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Question Man Co (Mar/Jun 16 amended)
For part a) of this question, I am confused as to how the incremental profit/loss should be calculated. How to approach this question and from where to start calculating it.
For part b) of this question, I replaced the cost of component L of 40 with the 37 external purchase price as this was lower. Is it correct. Also , how to draw a profit statement for the group as a whole, e.g. should the selling price of 96 or 40 be used when drawing up the group profit statement.
For part (a), as far as the group is concerned, the cost of making product L and transferring it internally is 12 + 6 + 2 = $20 per unit (there are no selling and distribution costs when selling internally).
If product L is not make internally but is bought externally then it will cost $37 per unit.
Therefore buying externally will cost the group and extra/incremental cost of 37 – 20 = $17 per unit. So the profit of the group would fall by $17 per unit.
For part (b), the question says to use the current transfer price which is $40 per unit and to use the quantities calculated in (as) which is that M will buy all 120,000 units from L. Therefore the profit is the contribution of $26 per unit less the fixed costs.
The question does not ask for a profit statement for the group as a whole and to prepare one would be wasting time (especially given that there are only 6 marks). As always, the group profit is the total of the profits in the two division.