Easy Living Industries manufactures carpets, furniture and cushions in three separate divisions, the company’s profit statement is presented below:
Additional information regarding Easy Living Industries operations is as follows:
• Included in the Cushion Division’s sales revenue is $500 000 that represents sales made to the Furniture Division, The transfer price for these sales was at variable cost.
• The three divisions’ cost of goods sold comprise the following costs:
•Administrative expenses include the following:
• All selling expense in incurred at the divisional level. It is 80 per cent variable.
Meg Johnson, manager of the Cushion Division, is not pleased with the company’s report on operating performance. Johnson claims:
The Cushion Division makes a greater contribution to the company’s profits than is shown. I sell cushions to the Furniture Division at cost and it gets our share of the profit. I can sell these cushions on the outside market at my regular markup, but I sell to Furniture for the wellbeing of the company. I think my division should get credit for those internal safes at market price. I think we should also revise our operating statements for internal purposes. Why don’t we consider preparing these internal statements in a format that shows internal transfers at market price?
1. Meg Johnson believes that the transfers from the Cushion Division to the Furniture Division should be at market price rather than at cost, for divisional performance measurement.
(a) Is Johnson correct? Explain your answer.
(b) Describe another approach that the company could use to set transfer prices other than manufacturing cost and market price.
2. Using transfer prices based on market prices, prepare a revised profit statement, by division, for Easy Living Industries that will facilitate the evaluation of divisional performance. Use the contribution margin format?