Case 13-52 Interdivisional Transfers; Pricing the Final Product (LO 13-6, 13-7, 13-8)

Continental Industries is a diversified corporation with separate operating divisions. Each divisions performance is evaluated on the basis of profit and return on investment. The Air Comfort Division manufactures and sells air-conditioner units. The coming years budgeted income statement, which follows, is based upon a sales volume of 15,000 units.

AIR COMFORT DIVISION
Budgeted Income Statement
(In thousands)
	Total			Per Unit
Sales revenue	$	6,285		$	419
Manufacturing costs:
Compressor	$	1,170		$	78
Other direct material		540			36
Direct labor		570			38
Variable overhead		615			41
Fixed overhead		330			22
Total manufacturing costs	$	3,225		$	215
Gross margin	$	3,060		$	204
Operating expenses:
Variable selling	$	360		$	24
Fixed selling		345			23
Fixed administrative		495			33
Total operating expenses	$	1,200		$	80
Net income before taxes	$	1,860		$	124

Air Comforts division manager believes sales can be increased if the price of the air-conditioners is reduced. A market research study by an independent firm indicates that a 4 percent reduction in the selling price would increase sales volume 23 percent, or 3,450 units. The division has sufficient production capacity to manage this increased volume with no increase in fixed costs.

The Air Comfort Division uses a compressor in its units, which it purchases from an outside supplier at a cost of $78 per compressor. The Air Comfort Division manager has asked the manager of the Compressor Division about selling compressor units to Air Comfort. The Compressor Division currently manufactures and sells a unit to outside firms which is similar to the unit used by the Air Comfort Division. The specifications of the Air Comfort Division compressor are slightly different, which would reduce the Compressor Divisions direct material cost by $3.40 per unit. In addition, the Compressor Division would not incur any variable selling costs in the units sold to the Air Comfort Division. The manager of the Air Comfort Division wants all of the compressors it uses to come from one supplier and has offered to pay $47 for each compressor unit.

The Compressor Division has the capacity to produce 75,000 units. Its budgeted income statement for the coming year, which follows, is based on a sales volume of 64,000 units without considering Air Comforts proposal.

COMPRESSOR DIVISION
Budgeted Income Statement
(In thousands)
	Total			Per Unit
Sales revenue	$	5,888		$	92
Manufacturing costs:
Direct material	$	768		$	12
Direct labor		512			8
Variable overhead		640			10
Fixed overhead		832			13
Total manufacturing costs	$	2,752		$	43
Gross margin	$	3,136		$	49
Operating expenses:
Variable selling	$	384		$	6
Fixed selling		256			4
Fixed administrative		448			7
Total operating expenses	$	1,088		$	17
Net income before taxes	$	2,048		$	32

Required:

1-a.

Calculate the increase/decrease in net income before taxes for Continental Industries assuming the Air Comfort Division institutes the 4 percent price reduction on its air-conditioner units even if it cannot acquire the compressors internally for $47 each. (Round intermediate calculations to 2 decimal places and your final answer to the nearest whole dollar amount. Enter your answer in dollars and not in thousands.)

in net income before taxes of

1-b.	Should the Air Comfort Division institute the 4 percent price reduction?
	Yes No

2.

Independently of your answer to Required 1-a, assume the Air Comfort Division needs 18,450 units. Calculate the increase/decrease in net income before taxes for the Compressor Division if it supplies the 18,450 compressor units for $47 each. (Round intermediate calculations to 2 decimal places and your final answer to the nearest whole dollar amount. Enter your answer in dollars and not in thousands.)

in net income before taxes of

3.

Independently of your answer to Required 1-a, assume the Air Comfort Division needs 18,450 units units. Calculate the increase/decrease in net income before taxes for Continental Industries if the Compressor Division supplies the 18,450 compressor units for $47 each. (Enter your answer in dollars and not in thousands.)

in net income before taxes of