Q10SE - Horngren'S Financial And Managerial Accounting

Question

Henderson Company manufactures electronics. The Calculator Division (an investment center) manufactures handheld calculators. The division can purchase the batteries used in the calculators from the Battery Division (another investment center) or from an outside vendor. The cost to purchase batteries from the outside vendor is \(5. The transfer price to purchase from the Battery Division is \)6. The Battery Division also sells to outside customers. The sales price is \(6, and the variable cost is \)3. The Battery Division has excess capacity. 

Requirements 

1. Should the Calculator Division purchase from the Battery Division or the outside vendor? 

2. If Henderson Company allows division managers to negotiate transfer prices, what is the maximum transfer price the manager of the Calculator Division should consider? 

3. What is the minimum transfer price the manager of the Battery Division should consider? 

4. Does your answer to Requirement 3 change if the Battery Division is operating at capacity?

Step-by-Step Solution

Answer

(1) The company should purchase from outside vendor.

(2)  Maximum transfer price the manager should consider will be $5

(3) Minimum transfer acceptable will be $3.

(4) Minimum transfer price for the battery should be $6 if battery division is operating on capacity

Step 1 : Explanation on purchase from the battery division or the outside vendor

$\begin{array}{c}\mathrm{Difference}=\mathrm{Purchase} \mathrm{from} \mathrm{battery} \mathrm{division}-\mathrm{Cost} \mathrm{to} \mathrm{purchase} \mathrm{batteries} \mathrm{from} \mathrm{outside} \mathrm{vendor}\\ =6-5\\ =\$1\end{array}$

There the calculator division should purchase from the outside vendor as they will save $1 per battery.

Step 2 : Maximum transfer price the manager should consider

The maximum transfer considered by the manager is the market price because if the transfer price is more than the calculator division will prefer to buy it from the outside market. So, the maximum price accepted should be $5.

Step 3 : Minimum transfer acceptable

The minimum transfer acceptable to the battery division is the variable cost which is incurred by the company on the battery. Hence, the minimum price for the battery division should be considered $3.

Step 4 : Minimum transfer price if battery division is operating at capacity

If the battery division is operating at its capacity then the minimum transfer price for the battery should be $6, which should be equal to the sales price for the outside customers of the company.