Scenario : Transfer Pricing
The Australian Instrument Company (AIC) consists of the Semiconductor Division and the Process Control Division. each of which operates as an independent profit centre.
The Semiconductor Division employs craftspeople who produce two different electronic components: the new high-performance Super-chip and an older product called Okay-chip. These two products have the following cost characteristics:
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Super-chip
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Okay-chip
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Direct materials
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$5
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$2
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Direct manufacturing labour, 3 hours x $20. 1 hour x $20
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60
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20
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Annual overhead in the Semiconductor Division totals $400 000, all fixed. Due to the high skill level necessary for the craftspeople. the Semiconductor Division's capacity is set at 45 000 hours per year.
One customer orders a maximum of 15 000 Super-chips per year, at a price of $80 per chip. The rest of the Semiconductor Division's capacity is devoted to the Okay-chip, for which there is unlimited demand at $26 per chip.
The Process Control Division produces only one product, a process-control unit, with the following cost structure:
direct materials (circuit board): $70
direct manufacturing labour: $45 (3 hours $15)
Fixed overhead costs of the Process Control Division are $80 000 per year. The current market price for the control unit is $132 per unit.
A joint research project has just revealed that a single Super-chip could be substituted for the circuit board currently used to make the process-control unit. Direct labour cost of the process-control unit would not change. The improved process-control unit could be sold for $145.
Required
1. Calculate the contribution margin per hour of selling the Super-chip and the Okay-chip. If no transfers of Super-chip are made to the Process Control Division, how many Super-chips and Okay-chips should the Semiconductor Division manufacture and sell? Show your calculations.
2. The Process Control Division expects to sell 5000 process-control units this year. From the viewpoint of AIC as a whole, should 5000 Super-chips be transferred to the Process Control Division to replace circuit boards? Show your calculations.