P12.38 Interdivisional transfers; pricing the final product: manufacturer LO 12.11 Palmer Industries is a diversified corporation with separate operating divisions. Each division's performance is 12.13 evaluated on the basis of profit and return on investment. The KoolAir Division manufactures and sells air-conditioning units. The coming year's budgeted profit statement, which follows, is based on a sales volume of 15 000 units. 612 PART THREE INFORMATION FOR MANAGING RESOURCES KoolAir Division Budgeted profit statement Per unit Total (in S'000s) $12000 5800 Sales revenue Manufacturing costs: SHO STO ale in Edition by Langfield Smith - 16.pdl 637 1132 KoolAlr Division Budgeted profit statement Per unit Total (In $'ooos) $12000 $800 $140 $ 2100 1 110 74 60 900 90 1 350 Sales revenue Manufacturing costs: Compressor Other direct material Direct labour Variable overhead Fixed overhead Total manufacturing costs Gross margin Operating expenses: Variable selling Fixed selling Fixed administrative Total operating expenses Net profit before taxes 64 S428 960 $ 6420 $ 5580 $372 36 38 $ 540 570 76 $150 1 140 $ 2 250 $222 $ 3330 The manager of the KoolAir Division believes that sales can be increased if the price of the air conditioners is reduced. Market research by an independent firm indicates that a 5 per cent reduction in the selling price The manager of the KoolAir Division believes that sales can be increased if the price of the air conditioners is reduced. Market research by an independent firm indicates that a 5 per cent reduction in the selling price would increase sales volume by 20 per cent, or 3 000 units. KoolAir has sufficient production capacity to manage this increased volume with no increase in fixed costs. KoolAir uses a compressor in its units, which it purchases from an outside supplier at a cost of $80 per compressor. The division manager of KoolAir has asked the manager of the components division about selling compressor units to KoolAir. The components division currently manufactures and sells a compressor to outside firms, but the specifications of the KoolAir compressor are slightly different. Producing compressors to suit Kool Air's specifications would reduce direct material cost by $2 per unit. In addition, the components division would not incur any variable selling costs in the units sold to KoolAir. The manager of KoolAir wants all the compressors it uses to come from one supplier, and has offered to pay $60 for each compressor unit. The components division has capacity to produce 75 000 compressors. Its budgeted profit statement for the coming year, which follows, is based on a sales volume of 64 000 units, without considering KoolAir's proposal. Components division Budgeted profit statement Per unit Total (In $'000s) $7040 $110 Sales revenue Manufacturing costs: Direct material $ 18 SI 152 Components division Budgeted profit statement Per unit Total (In $'000s) $7040 $110 Sales revenue Manufacturing costs: Direct material Direct labour Variable overhead Fixed overhead $ 18 12 15 $1 152 768 960 15 960 CHAPTER TWELVE MANAGING AND REPORTING PERFORMANCE MANAGIN 613 $60 $50 $3 840 $3200 Total manufacturing costs Gross margin Operating expenses Variable selling Fixed selling $9 $ 576 384 6 CHAPTER TWELVE MANAGING AND REPORTING PERFORMANCE 613 $60 $50 $3 840 $3200 $9 Total manufacturing costs Gross margin Operating expenses Variable selling Fixed selling Fixed administrative Total operating expenses Net profit before taxes 6 12 $27 $ 576 384 768 SI 728 $1 472 S23 Required: 1. Should KoolAir institute the 5 per cent price reduction on its air-conditioning units even if it cannot acquire the compressors internally for $60 each? Support your conclusion with appropriate calculations. 2. Independent of your answer to requirement 1, assume that KoolAir needs 18 000 units. Should the Components Division be willing to supply the compressor units for $60 each? Support your conclusions with appropriate calculations. Question One: Transfer pricing Langfield-Smith Problem 12.38 (Requirements 1 and 2 only) Note: There is an error in the textbook case information relating to the cost of the compressor (1" line, second paragraph, p.612). The cost should be $140 instead of $80 per compressor. This is consistent with the KoolAir Division's Budgeted Profit Statement. Additional Questions a) Following from P12.38, requirement 2 where KoolAir needs 18,000 units of compressors, use the general transfer pricing rule to calculate the transfer price that Components Division should charge KoolAir for 1 compressor b) Prepare profit and loss statements to calculate the profit/loss for Components Division, KoolAir Division and Palmer Industries if Components Division: i. Decides to sell 18,000 compressors to KoolAir based the transfer price calculated in (a). ii. Decides not to sell 18,000 compressors to KoolAir. c) If the bonus of the Components Division's manager is based on divisional profits, given the calculations in part (b), will she/he accept or reject KoolAir's offer? Is this an "goal congruent" decision? Explain Final Answers: The final answers to calculation questions are presented below, so you can check your own answers. If you have are unable to reach these answers, please raise your questions during the on-line tutorial. Part 1: The KoolAir Division should reduce the price of its air conditioners by 5% because their net profit would increase by $480,000. Part 2: The Components Division should not sell all 18,000 units to the KoolAir Division for $60 each because their net profit will decrease by $86,000. Additional Questions Part A: Transfer price for one compressor = $64.78 (rounded up) Part B: Prepare P&L for the Components and KoolAir Division; and Palmer Industries if: (i) Components Division sells 18,000 to KoolAir Division for $64.78 Component Koollir Palmer Division Division Industries Net profit $1,472,000 $5,164,000 $6,636,000 I (ii) Components Division do not sell to KoolAir Division Component KoolAir Division Division Net profit $1,472,000 $3,810,000 Palmer Industries $5,282,000 with appropriate calculations CHAPTER TWELVE MANAGING AND REPORTING PERFORMANCE 613 $60 $50 $3 840 $3 200 $9 Total manufacturing costs Gross margin Operating expenses: Variable selling Fixed selling Fixed administrative Total operating expenses Net profit before taxes 6 12 $ 576 384 768 $1 728 $1 472 $27 $23 Required: 1. Should KoolAir Institute the 5 per cent price reduction on its air-conditioning units even if it cannot acquire the compressors internally for $60 each? Support your conclusion with appropriate calculations. 2. Independent of your answer to requirement 1, assume that koolAir needs 18 000 units. Should the Components Division be willing to supply the compressor units for $60 each? Support your conclusions with appropriate calculations