APPLY THE CONCEPTS: Determining benefits of negotiated transfer price

Assume that Selling Division and Buying Division are both owned by Overall Corporation. Selling Division sells a product that is used by Buying Division and outside customers. Selling Division has 27,000 units of excess capacity. Selling Division currently sells the product for $90 per unit and Buying Division currently buys 27,000 units of the product from an outside source for $90 per unit. Variable costs of the product are $18, of which $4.5 is the cost of selling the product to an outside customer.

Using Selling price less avoidable costs as the minimum price, fill in the following formula for the desired transfer price: $ < transfer price < $.

Using Variable costs as the minimum price, fill in the following formula for the desired transfer price: $ < transfer price < $.

Assume there are no avoidable costs with an internal sale (variable costs equal $18) and that Buying Division buys 27,000 units from Selling Division. Complete the table for each transfer price:

	Transfer Price	Transfer Price
	$85	$25
Increase in net income of Selling Division	$	$
Increase in net income of Buying Division	$	$
Increase in net income of Overall Corporation	$	$

Make or Buy Decision:

Zee-Drive Ltd. is a computer manufacturer. One of the items they make is monitors. Zee-Drive has the opportunity to purchase 17,000 monitors from an outside supplier for $202 per unit. One of the company's cost-accounting interns prepared the following schedule of Zee-Drive's cost to produce 17,000 monitors:

	Total cost of producing 17,000 monitors		Unit cost
Direct materials	$	2,023,000	$	119
Direct labor		1,122,000		66
Variable factory overhead		476,000		28
Fixed manufacturing overhead		510,000		30
Fixed non-manufacturing overhead		714,000		42
	$	4,845,000	$	285

You are asked to look over the intern's estimate before the information is shared with members of management who will decide to continue to make the monitors or buy them. The company's controller believes that the estimate may be incorrect because it includes costs that are not relevant. If Zee-Drive buys the monitors, the direct labor force currently employed in producing the monitors will be terminated and there would be no termination costs incurred. There are no materials on hand and no commitments to suppliers to purchase materials, so all materials would need to be purchased to make the monitors. Variable overheads are avoidable if monitors are bought. Fixed manufacturing overhead costs would be reduced by $40,600, but non-manufacturing costs would remain the same if monitors are bought.

Fill in the differential analysis.

Make or Buy Decisions Differential Analysis Report
Purchase price of 17,000 monitors		$
Differential cost to make:
Direct materials	$
Direct labor
Overhead
Differential income (loss) from making monitors		$

Feedback

Enter only the differential relevant costs in the appropriate space and calculate differential income or loss. The challenge is in determining differential overhead.

Keep or Replace Machine:

Skiles Coporation is a manufacturer of classic rocking chairs. The company has been using a particular sanding and finishing machine for over 10 years and believes that it may be time to replace the machine. The company is trying to decide whether replacing the old machine is a wise economic decision. The company's controller pulled together the following information on the old machine and the new possible replacement machine.

Old Machine:
Original cost	$450,100
Current accumulated depreciation	327,700
Estimated annual variable manufacturing costs for machine	74,550
Estimated selling price of machine	174,500
Estimated remaining useful life (in years)	6
New Machine:
Purchase cost	$790,800
Estimated annual variable manufacturing costs for machine	48,950
Estimated residual value	0
Estimated useful life (in years)	6

Select the relevant or irrelevant information below:

Annual variable costs of old machine	Relevant
Selling price of old machine	Relevant
Matching lives	Relevant
Purchase price of new machine	Relevant
Accumulated depreciation of old machine	Irrelevant

Fill in the differential analysis.

Replace or Keep Decision Differential Analysis Report
Cost of replacing old machine:
Annual differential decrease in cost	$
x number of years
Total differential decrease in cost
Proceeds from sale of present machine		$
Cost of new machine
Net differential (increase)/decrease in cost, six year total		$