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 $210 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 $174 per unit. a. If a transfer price of $191 per unit is established and 45,700 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

Answer a

Note : For Armstrong Motors company as a whole the difference between purchase price of materials & variable cost for manufacturing materials will result in saving in expense of $36 per unit ($210 - $174)

Increase in Armstrong Motor's total income from operation = 45,700 units * ($210 - $174) = $1,645,200

Answer b

Note : For Truck Division the difference between purchase price of materials & transfer price materials will result in saving in expense of $19 per unit ($210 - $191)

Increase in Truck Division's total income from operation = 45,700 units * ($210 - $191) = $868,300

Answer c

Note : For Component Division the difference between transfer price of materials & variable cost for manufacturing materials will result in operational income of $17 per unit ( $191 - $174).

Increase in Component Division's total income from operation = 45,700 units * ( $191 - $174) = $776,900

CROSS CHECK

Increse of  total income from operation for both the divisions together must be equal to the increse of total income from operation for the company as a whole

Increase in Truck Division's total income + Increase in Component Division's total income

$868,300 + $776,900 =  $1,645,200 (which is equal to the amount computed in Ans.a)

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