| Better Food Company recently acquired an olive oil processing company | ||||||
| that has an annual capacity of 2,000,000 liters, and that processed and sold | ||||||
| 1,400,000 liters last year at a price of $4 per liter. The purpose of the | ||||||
| acquisition was to furnish oil for the Cooking Division. The Cooking | ||||||
| Division needs 800,000 liters of oil per year. It has been purchasing oil | ||||||
| from supplies at the market price. Production costs at capacity of the olive | ||||||
| oil company, now a division, are as follows: | ||||||
| Direct materials per liter | $ 1.00 | |||||
| Direct processing labor | $ 0.50 | |||||
| Variable processing overhead | $ 0.24 | |||||
| Fixed processing overhead | $ 0.40 | |||||
| Total | $ 2.14 | |||||
| Management is trying to decide what transfer price to use for sales from | ||||||
| the newly acquired company to the Cooking Division. The manager of the | ||||||
| Olive Oil Division argues that $4, the market price, is appropriate. The | ||||||
| manager of the Cooking Division argues that the cost of $2.14 should be | ||||||
| used, or perhaps a lower price, since fixed overhead cost should be | ||||||
| recomputed with the larger volume. Any output of the Olive Oil Division not | ||||||
| sold to the Cooking Division can be sold to outsiders for $4 per liter. | ||||||
| Required: | ||||||
| a | Compute the operating income for the Olive Oil Division using a | |||||
| transfer price of $4. | ||||||
| b | Compute the operating income for the Olive Oil Division using a | |||||
| transfer price of $2.14. | ||||||
| c | What transfer price(s) do you recommend? Compute the operating | |||||
| income for the Olive Oil Division using your recommendation. | ||||||
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