(Appendix 12A)The Red River Division of Alto Company produces and sells bags of pottery clay which can either be sold to outside customers or transferred to the White Mountain Division of Alto Company.The following data are available for the last year: By selling to the White Mountain Division, the Red River Division will avoid $3 per bag in selling costs. If Red River can sell 15, 000 bags annually to outside customers, according to the formula in the text, what is the lowest acceptable transfer price from the viewpoint of the selling division?
A)$20 per bag
B)$16 per bag
C)$11 per bag
D)$14 per bag

Question

(Appendix 12A)The Red River Division of Alto Company produces and sells bags of pottery clay which can either be sold to outside customers or transferred to the White Mountain Division of Alto Company.The following data are available for the last year:   By selling to the White Mountain Division, the Red River Division will avoid $3 per bag in selling costs. If Red River can sell 15, 000 bags annually to outside customers, according to the formula in the text, what is the lowest acceptable transfer price from the viewpoint of the selling division?
A)$20 per bag 
B)$16 per bag 
C)$11 per bag 
D)$14 per bag

Quizplus · Accepted Answer

Available capacity for outside sales = Capacity - Internal sales
= 18, 000 bags - 6, 000 bags = 12, 000 bags
Lost outside sales = Total outside demand - Available capacity for outside sales
= 15, 000 bags - 12, 000 bags = 3, 000 bags
Total contribution margin on lost sales = CM per unit × Lost outside sales
= [$20 per bag - ($10 per bag + $4 per bag)] × 3, 000 bags = $18, 000
From the perspective of the selling division, profits would increase as a result of the transfer if and only if:
Transfer price > Variable cost per unit + Opportunity cost per unit
Transfer price > Variable cost per unit + (Total contribution margin on lost sales ÷ Number of units transferred)
Transfer price > [$10 per bag + ($4 per bag - $3 per bag)] + ($18, 000 ÷ 6, 000 bags)= $11 per bag + $3 per bag = $14 per bag

(Appendix 12A)The Red River Division of Alto Company Produces and Sells