Avery Company has two divisions, Polk and Bishop. Polk produces an item that Bishop could use in its production. Bishop currently is purchasing 22,000 units from an outside supplier for $14 per unit. Polk is currently operating at less than its full capacity of 580,000 units and has variable costs of $7 per unit. The full cost to manufacture the unit is $13. Polk currently sells 450,000 units at a selling price of $17 per unit. A. What will be the effect on Avery Company’s operating profit if the transfer is made internally?
B. What is the minimum transfer price from Polk’s perspective?C. What is the maximum transfer price from Bishop’s perspective?

Answer :

a) Impact on profit increased by $154,000

b) Minimum transfer price = $7

c) Maximum transfer price from Bishop's perspective= $14

Explanation :

As per the data given in the question,

a) Effect on operating profit :

Purchase price from outside = $14 per unit

Variable cost of production internally = $7

Profit per unit = $7

Total number of units = 22,000

Total increment in operating profit is

= 22,000 units  × $7

= $154,000

In this case the fixed cost is to ignored

b) Minimum transfer price :

Since, Polk has excess capacity so there will be no increment in fixed cost and Polk would recover its variable cost which is $7

Hence, Minimum transfer price = $7

c) Maximum transfer price from perspective of Bishop :

If price i.e internal is more than $14, there would be a loss For Bishop so it would be purchase from outside due to which the whole company will lose the incremental operating profit of $154,000

Hence, Maximum transfer price = $14