Question:
(Transfer price) Two of the divisions of Construction Equipment Company are the Engine Division and the Mobile Systems Division. The Engine Division produces engines used by both the Mobile Systems Division and a variety of external industrial customers. For external sales, sales orders are generally produced in 50-unit lots. Using this typical lot size, the cost per engine is as follows:
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Variable production cost
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$1,050
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Fixed manufacturing overhead
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450
|
|
Variable selling expense
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150
|
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Fixed selling expense
|
210
|
|
Fixed administrative expense
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320
|
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Total unit cost
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$2,180
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The Engine Division normally earns a profit margin of 20 percent by setting the external selling price at $2,616. Because a significant number of sales are being made internally, Engine Division managers have decided that $2,616 is the appropriate price to use for all transfers to the Mobile Systems Division. When the managers in the Mobile Systems Division heard of this change in the transfer price, they became very upset because the change would have a major negative impact on Mobile Systems' net income figures. Because of competition, Mobile Systems has asked the Engine Division to lower its transfer price; by reducing the transfer price, Engine's profit margin will be 15 percent. Mobile Systems' managers have asked Construction Equipment top management whether the Division can buy engines externally. Bud Dawkins, Construction Equipment's president, has gathered the following price information to help the two divisional managers negotiate an equitable transfer price:
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Current external sales price
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$2,616
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Total variable production cost plus a 20% profit margin ($1,050 1.2)
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1,260
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Total production cost plus a 20% profit margin ($1,500 1.2)
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1,800
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Bid price from external supplier (if motors are purchased in 50-unit lots)
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2,320
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a. Discuss advantages and disadvantages of each of the above transfer prices to both the selling and buying divisions and to Construction Equipment.
b. If the Engine Division could sell all of its production externally at $2,616, what is the appropriate transfer price and why?