Ex 24-20 Decision on transfer pricing

Materials used by the Instrument Division of Dart Industries are currently purchased from outside suppliers at a cost of $180 per unit. However, the same materials are available from the Components Division. The Components Division has unused capacity and can produce the materials needed by the Instrument Division at a variable cost of $125 per unit.

a. If a transfer price of $145 per unit is established and 40,000 units of materials are transferred, with no reduction in the Components Division’s current sales, how much would Dart Industries’ total income from operations increase?

b. How much would the Instrument Division’s income from operations increase?

c. How much would the Components Division’s income from operations increase?


Answer:

a. Increase in Dart Industries’ Market Variable Cost Unit 
 Income from Operations =  Price –  per Unit × Transferred 
$2,200,000 = ($180 –  $125) × 40,000 

b. 

Increase in the Instrument Division’s 
Income from Operations 

= 


Market 
Price 

– 


Transfer 
Price 

× 

Unit 
Transferred 
 $1,400,000 = ($180 –  $145) × 40,000 

c. 

Increase in the Components Division’s 
Income from Operations 

= 
  
Transfer 
Price 

– 


Variable Cost 
per Unit 

× 

Unit 
Transferred 
 $800,000 = ($145 –  $125) × 40,000