Materials used by Square Yard Products Inc. in producing Division 3's product are currently purchased from outside suppliers at a cost of $5 per unit. However, the same materials are available from Division 6. Division 6 has unused capacity and can produce the materials needed by Division 3 at a variable cost of $3 per unit. A transfer price of $3.20 per unit is established, and 40,000 units of material are transferred, with no reduction in Division 6's current sales. How much would Square Yard Products total income from operations increase?
A) $32,000
B) $112,000
C) $80,000
D) $150,000

Question

Quizplus · Accepted Answer

If Square Yard Products Inc. purchases materials from outside suppliers, the cost will be $5 per unit, but if they purchase the materials from Division 6, the cost will be $3.20 per unit (transfer price). Therefore, Square Yard Products can save $1.80 per unit. As they are transferring 40,000 units of material, their cost savings will be $72,000 (40,000 x $1.80).

Thus, the total income from operations will increase by $80,000 ($72,000 cost savings + $8,000 profit from Division 6), which is the difference between the cost of purchasing from outside suppliers and the cost of purchasing from Division 6, plus the additional profit from Division 6. Therefore, the best choice is C ($80,000).

Materials Used by Square Yard Products Inc