Allied Company’s Small Motor Division manufactures a number of small motors used

Question

Allied Company’s Small Motor Division manufactures a number of small motors used in household and office appliances. The Household Division of Allied then assembles and packages such items as blenders and juicers. Both divisions are free to buy and sell any of their components internally or externally. The following costs relate to small motor LN233 on a per unit basis.

Fixed cost per unit

$5

Variable cost per unit

$8

Selling price per unit

$30

Instructions

(a) Assuming that the Small Motor Division has excess capacity, compute the minimum acceptable price for the transfer of small motor LN233 to the Household Division.

(b) Assuming that the Small Motor Division does not have excess capacity, compute the minimum acceptable price for the transfer of the small motor to the Household Division.

(c) Explain why the level of capacity in the Small Motor Division has an effect on the transfer price.
(Essentials of Accounting, 4th Edition. John Wiley & Sons p. 514).
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Explanation / Answer

(a) Since Small Motor Division has excess capacity, its fixed costs are being recovered by existing volumes. So if it can recover its var costs per motor, it will not incur any loss. SO Minimum txfer price will be = Var cost pu = $8 (b) If Small Motor Division doesn't have exces capacity, it will incur addl period or fixed costs beyond full capacity. Thus its cost of production will be $8+$5 = $13 pu. So minimum accpetable txfer price will be $13 pu (c) Level of capaity impacts total costs. We know that period costs are fixed costs which are valid for a stated or rated capacity. THus fixed costs remain constant as long as rated capaicty is not exceeded beyond which the fixed costs tend to increase. Hence when in case (a), excess capacity was available, only var cost was considered for txfer prcing. However in case (b), as rated capaity has reached, proodcution would hav ereqd addl investments in producing extra units. Hence in such case, fixed cost + Var cost was used for txfer pricing

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