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ABC Inc is a manufacturing company, that has two divisions: Left and Right. Left produces a components and transfer it to Right as well as selling to outside customers. Right has been offered 3000 units of the components from a third paty supplier for $35.
The following is an extract from the operating stmt of division LEFT:
$
Sales to Right at $40 400,000
3rd party sales at $45 270,000
Less:
Variable cost at $22 352,000
Fixed cost 100,000
Profit 218,000Required:
Discuss with supporting calculations, whether it is advisable for Division Left and ABC Ltd to out-source the components?The answer given is
Left
Selling price 40
VC 22
Contribution 18
Quantity outsourced 3000 units
Impact: 54,000Right
Transfer price 40
Outsource 35
Diff 5Quantity outsourced 3000 units
Impact: 15,000Profit difference by company= -$39,000
I am not really understand the answer. Is that means from left point of view, right should not outsource its components because if right do so, left will lost contribution of $54,000.
However, from right point of view, right should outsources its components because right can save $15,000.
Therefore, from company point of view, right should not outsouces its components because the company will lost $39,000 ??
I am wondering the lost contribution of $54,000 for left will it bring any impact to company??
Thanks
But the loss to the company is the 54,000 lost by Left plus the 15,000 gained by Right.
Have you watched our free lectures on transfer pricing?
ya I have watched the free lectures video on T.P/
So that means the lost contribution $54,000 of Left will affect the company profitability right?
BUT, the things that I don’t understand is since the $54,000 contribution is getting from what Left sell to Right, meaning internal sales. So how will it affect the company as a whole because it seems like can cancel each other??
The 15,000 gained by right is if right choose to use outsource suppliers. How about if they use outsource suppliers, the Left division’s spare capacity will be wasted?? and actually the variable cost incur by Left division is actually just $22 per unit, so if that is the case, actually the company will lost $13 per unit($35-$22) by using outsource suppliers??? Is it correct?
Left and Right are divisions of the same company.
Left sells to Right and then right sells externally. We don’t know at what price Right sells externally because it is irrelevant to the question, but just suppose they sell at $60 per unit externally (but any figure will end up giving the same result).
If Left produces the goods, then as far as the company is concerned the profit per unit is $60 – $22 = $38.
If instead Right buys the units externally, then the company makes a profit of $60 – $35 = $25 per unit.
So the company does indeed lose $13 per unit if they buy externally 🙂
So for 3,000 units, the company loses 3,000 x $13 = $39,000.
Orhh I see so that means I can choose whether to use lost contribution -54,000 plus cost saving 15,000 to get 39,000 OR
using (3,000x $13)=39,000 also can be accepted?but if using lost contribution 54000 and cost saving 15000, i should how to explain and say it will impact on company’s profitability?
thanks
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