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- This topic has 3 replies, 2 voices, and was last updated 3 years ago by John Moffat.
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- June 24, 2020 at 9:52 am #574594
Hello Sir, I hope you’re doing great, Please help me understand this point in the following illustration…
Suppose a company has two profit centres, A and B. A can only sell half its maximum output of 800 units externally because of limited demand. It transfers the other half of its output to B which also faces limited demand. Costs and revenues in an accounting period are as follows.
A B Total
$ $ $
External sales 8,000 24,000 32,000
Costs of production in the division 13,000 10,000 23,000
Profit 9,000For example, suppose division B could buy the product from an outside supplier for $10 instead of paying $15 ($6,000/(800/2)) to division A. This transfer price would therefore force division B to buy the product
externally at $10 per unit, although it could be manufactured internally for a variable cost of $(13,000 – 4,800 – 1,000)/800 = $9 per unit.
Although division B (the buying division) would save ($15 – $10) = $5 per unit by buying externally, the organisation as a whole would lose $400, as follows.Per unit $
Marginal cost of production 9
External purchase cost 10
Loss if buy in 1
The overall loss on transfer/purchase of 400 units is therefore 400 * $1 = $400.””””””This loss of $1 per unit assumes that any other use for the released capacity would produce a benefit of less than $400.”””””
( I don’t understand this quoted phrase above can you please elaborate to make it clear to me..)
June 24, 2020 at 10:30 am #574604What it is saying is the following:
If B did buy externally, then A will have spare capacity (because they are capable of producing 800 units but will end up only producing the 400 they can sell externally).
It might be that they could use that spare capacity to produce and sell something else and if they could it would then be worth B buying externally if the ‘something else’ would earn the company more than $400.
June 24, 2020 at 6:12 pm #574635Thanks Sir, I do get your point.. but then why doesn’t it say benefit of ”more than $400”?
June 25, 2020 at 9:22 am #574652They could have worded it better but what they really mean is that the decision assumes that any benefit is less than $400.
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