Based on Dart Industries’ data in Exercise 24–20, assume that a transfer price of $158 has been established

Based on Dart Industries’ data in Exercise 24–20, assume that a transfer price of $158 has been established and that 40,000 units of materials are transferred, with no reduction in the Components Division’s current sales.

a. How much would Dart Industries’ total income from operations increase?

b. How much would the Instrument Division’s income from operations increase?

c. How much would the Components Division’s income from operations increase?

d.  If the negotiated price approach is used, what would be the range of accept-

able transfer prices and why?

Answer:

a. Increase in Dart Industries’ 

Income from Operations 

= 

 Market 

Price 

– 

 Variable Cost 

per Unit 

× 

Units 

Transferred 

 $2,200,000 =  ($180 –  $125) × 40,000 

This amount is the same amount by which Dart Industries’ income from 

operations increased in Ex. 24–20, when a transfer price of $145 was used. 

b. Increase in the Instrument Division’s   Market   Transfer  Units 

 Income from Operations =  Price –  Price × Transferred 

 $880,000 = ($180 –  $158) × 40,000 

This is the amount the Instrument Division saves by purchasing from the 

Components Division at an internal price that is lower than the market price. 

c. Increase in the Components Division’s   Transfer   Variable Cost  Units 

 Income from Operations = Price –  per Unit × Transferred 

 $1,320,000 =  ($158 –  $125) × 40,000 

This is the amount the Components Division earns by using available excess capacity 

to produce and sell products above variable cost to the Instrument Division. 

d. Any transfer price will cause the total income of the company to increase, 

as long as the supplier division capacity is used toward making materials for 

products that are ultimately sold to the outside. However, transfer prices should 

be set between variable cost and selling price in order to give the division 

managers proper incentives. A transfer price set below variable cost would 

cause the supplier division to incur a loss, while a transfer price set above 

market price would cause the purchasing division to incur opportunity costs. 

Neither situation is an attractive alternative for an investment center manager. 

Thus, the general rule is to negotiate transfer prices between variable cost and 

market price when the supplier division has excess capacity. The range of 

acceptable transfer prices for Dart Industries would be between $180 and $125.