Gauani Products, Inc., has a Detector Division that manufactures and sells a number of products, including a standard detector. Data concerning that detector appear below:?Capacity in units51,000?Selling price to outside customers$72?Variable cost per unit$35?Fixed cost per unit (based on capacity)$17The company has a Commercial Security Division that could use this detector in one of its products. The Commercial Security Division is currently purchasing 5,000 of these detectors per year from an overseas supplier at a cost of $65 per detector.Required:a. Assume that the Detector Division has enough idle capacity to handle all of the Commercial Security Division's needs. What is the acceptable range, if any, for the transfer price between the two divisions?b. Assume that the
Detector Division is selling all of the detectors it can produce to outside customers. What is the acceptable range, if any, for the transfer price between the two divisions?
What will be an ideal response?
a. From the perspective of the selling division, profits would increase as a result of the transfer if and only if:
Transfer price > Variable cost per unit + (Total contribution margin on lost sales ÷ Number of units transferred)
Transfer price > $35 per unit + ($0 ÷ 5,000 units) = $35 per unit + $0 per unit = $35 per unit
From the perspective of the purchasing division, the transfer is financially attractive if and only if:
Transfer price < Cost of buying from outside supplier
Transfer price < $65 per unit
Combining the two requirements, the range of acceptable transfer prices is:
$35 per unit < Transfer price < $65 per unit
b. The total contribution margin on lost sales is computed as follows:
| ? | Selling price to outside customers | $72 |
| ? | Variable cost per unit | $35 |
| ? | Unit contribution margin | $37 |
| ? | Reduction in outside unit sales | 5,000 |
| ? | Total contribution margin on lost sales | $185,000 |
From the perspective of the selling division, profits would increase as a result of the transfer if and only if:
Transfer price > Variable cost per unit + (Total contribution margin on lost sales ÷ Number of units transferred)
Transfer price > $35 per unit + ($185,000 ÷ 5,000 units) = $35 per unit + $37 per unit = $72 per unit
From the perspective of the purchasing division, the transfer is financially attractive if and only if:
Transfer price < Cost of buying from outside supplier
Transfer price < $65 per unit
No transfer will be made between the two divisions because the minimum price that the selling division is willing to accept is greater than the maximum price that the buying division is willing to pay.
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