Decision on Transfer Pricing Materials used by the Truck Division of Armstrong M

Question

Decision on Transfer Pricing Materials used by the Truck Division of Armstrong Motors are currently purchased from outside suppliers at a cost of $389 per unit. However, the same materials are available from the Components Division. The Components Division has unused capacity and can produce the materials needed by the Truck Division at a variable cost of $323 per unit. a. If a transfer price of $354 per unit is established and 33,600 units of materials are transferred, with no reduction in the Components Division's current sales, how much would Armstrong Motors' total income from operations increase? $ b. How much would the Truck Division's income from operations increase? $ c. How much would the Components Division's income from operations increase? $

Explanation / Answer

a)

Component Division

As the Components division has spare capacity, production and transfer of 33600 units of materials to truck division will not increase its fixed cost.

Transfer price per unit                                   = $ 354

Less: variable cost per unit                           = $ 323

Contribution per unit                                     = $ 31

Truck Division

Purchase price per unit                        = $389

Less: transfer price                              = $354

Saving in purchase price per unit = $35

Increase in the total income of Armstrong’s motors

Increase in income of Component division from additional contribution = 33600 units x $31/unit   = $1041600

Increase in income of Truck division from saving of purchase cost = 33600 units x $35 / unit = $1176000 Total increase in income of Armstrong Motors   = $2217600

b) Truck division's income will increase by $1176000

c) Component division's income will increase by $ 1041600   

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