Better Food Company recently acquired an olive oil processing company
that has an annual capacity of 2,000,000 liter's and that processed and sold
1,400,000 litres last year at a market price of $4 per liter. The purpose
of the acquisition was to furnish oil for the cooking division. The
cooking division needs 800,000 litres of oil per year. It has been
purchasing oil from suppliers at the market price. Production costs at
capacity of the olive oil company, now a division, are as follows:
|
Direct materials per liter
|
$1.00
|
|
Direct processing labor
|
0.50
|
|
Variable processing overhead
|
0.24
|
|
Fixed processing overhead
|
0.40
|
|
Total
|
$2.14
|
Management is trying to decide what transfer price to use for sales from
the newly acquired company to the cooking division. The manager of the
olive oil division argues that $4, the market price, is appropriate. The
manager of the cooking division argues that the cost of $2.14 should be used,
or perhaps a lower price, since fixed overhead cost should be recomputed with
the larger volume. Any output of the olive oil division not sold to the
cooking division can be sold to outsiders for $4 per liter.
1 Compute the operating income for the olive oil division using a
transfer price of $4
2 Compute the operating income for the olive oil division using a
transfer price of $2.14.
3 What transfer price(s) do you recommend? Compute the operating
income for the olive oil division using your recommendation.
a.
|
Sales:
|
|
|
|
External (1,200,000 x $4)
|
$4,800,000
|
|
|
Internal (800,000 x $4)
|
3,200,000
|
$8,000,000
|
|
Cost of goods sold:
|
|
|
|
Variable (2,000,000 x $1.74)
|
$3,480,000
|
|
