a. 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?
d. If the negotiated price approach is used, what would be the range of accept-
able transfer prices and why?
Answer:
a. Increase in Dart Industries’
Income from Operations
=
Market
Price
–
Variable Cost
per Unit
×
Units
Transferred
$2,200,000 = ($180 – $125) × 40,000
This amount is the same amount by which Dart Industries’ income from
operations increased in Ex. 24–20, when a transfer price of $145 was used.
b. Increase in the Instrument Division’s Market Transfer Units
Income from Operations = Price – Price × Transferred
$880,000 = ($180 – $158) × 40,000
This is the amount the Instrument Division saves by purchasing from the
Components Division at an internal price that is lower than the market price.
c. Increase in the Components Division’s Transfer Variable Cost Units
Income from Operations = Price – per Unit × Transferred
$1,320,000 = ($158 – $125) × 40,000
This is the amount the Components Division earns by using available excess capacity
to produce and sell products above variable cost to the Instrument Division.
d. Any transfer price will cause the total income of the company to increase,
as long as the supplier division capacity is used toward making materials for
products that are ultimately sold to the outside. However, transfer prices should
be set between variable cost and selling price in order to give the division
managers proper incentives. A transfer price set below variable cost would
cause the supplier division to incur a loss, while a transfer price set above
market price would cause the purchasing division to incur opportunity costs.
Neither situation is an attractive alternative for an investment center manager.
Thus, the general rule is to negotiate transfer prices between variable cost and
market price when the supplier division has excess capacity. The range of
acceptable transfer prices for Dart Industries would be between $180 and $125.