Westminster Inc. produces clocks and has two divisions: the Frames Division and

Question

Westminster Inc. produces clocks and has two divisions: the Frames Division and the Works Division. The Frames Division produces the outside casings for clocks, which it sells to the outside market. The casing for the desktop grandfather clock sells for $135. The casing has variable costs per unit of $72 and fixed costs of $280, 000, based on monthly production of 5,500 casings. Each casing could be sold to outside customers by the Frames Division, as casings are in high demand. The Frames Division has no idle capacity. The Works Division uses the casing in the production of the desktop grandfather clock, one of its most popular clocks. The market price of a desktop grandfather clock is $275. The Works Division can acquire casings from outside suppliers for $140. The manager of the Works Division is interested in purchasing 3,000 casings from the Frames Division, but he wants to negotiate for a lower transfer price of $130. The current transfer price for a casing is the full market price of $135. The fixed costs in producing desktop grandfather clocks are $104,000 and the variable cost of producing a clock is $85, excluding the cost of the casing. What is the operating profit before tax for each division using the market transfer price of $135? What is the operating profit before tax for each division using the transfer price of $130, as suggested by the manager of the Works Division? How is the company's net income affected under the two transfer pricing scenarios? Would it be more beneficial to the company if the Frames Division sold casings externally and the Works Division purchased casings from an outside supplier? Show your calculations.

Explanation / Answer

Requirement a:

Operating Profit before Tax using market transfer price of $135:

Particulars

Frames Division

Works Division

Market Price

$135

$275

Less: Transfer price from frames division

$135

Less: Variable Cost

$72

$85

Contribution Margin

$63

$55

Total Contribution

$346500 (63*5500)

$165000 (55*3000)

Less: Fixed Costs

$280000

$104000

Operating Profit before Tax

$66500

$61000

Requirement b:

Operating Profit before Tax using transfer price of $130:

Particulars

Frames Division

Works Division

Market Price

$135

$275

Less: Transfer price from frames division

$130

Less: Variable Cost

$72

$85

Contribution Margin

$63

$60

Total Contribution

$346500 (63*5500)

$180000 (60*3000)

Less: Fixed Costs

$280000

$104000

Operating Profit before Tax

$66500

$76000

Requirement c:

Operating Profit before tax increases by $15000 (76000-61000) to works division if transfer price is $130 as suggested by the manager.

Overall net income increases by $15000 as well.

Requirement d:

It would not be more beneficial if the works division purchases casings from outside suppliers instead of purchasing from Frames Division as the purchase price from outside suppliers is $140, which is more than the market transfer price and the transfer price as suggested by the manager.

Particulars

Frames Division

Works Division

Market Price

$135

$275

Less: Transfer price from frames division

$135

Less: Variable Cost

$72

$85

Contribution Margin

$63

$55

Total Contribution

$346500 (63*5500)

$165000 (55*3000)

Less: Fixed Costs

$280000

$104000

Operating Profit before Tax

$66500

$61000

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