Chapter 22, Problem 8AP

a.

To determine

Ascertain the operating profit before tax for each division using the market transfer price of $150.

Explanation of Solution

Ascertain the operating profit before tax for each division using the market transfer price of $150 as follows:

	Entire Company	Green Division	White Division
Sales	$525,000	$300,000	$450,000
Variable Costs	242,500	130,000	337,500
Contribution Margin	$282,500	$170,000	$112,500
Fixed Costs	157,500	100,000	57,500
Operating Profit	$125,000	$70,000	$55,000

Table (1)

Calculate the sales of Green division.

$\begin{array}{c}\text{Sales=Number of units}\times \text{Market price}\\ \text{=2,000}\text{units}\times \text{\$150}\\ \text{=\$300,000}\end{array}$

Calculate the sales of White division.

$\begin{array}{c}\text{Sales=Number of units}\times \text{Market price}\\ \text{=1,500}\text{units}\times \text{\$300}\\ \text{=\$450,000}\end{array}$

Calculate the sales of Entire Company.

$\begin{array}{c}\text{Sales=}\left[\begin{array}{l}\left(\begin{array}{l}\text{Number of Green division units}-\\ \text{Number of White division units}\end{array}\right)\times \left(\begin{array}{l}\text{Market price of green}\\ \text{division}\end{array}\right)+\\ \left(\begin{array}{l}\text{Number of units of White division}\times \\ \text{Market price of White division}\end{array}\right)\end{array}\right]\\ \text{=}\left(2,000-1,500\right)\times \left(150\right)+\left(\text{1,500}\times \text{\$300}\right)\\ \text{=\$525,000}\end{array}$

Calculate the variable cost of Green division.

$\begin{array}{c}\text{Variable cost=Number of units}\times \text{Variable cost per unit}\\ \text{=2,000}\text{units}\times \text{\$65}\\ \text{=\$130,000}\end{array}$

Calculate the variable cost of White division.

$\begin{array}{c}\text{Variable cost=Number of units}\times \left(\text{Transfer price+Variable cost}\right)\\ \text{=1,500}\text{units}\times \left(\text{\$150+\$75}\right)\\ \text{=\$337,500}\end{array}$

Calculate the variable cost of Entire Company.

$\begin{array}{c}\text{Variable cost=}\left[\left(\begin{array}{l}\text{Number of Green division units}\times \\ \text{Variable cost of Green division}\end{array}\right)+\left(\begin{array}{l}\text{Number of White division units}\times \\ \text{Variable cost of White division}\end{array}\right)\right]\\ =\left(2,000\times \$65\right)+\left(\text{1,500}\times \text{\$75}\right)\\ \text{=\$242,500}\end{array}$

b.

To determine

Ascertain the operating profit before tax for each division using the transfer price of $135, as suggested by the manager of the white division.

Explanation of Solution

Ascertain the operating profit before tax for each division using the transfer price of $135, as suggested by the manager of the white division as follows:

	Entire Company	Green Division	White Division
Sales	$525,000	$277,500	$450,000
Variable Costs	242,500	130,000	315,000
Contribution Margin	$282,500	$147,500	$135,000
Fixed Costs	157,500	100,000	57,500
Operating Profit	$125,000	$47,500	$77,500

Table (2)

Calculate the sales of Green division.

$\begin{array}{c}\text{Sales cost=}\left[\left(\begin{array}{l}\text{Number of Green division units transferred}\times \\ \text{Transfer price}\end{array}\right)+\left(\begin{array}{l}\text{Number of units sold}\\ \text{ to market}\times \\ \text{Market price}\end{array}\right)\right]\\ =\left(1,500\times \$135\right)+\left(\text{500}\times \text{\$150}\right)\\ \text{=\$277,500}\end{array}$

Calculate the sales of White division.

$\begin{array}{c}\text{Sales=Number of units}\times \text{Market price}\\ \text{=1,500}\text{units}\times \text{\$300}\\ \text{=\$450,000}\end{array}$

Calculate the variable cost of Green division.

$\begin{array}{c}\text{Variable cost=Number of units}\times \text{Variable cost per unit}\\ \text{=2,000}\text{units}\times \text{\$65}\\ \text{=\$130,000}\end{array}$

Calculate the variable cost of White division.

$\begin{array}{c}\text{Variable cost=Number of units}\times \left(\text{Negotiated transfer price+Variable cost}\right)\\ \text{=1,500}\text{units}\times \left(\text{\$135+\$75}\right)\\ \text{=\$315,000}\end{array}$

c.

To determine

Discuss the manner in which the company’s net income affected under the two transfer pricing scenarios.

Explanation of Solution

Discuss the manner in which the company’s net income affected under the two transfer pricing scenarios as follows:

Accounting entries that show the flow of goods between the departments are generated by the transfer prices. One department records the transfer price as revenue while on the other hand, the same is treated as an expense by the other department. These entries of revenue and expense are cancelled out for the entire company and hence, internal transfer prices do not have a direct effect on the net income of the company.

d.

To determine

Discuss whether it would be more beneficial to the company if the green division sold trophy bases externally and the white division purchased trophy bases from an outside supplier.

Explanation of Solution

Calculate the pre-tax operating profit, using the external sale price and purchase price for the trophy base as follows:

	Entire Company	Green Division	White Division
Sales	$750,000	$300,000	$450,000
Variable Costs	482,500	130,000	352,500
Contribution Margin	$267,500	$170,000	$97,500
Fixed Costs	157,500	100,000	57,500
Operating Profit	$110,000	$70,000	$40,000

Table (3)

Calculate the sales of Green division.

$\begin{array}{c}\text{Sales=Number of units}\times \text{Market price}\\ \text{=2,000}\text{units}\times \text{\$150}\\ \text{=\$300,000}\end{array}$

Calculate the sales of White division.

$\begin{array}{c}\text{Sales=Number of units}\times \text{Market price}\\ \text{=1,500}\text{units}\times \text{\$300}\\ \text{=\$450,000}\end{array}$

Calculate the variable cost of Green division.

$\begin{array}{c}\text{Variable cost=Number of units}\times \text{Variable cost per unit}\\ \text{=2,000}\text{units}\times \text{\$65}\\ \text{=\$130,000}\end{array}$

Calculate the variable cost of White division.

$\begin{array}{c}\text{Variable cost=Number of units}\times \left(\text{Purchase price from outside supplier+Variable cost}\right)\\ \text{=1,500}\text{units}\times \left(\text{\$160+\$75}\right)\\ \text{=\$352,500}\end{array}$

The company earns $15,000 more in operating profit if the White division purchases the trophy base from the Green division and hence, as a whole it is more beneficial to the company.