Question

Materials used by Ford company in producing Division A's product are currently purchased from outside suppliers at a cost of $30 per unit. However, the same materials are available from Division B. Division B has unused capacity and can produce the materials needed by Division A at a variable cost of $20 per unit. If a transfer price of $25 per unit is established and 60,000 units of material are transferred with no reductions in Division B's current sales, how much would Ford company's total operating income increase? Fill in the blank: _________. How much would the operating income of Division A increase? Fill in the blank: _________. How much would the operating income of Division B increase? Fill in the blank: _________. If the negotiated price approach is used, what would be the range of acceptable transfer prices? Round your answer to two decimal places.

Answer 1

Total operating income for Ford Company would increase by $600,000, Division A's operating income would increase by $300,000, and Division B's operating income would also increase by $300,000. The range of acceptable transfer prices is $20.01 to $29.99 per unit.

Step-by-step explanation:

Calculation of Increase in Operating Income

If Division A purchases the materials from Division B at a transfer price of $25 per unit instead of $30 from an external supplier, Division A saves $5 per unit (difference between external price and internal transfer price). For the transfer of 60,000 units, the total savings for Division A would be 60,000 units × $5/unit, which equates to a $300,000 increase in operating income for Division A.

On the other hand, Division B's variable cost is $20 per unit and the transfer price is $25 per unit, this provides Division B with a profit of $5 per unit. Thus, Division B's increase in operating income would be 60,000 units × $5/unit, which results in a $300,000 increase for Division B.

For Ford Company as a whole, since there are no reductions in Division B's sales, the increase in total operating income is the sum of the increases of both divisions, which is a $600,000 increase in total operating income.

Regarding the range of acceptable transfer prices using the negotiated price approach, any price above Division B's variable cost of $20 per unit and below Division A's external purchase price of $30 per unit would be acceptable. Therefore, the range of acceptable transfer prices is $20.01 to $29.99, ensuring both divisions benefit from the internal transfer.