Chapter 24: Q25RQ (page 1355)
What is a transfer price?
Answer
Transfer price is the consideration amount paid by one unit of an organization to another unit.
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Wolf Paints is a national paint manufacturer and retailer. The company is segmented into five divisions: Paint Stores (branded retail locations), Consumer (paint sold through home improvement stores), Automotive (sales to auto manufacturers), International, and Administration. The following is selected divisional information for its two largest divisions: Paint Stores and Consumer.
Net Sales Operating Average
Revenue Income Total Assets
Paint Stores \( 3,980,000 \) 476,000 $ 1,380,000
Consumer 1,315,000 195,000 1,600,000
Management has specified a 21% target rate of return.
Requirements
1. Calculate each division’s ROI. Round all of your answers to four decimal places.
2. Calculate each division’s profit margin ratio. Interpret your results.
3. Calculate each division’s asset turnover ratio. Interpret your results.
4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.
5. Calculate each division’s RI. Interpret your results, and offer a recommendation for any division with negative RI.
6. Describe some of the factors that management considers when setting its minimum target rate of return.
Explain the difference between a lag indicator and a lead indicator.
Decentralization divides company operations into various reporting units. Most decentralized subunits can be described as one of four different types of responsibility centers.
Requirements
1. Explain why companies decentralize. Describe some typical methods of decentralization.
2. List the four most common types of responsibility centers, and describe their responsibilities.
Refer to the information in Short Exercise S24-7. Compute each division’s RI. Interpret your results. Are your results consistent with each division’s ROI?
Question: Determining transfer pricing
The Hernandez Company is decentralized, and divisions are considered investment centers. Hernandez 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 \(32 from an outside vendor. The Cushion Division manufactures upholstered seat cushions that are sold to customers outside the company. The Chair Division currently sells 1,800 chairs per quarter, and the Cushion Division is operating at capacity, which is 1,800 cushions per quarter. The two divisions report the following information:
Chair Division Cushion Division
Sales Price per Chair \) 95 Sales Price per Cushion \( 34
Variable Cost (other than cushion) 56 Variable Cost per Cushion 12
Variable Cost (cushion) 32
Contribution Margin per Chair \) 7 Contribution Margin per Cushion $ 22
Requirements
1. Determine the total contribution margin for Hernandez Company for the quarter.
2. Assume the Chair Division purchases the 1,800 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 1,800 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 Hernandez Company?
5. Assume the Cushion Division has capacity of 1,800 cushions per quarter and can continue to supply its outside customers with 1,800 cushions per quarter and also supply the Chair Division with 1,800 cushions per quarter. What transfer price should Hernandez Company set? Explain your reasoning. Using the transfer price you determined, calculate the total contribution margin for the quarter.
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