Brown's Mill has two operating units,each of which is considered an investment center for evaluation purposes.The Cutting Division of the mill prepares timber at its sawmills.Afterwards,the Assembly Division prepares the cut lumber into finished wood,to be sold to furniture manufacturers.During the most recent year,the Cutting Division produced 120,000 cords of wood,at a total cost of $1,320,000.The entire output was transferred to the Assembly Division,where additional costs of $6 per cord were incurred.The 1,200,000 board-feet of finished wood were then sold in the open market for $5,000,000.
Required:
1.Determine the operating income for each division if the transfer price from the Cutting Division to the Assembly Division is set at cost,$11 per cord.
2.Determine the operating income for each division if the transfer price is set at $9 per cord.
3.Since the Cutting Division sells all of its output internally,does the manager care about what price is charged? Why? Should the Cutting Division in this case be considered a cost center or a profit/investment center?

Question

Quizplus · Accepted Answer

Feedback: 1.Transfer price set at $11 per cord: 11ea6e70_bd73_15da_8f54_b9d75136f8de_TB1699_00 2.Transfer price set at $9 per cord: 11ea6e70_bd73_15db_8f54_8d560c9f8a9f_TB1699_00 3.As indicated by the calculations presented above in (a)and (b),the manager of the Cutting Division probably cares very much whether the division is treated as a cost or profit (or investment)center for performance-evaluation purposes.If the Cutting Division has the option or opportunity of selling outside,then there are reasons why it should be considered a profit or investment center.On the other hand,if we envision that the Cutting Division will remain a captive supplier of the Assembly Division,then it should probably be evaluated as a cost center,in which case the issue of transfer pricing is not important from its perspective.Note that to be considered a profit or an investment center,there is a presumption that the manager of the division exercises control over costs incurred and revenues generated (and,in the case of an investment center,level of investment in the division).It does not appear that such control exists in the current situation.

Brown's Mill Has Two Operating Units,each of Which Is Considered