27PGB
ExpertverifiedQuestion: 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
By reviewing requirements 1, 2, and
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 
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 
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 
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 
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