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Horngren'S Financial And Managerial Accounting
Found in: Page 1367

Short Answer

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.

Answer

  1. The total contribution margin for the chair is $12,600 and for the cushion is $39,600.
  2. The total contribution margin when the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its current sales price for chairs is $9,000 and for cushions is $35,200.
  3. The total contribution margin when the Chair Division purchases the 1,800 cushions needed from the Cushion Division at the current variable cost for the chair is $48,600 and for cushion is $0.

By reviewing requirements 1, 2, and

  1. It can be concluded that the company shall purchase the 1,800 cushions needed from the Cushion Division at its current sales price, i.e., $44,200 total contribution margin less than requirements 1 and 3.
  1. The company should set the transfer price between $12 to $ 32, the variable cost range per cushion. The total contribution margin does not alter for the entire company when the transfer price changes, but it affects each division’s contribution margin. The total contribution margin is $88,200 that includes chair $12,600; cushion (external) $39,600; and cushion (internal) $36,000.

See the step by step solution

Step by Step Solution

Step 1: Computing the total contribution margin-

Division

Units

x

Contribution margin per unit

=

Total contribution margin

Chair

1,800

x

$7

=

$12,600

Cushion

1,800

x

$22

=

$39,600

$52,200

Step 2: Computing the total contribution margin when the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its current sales price- 

Division

Units

x

Contribution margin per unit

=

Total contribution margin

Chair

1,800

x

$5 ($7+$32-$34)

=

$9,000

Cushion

1,800

x

$22

=

$35,200

$44,200

 Step 3: Computing the total contribution margin when the Chair Division purchases the 1,800 cushions needed from the Cushion Division at current variable cost-

Division

Units

x

Contribution margin per unit

=

Total contribution margin

Chair

1,800

x

$27 ($7+$32-$12)

=

$48,600

Cushion

1,800

x

$0 ($22+$12-$34)

=

$0

$48,600

Step 4: Determining the best option-

Division

Units

x

Contribution margin per unit

=

Total contribution margin

Chair

1,800

x

$7

=

$12,600

Cushion (external)

1,800

x

$22

=

$39,600

Cushion (internal)

1,800

x

$20

=

$36,000

$88,200

Most popular questions for Business-studies Textbooks

The Harris Company is decentralized, and divisions are considered investment centers. Harris 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 $22 from an outside vendor. The Cushion Division manufactures upholstered seat cushions that are sold to customers outside the company. The Chair Division currently sells 800 chairs per quarter, and the Cushion Division is operating at capacity, which is 800 cushions per quarter. The two divisions report the following information:

Chair Division Cushion Division

Sales Price per Chair $ 85 Sales Price per Cushion $ 32

Variable Cost (other than cushion) 42 Variable Cost per Cushion 13

Variable Cost (cushion) 22

Contribution Margin per Chair $ 21 Contribution Margin per Cushion $ 19

Requirements

1. Determine the total contribution margin for Harris Company for the quarter.

2. Assume the Chair Division purchases the 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 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 Harris Company?

5. Assume the Cushion Division has capacity of 1,600 cushions per quarter and can continue to supply its outside customers with 800 cushions per quarter and also supply the Chair Division with 800 cushions per quarter. What transfer price should Harris Company set? Explain your reasoning. Using the transfer price you determined, calculate the total contribution margin for the quarter.

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