ACC2002 Managerial Accounting (S2, 2011/12)

Tutorial 9
For week beginning 2 April 2012
Discussion Questions
1. Problem 13-23 (p.666) Finely segmented income statements
2. Problem 13-27 (p.670) Restructuring a segmented income statement
3. Problem 13A-4 (p.685) Basic transfer pricing
4. Supplement Question: Interdivisional transfers; pricing the final product (see below)
5. Problem A-7 (p.824) Missing data; markup computations: return on investment (ROI);
pricing
6. Problem A-8 (p.824) Target costing

SUPPLEMENT QUESTION: Interdivisional transfers; pricing the final product

Continental Industries is a diversified corporation with separate operating divisions. Each

divisions performance is evaluated on the basis of profit and return on investment. The Air
Comfort Division manufactures and sells air-conditioner units. The coming years budgeted
income statement, which follows, is based upon a sales volume of 15,000 units.

Air Comfort Division

Budgeted Income Statement
(in thousands)
Total Per unit
Sales revenue $12,000 $800
Manufacturing costs:
Compressor $2,100 $140
Other direct material 1,110 74
Direct labor 900 60
Variable overhead 1,350 90
Fixed overhead 960 64
Total manufacturing costs $6,420 $428
Gross margin $5,580 $372
Operating expenses:
Variable selling $540 $36
Fixed selling 570 38
Fixed administrative 1,140 76
Total operating expenses $2,250 $150
Net income before taxes $3,330 $222

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Air Comforts division manager believes sales can be increased if the price of the air-
conditioners is reduced. A market research study by an independent firm indicates that a 5
percent reduction in the selling price would increase sales volume 16 percent or 2,400 units. The
division has sufficient production capacity to manage this increased volume with no increase in
fixed costs.

The Air Comfort Division uses a compressor in its units, which it purchases from an outside
supplier at a cost of $140 per compressor. The Air Comfort Division manager has asked the
manager of the Compressor Division about selling compressor units to Air Comfort. The
Compressor Division currently manufactures and sells a unit to outside firms which is similar to
the unit used by the Air Comfort Division. The specifications of the Air Comfort Division
compressor are slightly different, which would reduce the Compressor Divisions direct
materials cost by $3 per unit. In addition, the Compressor Division would not incur any variable
selling costs in the units sold to the Air Comfort Division. The manager of the Air Comfort
Division wants all of the compressors it uses to come from one supplier and has offered to pay
$100 for each compressor unit.

The compressor Division has the capacity to produce 75,000 units. Its budgeted income
statement for the coming year, which follows, is based on a sales volume of 64,000 units without
considering Air Comforts proposal.

Compressor Division
Budgeted Income Statement
(in thousands)
Total Per unit
Sales revenue $12,800 $200
Manufacturing costs:
Direct material $1,536 $ 24
Direct labor 1,024 16
Variable overhead 1,280 20
Fixed overhead 1,408 22
Total manufacturing costs $5,248 $82
Gross margin $7,552 $118
Operating expenses:
Variable selling $768 $12
Fixed selling 512 8
Fixed administrative 896 14
Total operating expenses $2,176 $34
Net income before taxes $5,376 $84

Required:
1. Should the Air Comfort Division institute the 5 percent price reduction on its air-
conditioner units even if it cannot acquire the compressors internally for $100 each?
Support your conclusion with appropriate calculations.

2
2. Independently of your answer to requirement (1), assume the Air Comfort Division needs
17,400 units. Should the Compressor Division be willing to supply the compressor units
for $100 each? Support your conclusions with appropriate calculations.
3. Independently of your answer to requirement (1), assume Air Comfort needs 17,400 units.
Suppose Continentals top management has specified a transfer price of $100. Would it
be in the best interest of Continental Industries for the Compressor Division to supply the
compressor units at $100 each to the Air Comfort Division? Support your conclusions
with appropriate calculations.
4. Is $100 a goal-congruent transfer price? [Refer to your answers for requirements (2) and
(3).]

(CMA, adapted)