23PGA

Question

The Harris Company is decentralized, and divisions are considered investment centers. Harris has one division that manufactures oak dining room chairs with upholstered seat cushions. The Chair Division cuts, assembles, and finishes the oak chairs and then purchases and attaches the seat cushions. The Chair Division currently purchases the cushions for \(22 from an outside vendor. The Cushion Division manufactures upholstered seat cushions that are sold to customers outside the company. The Chair Division currently sells 800 chairs per quarter, and the Cushion Division is operating at capacity, which is 800 cushions per quarter. The two divisions report the following information:

Chair Division Cushion Division

Sales Price per Chair \) 85 Sales Price per Cushion \( 32

Variable Cost (other than cushion) 42 Variable Cost per Cushion 13

Variable Cost (cushion) 22

Contribution Margin per Chair \) 21 Contribution Margin per Cushion $ 19

Requirements

1. Determine the total contribution margin for Harris Company for the quarter.

2. Assume the Chair Division purchases the 800 cushions needed from the Cushion Division at its current sales price. What is the total contribution margin for each division and the company?

3. Assume the Chair Division purchases the 800 cushions needed from the Cushion Division at its current variable cost. What is the total contribution margin for each division and the company?

4. Review your answers for Requirements 1, 2, and 3. What is the best option for Harris Company?

5. Assume the Cushion Division has capacity of 1,600 cushions per quarter and can continue to supply its outside customers with 800 cushions per quarter and also supply the Chair Division with 800 cushions per quarter. What transfer price should Harris Company set? Explain your reasoning. Using the transfer price you determined, calculate the total contribution margin for the quarter.

Step-by-Step Solution

Verified

Answer

Question	Contribution of Chair division	Contribution of Cushion division	Contribution of Company

1.	$16,800	$15,200	$32,000
2.	$8,800	$15,200	$24,000
3.	$24,000	$0	$24,000
4.	Purchase from outside	Sold to outside
5.	Transfer price $32 per unit
$8,800	$30,400	$39,200

1Computation of total contribution margin

$\begin{matrix} C o n t r i b u t i o n m a r g i n b y c h a i r d i v i s i o n = T o t a l s a l e s r e v e n u e - T o t a l v a r i a b l e c o s t \\ = ($ 85 \times 800) - (($ 42 + $ 22) \times 800) \\ = $ 68, 000 - $ 51, 200 \\ = $ 16, 800 \end{matrix}$

$\begin{matrix} C o n t r i b u t i o n m a r g i n b y c u s h i o n d i v i s i o n = T o t a l s a l e s r e v e n u e - T o t a l v a r i a b l e c o s t \\ = ($ 32 \times 800) - ($ 13 \times 800) \\ = $ 25, 600 - $ 10, 400 \\ = $ 15, 200 \end{matrix}$

$\begin{matrix} TotalcontributionmarginforHarrisCompany = Contribution margin by chair company + Contribution margin by cushion company \\ = $ 16, 800 + $ 15, 200 \\ = $ 32, 000 \end{matrix}$

2Contribution margin in case of transfer between divisions at the selling price

$\begin{matrix} N e w C o n t r i b u t i o n m a r g i n b y c h a i r d i v i s i o n = T o t a l s a l e s r e v e n u e - T o t a l v a r i a b l e c o s t \\ = ($ 85 \times 800) - (($ 42 + $ 32) \times 800) \\ = $ 68, 000 - $ 59, 200 \\ = $ 8, 800 \end{matrix}$

$\begin{matrix} C o n t r i b u t i o n m a r g i n b y c u s h i o n d i v i s i o n = C u r r e n t C o n t r i b u t i o n p e r u n i t \times N o . o f u n i t s s o l d \\ = $ 19 \times 800 \\ = $ 15, 200 \end{matrix}$

3Contribution margin in case of transfer between divisions at variable cost

$\begin{matrix} N e w C o n t r i b u t i o n m a r g i n b y c h a i r d i v i s i o n = T o t a l s a l e s r e v e n u e - T o t a l v a r i a b l e c o s t \\ = ($ 85 \times 800) - (($ 42 + $ 13) \times 800) \\ = $ 68, 000 - $ 44, 000 \\ = $ 24, 000 \end{matrix}$

$\begin{matrix} N e w C o n t r i b u t i o n m a r g i n b y c u s h i o n d i v i s i o n = T o t a l s a l e s r e v e n u e - T o t a l v a r i a b l e c o s t \\ = ($ 13 \times 800) - ($ 13 \times 800) \\ = $ 0 \end{matrix}$

$\begin{matrix} T o t a l c o n t r i b u t i o n m a r g i n f o r H a r r i s C o m p a n y = C o n t r i b u t i o n m a r g i n b y c h a i r c o m p a n y + C o n t r i b u t i o n m a r g i n b y c u s h i o n c o m p a n y \\ = $ 24, 000 + $ 0 \\ = $ 24, 000 \end{matrix}$

4Best option for Harris Company

After computing the contribution margin from all the case i.e. –

a) Purchase from outside

b) Purchase from the division at selling price, and

c) Purchase from the division at variable, and

it comes to the notice that each division earns almost the same contribution margin under the first case and the total contribution margin for the company is also highest under the first case.

Under the second case, the contribution margin for the cushion division remains constant but the contribution margin for the chair division and the total contribution margin decrease.

Under the third case, the contribution margin for the chair division increases but the overall contribution margin for the company decreases and the cushion division earns zero margins.

Thus the best option for the company is to purchase the cushion from an outside vendor. By doing so, each division would earn a satisfactory contribution margin and the overall contribution margin for the company would also increase.

5Computation of transfer price

As given the revised capacity for the cushion, the division is 1,600 units and the division is operating at capacity by selling units to vendors and to the chair division.

Thus in this case, the transfer price should be equal to the selling price i.e.- $32 per unit. The reason for this is that if the cushion department charges less transfer price from the chair department then the contribution margin for the division would decrease and the company too would encounter a decreased contribution margin due to the operating at capacity by the cousin division.

Thus the transfer price = $32

Computation of contribution margin under this case

$\begin{matrix} N e w C o n t r i b u t i o n m a r g i n b y c u s h i o n d i v i s i o n = C u r r e n t C o n t r i b u t i o n p e r u n i t \times N o . o f u n i t s s o l d \\ = $ 19 \times 1, 600 \\ = $ 30, 400 \end{matrix}$

\begin{matrix} T o t a l c o n t r i b u t i o n m a r g i n f o r H a r r i s C o m p a n y = C o n t r i b u t i o n m a r g i n b y c h a i r c o m p a n y + C o n t r i b u t i o n m a r g i n b y c u s h i o n c o m p a n y \\ = $ 8, 800 + $ 30, 400 \\ = $ 39, 200 \end{matrix}

22PGA

24 PGB

Other exercises in this chapter

21PGA

Consider the following condensed financial statements of Forever Free, Inc. The company’s target rate of return is 40%.Forever Free, IncIncome StatementFo

View solution

22PGA

Wolf Paints is a national paint manufacturer and retailer. The company is segmented into five divisions: Paint Stores (branded retail locations), Consumer (pain

View solution

24 PGB

One subunit of Track Sports Company had the following financial results last month: Subunit X Actual Results

View solution

25 PGB

Using ROI and RI to evaluate investment centersConsider the following condensed financial statements of Pure Life, Inc. The company’s target rate of retur

View solution