters for commercial vehicles and could only sell 80 percent of its annual capacity of 100,000 units to the external market for a selling price of $8 per unit.
Unit costs of producing the oil filters for the external market are given below:

Variable manufacturing: 2.80$
Fixed manufacturing: 1.30$
Variable selling &administrative: 1.20$
Fixed selling and administrative: 1.80$
Total: 7.10$

Assembly Division requested an internal transfer of 20,000 units from the Parts Division at a transfer price of $5 per unit. This internal transfer could save Parts Division $7,200 of delivery cost. Assume the delivery cost per unit is constant regardless of the units transferred.

Assembly Division could buy the oil filters from an external supplier at $7.80 per unit.

for the internal transfer of 20,000 units of oil filters, determine:

(1) minimum and maximum transfer price acceptable to the relevant divisions and explain.
(2) impact on the profit of each division and company

Should the internal transfer take place? Explain.

Answer 1

Answer:

1. Minimum transfer price to Parts: $3.64 per filter

Maximum transfer price to Assembly : $7.80 per filter

2. Profit of Parts: Increase $27,200

Profit of Assembly: Increase $56,000

Profit of the whole company: Increase $83,200

The internal transfer should take place as it creates incremental profit for the whole company.

Explanation:

1. The minimum transfer price to Parts should be equal to all variable cost incurred minus variable cost saved once the internal transfer take place: 2.8+ 1.2 - 7,200/20,000 = $3.64.

The maximum transfer price to Assembly should not exceed the price it may get from external provider which is $7.80 per filter.

2. Impact on Profit of Parts: Sales revenue from internal transfer - variable cost incurred + delivery cost saving = 20K x ( 5 - 2.8- 1.2) + 7.2K = $27,200 .

Impact on profit of Assembly: Difference of cost paid to 20K of filters = (7.8-5) x 20K = $56,000 .

Impact on profit of the whole company: Saving of external purchase + saving of delivery cost - variable cost incurred in producing of 20K filters = 20K x 7.8 + 7.2K - 20K x (2.8+1.2) = $83,200 .

As the internal transfer makes money for the whole company, it should take place.