General Instrumentation Corporation manufactures dashboard instruments for heavy
ID: 2577704 • Letter: G
Question
General Instrumentation Corporation manufactures dashboard instruments for heavy construction equipment. The firm is based in Baltimore, but operates several divisions in the United States, Canada, and Europe. The Hudson Bay Division manufactures complex electrical panels that are used in a variety of the firm's instruments. There are two basic types of panels. The high-density panel (HDP) is capable of many functions and is used in the most sophisticated instruments, such as tachometers and pressure gauges. The low-density panel (LDP) is much simpler and is used in less complicated instruments. Although there are minor differences among the different high-density panels, the basic manufacturing process and production costs are the same. The high-density panels require considerably more skilled labor than the low-density panels, but the unskilled labor needs are about the same. Moreover, the direct materials in the high-density panel run substantially more than the cost of materials in the low-density panels. Production costs are summarized as follows:
LDP
HDP
Unskilled labor (.5 hour @ $10) …………………………………..........................
$ 5
$ 5
Skilled labor:
LDP (.25 hour @ $20) ………………………………………………………….
5
HDP (1.5 hours @ $20) ………………………………………………………...
30
Raw material ………………………………………………....................................
3
8
Purchased components ……………………………………………………………
5
15
Variable overhead …………………………………………....................................
4
12
Total variable cost …………………………………………...................................
$22
$70
The annual fixed overhead in the Hudson Bay Division is $1,000,000. There is a limited supply of skilled labor available in the area, and the division must constrain its production to 40,000 hours of skilled labor each year. This has been a troublesome problem for Jacqueline Ducharme, the division manager. Ducharme has successfully increased demand for the LDP line to the point where it is essentially unlimited. Each LDP sells for $28. Business also has increased in recent years for the HDP, and Ducharme estimates the division could now sell anywhere up to 6,000 units per year at a price of $115.
On the other side of the Atlantic, General Instrumentation operates its Volkmar Tachometer Division in Berlin. A recent acquisition of General Instrumentation, the division was formerly a German company known as Volkmar Construction Instruments. The division's main product is a sophisticated tachometer used in heavy-duty cranes, bulldozers, and backhoes. The instrument, designated as a TCH–320, has the following production costs.
TCH-320
Unskilled labor (.5 hour @ $9) ……………………………………………………………..
$ 4.50
Skilled labor (3 hour @ $17) ……………………………………………………………….
51.00
Raw material ………………………………………………..................................................
10.50
Purchased components ……………………………………………………………………...
150.00
Variable overhead …………………………………………..................................................
12.00
Total variable cost …………………………………………..................................................
$228.00
The cost of purchased components includes a $145 control pack currently imported from an Asian electronics company. Fixed overhead in the Volkmar Tachometer Division runs about $800,000 per year. Both skilled and unskilled labor are in abundant supply. The TCH–320 sells for $275.
Bertram Mueller, the division manager of the Volkmar Tachometer Division, recently attended a high-level corporate meeting in Baltimore. In a conversation with Jacqueline Ducharme, it was apparent that Hudson Bay's high-density panel might be a viable substitute for the control pack currently imported from Asia and used in Volkmar's TCH–320. Upon returning to Berlin, Mueller asked his chief engineer to look into the matter. Hans Schmidt obtained several HDP units from Hudson Bay, and a minor R&D project was mounted to determine if the HDP could replace the imported control pack. Several weeks later, the following conversation occurred in Mueller's office:
Schmidt: There's no question that Hudson Bay's HDP unit will work in our TCH–320. In fact, it could save us some money.
Mueller: That's good news. If we can buy our components within the company, we'll help Baltimore's bottom line without hurting ours. Also, it will look good to the brass at corporate if they see us working hard to integrate our division into General Instrumentation's overall production program.
Schmidt: I've also been worried about the reliability of supply of the imported control pack. I don't like being dependent on such a critical supplier that way.
Mueller: I agree. Let's look at your figures on the HDP replacement.
Schmidt: I got together with the controller's people, and we worked up some numbers. If we replace the imported control pack with the HDP from Canada, we'll avoid the $145 control pack cost we're now incurring. In addition, I figure we'll save $5.50 on the basic raw materials. There is one catch, though. The HDP will require some adjustments in order to use it in the TCH–320. We can make the adjustments here in Berlin. I'm guessing it will require an additional two hours of skilled labor to make the necessary modifications. I don't think variable overhead would be any different. Then there is the cost of transporting the HDPs to Berlin. Let's figure on $4.50 per unit.
Mueller: Sounds good. I'll give Jacqueline Ducharme a call and talk this over. We can use up to 10,000 of the HDP units per year given the demand for the TCH–320. I wonder what kind of a transfer price Hudson Bay will want.
