Italian Sausages Inc. is still a family-owned company located in Maple, Ontario. It has experienced significant growth in the last 10 years, and nowadays it employs more than 100 persons in production-related activities and another 20 persons in support activities such as selling, administrative, health and safety, and so on.
Italian Sausages manufactures and sells high-quality sausages and is organized along two divisions: (Meat) Grinding/Mixing and (Sausage) Stuffing.
The first step in the production of sausages is done in the Grinding/Mixing Division, where the meat is ground in special machines and then several spices and additives are added to the mixture. The mixture is transferred to the Stuffing Division in 50-kilogram metal containers. Each container is directed to a particular stuffing machine, whether vertical or horizontal, where sausages of different diameters are assembled. In Maple and vicinity there are active markets for both the mixture and the sausages. Each division is evaluated as a profit centre. The transfer price for the mixture has been set at the long-run average market price.
The following data per kilogram are available to each division:
Estimated selling price of 1 kg of sausages............ $5.00
Long-run average selling price for 1 kg of mixture......... $3.25
Incremental costs for completion in Stuffing Division......... $2.00
Incremental costs for preparing the mixture in Grinding/Mixing Division.. $1.00
The manager of the Stuffing Division has made the following calculation:
Estimated selling price of 1 kg of sausages............. $5.00
Transferred-in costs at market price................ $3.25
Incremental costs for completion in Stuffing Division........ $2.00
Contribution (loss) on 1 kg of sausage............... $(0.25)
REQUIRED
1. Should transfers be made to Stuffing if there is no excess capacity in Grinding/Mixing? Is the market price the correct transfer price?
2. Assume that Grinding/Mixing's maximum capacity is 10,000 kilograms per week and sales to the intermediate market are now 5,000 kilograms. Should 5,000 kilograms be transferred to Stuffing? At what transfer price? Assume that for a variety of reasons, Grinding Mixing will maintain the $3.25 selling price indefinitely; that is, Grinding/Mixing is not considering lowering the price to outsiders even if idle capacity exists.
3. Suppose Grinding/Mixing quoted a transfer price of $3 for up to 5,000 kilograms. What would be the contribution to the company as a whole if the transfer were made? As manager of Stuffing, would you be inclined to buy at $3?