Question

The Mill Flow Company has two divisions. The Cutting Division prepares timber at its sawmills. The Assembly Division prepares the cut lumber into finished wood for the furniture industry. No inventories exist in either division at the beginning of 2015. During the year, the Cutting Division prepared 60,000 cords of wood at a cost of $660,000. All the lumber was transferred to the Assembly Division, where additional operating costs of $6 per cord were incurred. The 600,000 boardfeet of finished wood were sold for $2,500,000.

Required:
a. Determine the operating income for each division if the transfer price from Cutting to Assembly is at cost - $11 a cord.
b. Determine the operating income for each division if the transfer price is $9 per cord.
c. Since the Cutting Division sells all of its wood internally to the Assembly Division, does the manager care what price is selected? Why? Should the Cutting Division be a cost center or a profit center under the circumstances?

Answer 1

A. Cutting Assembly

Operating income $ 0 $1,480,000

B. Cutting Assembly

Operating income ($120,000) $1,600,000

C. Yes, the manager does care what price is selected becausethe manager what to know whether it is either cost center or profit center

Cutting Division should be a COST CENTER

Step-by-step explanation:

a. Calculation to Determine the operating income for each division if the transfer price from Cutting to Assembly is at cost - $11 a cord.

CUTTING ASSEMBLY

Revenue $660,000 $2,500,000

Cost of services:

Incurred $ 660,000 $ 360,000

(60,000*$11=$660,000)

(60,000*$6=$360,000)

Transferred-in $0 $660,000

Total Cost $ 660,000 $1,020,000

($660,000+$0=$660,000)

($360,000+$660,000=$1,020,000)

Operating income $ 0 $1,480,000

($660,000-$660,000=$0)

($2,500,000-$1,020,000=$1,480,000)

Therefore the operating income for each division if the transfer price from Cutting to Assembly is at cost - $11 a cord will be :

Cutting Assembly

Operating income $ 0 $1,480,000

b. Calculation to determine the operating income for each division if the transfer price is $9 per cord.

CUTTING ASSEMBLY

Revenue $540,000 $2,500,000

(60,000*$9=$540,000)

Cost of services:

Incurred $660,000 $360,000

(60,000*$11=$660,000)

(60,000*$6=$360,000)

Transferred-in $0 $540,000

(60,000*$9=$540,000)

Total Cost

$660,000 $900,000

($660,000+$0=$660,000)

($360,000+$540,000=$900,000)

Operating income ($120,000) $1,600,000

($540,000-$660,000=$120,000)

($2,500,000-$900,000=$1,600,000)

Therefore the operating income for each division if the transfer price is $9 per cord will be :

Cutting Assembly

Operating income ($120,000) $1,600,000

c. Yes, Based on the above calculation for both (a) and (b) in a situation where the Cutting Division sold all of its wood internally to the Assembly Division, the manager does care about what price is selected reason been that the manager what to know whether it is either cost center or profit center when carrying out performance evaluation.

Based on the above calculation Under the circumstances the Cutting Division should be a COST CENTER.