1. From the perspective of General Instrumentation's top management, should any of the TCH–320 units be produced using the high-density panel? If so, how many?
2. Suppose Hudson Bay transfers 10,000 HDP units per year to Volkmar. From the perspective of General Instrumentation's top management, what effect will the transfer price have on the company's income?
3. What is the minimum transfer price that the Hudson Bay Division would find acceptable for the HDP?
4. What is the maximum transfer price that the Volkmar Tachometer Division would find acceptable for the HDP?
LDP
HDP
Unskilled labor (.5 hour @ $10) …………………………………..........................
$ 5
$ 5
Skilled labor:
LDP (.25 hour @ $20) ………………………………………………………….
5
HDP (1.5 hours @ $20) ………………………………………………………...
30
Raw material ………………………………………………....................................
3
8
Purchased components ……………………………………………………………
5
15
Variable overhead …………………………………………....................................
4
12
Total variable cost …………………………………………...................................
$22
$70
Explanation / Answer
Answer
1. From General Instrumentation’s Top Management perspective, TCH-320 units should be produced using HDP units because the Maximum Transfer price is greater than the minimum transfer price. Therefore, internal transfer of HDP units for production of TCH-320 is a better alternative than producing TCH-320 using imported control pack.
Since the limiting factor is 40,000 hours of skilled labor, therefore 26,666 units of HDP can be produced at the maximum. (40,000/1.5 = 26,666)
Using 26,666 units of HDP, 26,666 units of TCH-320 can be produced at the maximum. However, since the demand of TCH-320 is upto 10,000 units, These 10,000 units can be produced using the HDP units since the Maximum Transfer price is greater than the minimum transfer price.
____________________________________________________________________________________
2. Incase 10,000 units of HDP are transferred, the income statement for sale of 10,000 units of TCH-320 -
TCH-320 with import component
TCH-320 with HDP units at minimum transfer price ($ 70)
TCH-320 with HDP units at maximum transfer price ($ 106.50)
Selling Price (A)
275
275
275
Variable Cost (B)
228
186
222.5
Contribution (A – B)
47
89
52.5
Total Contribution on 10,000 units
470000
890000
525000
total Fixed overheads
-800000
-800000
-800000
Profit/Loss
-330000
90000
-275000
Incase the 10,000 units of HDP are transferred at Minimum transfer Price of 70, then there will be profit of $ 90,000 to Volkmar.
Incase the 10,000 units of HDP are transferred at Maximum transfer Price of 106.50, then there will be loss of $ 2,75,000 to Volkmar. There will be a reduction in loss for about $ 55,000.
The variable cost is calculated as below-
TCH-320 with HDP units at minimum transfer price ($ 70)
TCH-320 with HDP units at maximum transfer price ($ 106.50)
Unskilled labor 0.5 hr @ 9
4.5
4.5
Skilled labor 5 Hr @ 17
85
85
Raw Material
5
5
Purchased Component
75
111.5
Variable Overhead
12
12
Transport cost
4.5
4.5
Total
186
222.5
Note – additional 2 hours of skilled labor is required for HDP and transport cost of 4.50 per unit. Also, the purchased component cost will be reduced by the cost of imported component (145) and the transfer price will be added.
__________________________________________________________________________________
3. Minimum Transfer Price for HDP
Since there is limited supply of skilled labor i.e. 40,000 hours per year. Assuming all the skilled labor hours are used in production of HDP. The annual capacity of HDP production is 40,000/1.5 = 26,666 units. The external demand for HDP is 6,000 units.
The internal demand from Volkmar Tachometer Division is 10,000 units of HDP.
idle capacity = 26,666 – 6,000 = 20,666
Since the idle capacity is more than the internal demand (10,000 units) –
Minimum Transfer Price = Variable Cost per unit. = $ 70 per unit.
_____________________________________________________________________________________
4. Maximum Transfer Price for HDP
Maximum transfer price is the price quoted by Hudson Bay division (Supplying division) above which the Volkmar Tachometer Division (Buying Division) will not accept the HDP.
= Price of Outside Supply per unit – Additional Cost to be incurred Volkmar to HDP usable
= 145 – (2*17 + 4.50) = 145 – 38.50 = $ 106.50 per unit
Additional cost incurred are = 2 hrs of skilled labor + Transport cost per unit
_____________________________________________________________________________________
TCH-320 with import component
TCH-320 with HDP units at minimum transfer price ($ 70)
TCH-320 with HDP units at maximum transfer price ($ 106.50)
Selling Price (A)
275
275
275
Variable Cost (B)
228
186
222.5
Contribution (A – B)
47
89
52.5
Total Contribution on 10,000 units
470000
890000
525000
total Fixed overheads
-800000
-800000
-800000
Profit/Loss
-330000
90000
-275000
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