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Final

BUS-2003 Study Guide - Final Guide: Earnings Before Interest And Taxes, Transfer Pricing, Fixed Cost


Department
BUSINESS AND ADMINISTRATION
Course Code
BUS-2003
Professor
Debbie Mortimer
Study Guide
Final

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BUS2003 Practice Final Exam
These questions are representative of the types of questions you may find on the final exam,
but in total are longer than the actual final exam.
QUESTION ONE
Bellow Division of Sound Corporation is currently operating at a loss. Bellow makes radios that
are sold to retail stores. The senior management of Sound Corporation is considering closing the
Bellow Division. Bellow’s statement of operations for the last year follows:
Bellow Division
Statement of Operations
for the past year
Revenues (80,000 units) $ 5,300,000
Operating expenses:
Variable costs 4,095,000
Traceable fixed costs 1,500,000
Allocated corporate overhead 800,000 6,395,000
Operating income (loss) $(1,095,000)
Recently, Sound Corporation acquired the Boom Speaker Company which manufactures
speakers that are sold to radio manufacturers.
In an effort to save the division from closing, the manager of the Bellow Division has asked that
the new Boom Speaker Division supply it with 80,000 speakers. The Bellow Division currently
purchases the speakers from outside suppliers for $28 each.
Boom Speaker produces and externally sells 400,000 speakers per year which represents 80% of
its operating capacity. At this production level the standard cost to produce one speaker is as
follows:
Direct materials $ 8.00
Direct labour 6.00
Overhead 3.00
Total unit cost $17.00
The standard direct labour rate is $12.00 per hour. The variable overhead rate is $2.00 per direct
labour hour and the fixed overhead rate is $4.00 per direct labour hour. Boom sells the speakers
for $32 each.
Required:
1. Calculate the minimum and maximum transfer prices. Show all your computations. (2 ½
marks)
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2. Should the transfer take place? Calculate the effect on Sound’s operating income if the
transfer takes place. Show all your computations. (3 marks)
3. Of the allocated corporate overhead, 10% is caused by the presence of Bellow and will be
avoided if Bellow is closed.
i. Assume the transfer takes place. Should the Bellow Division still be
closed? Show all your calculations. (4 marks)
4. Assume the transfer does not take place. Should the Bellow Division be closed? Show
all your calculations. (2 marks)
5. Assume Bellow Division has unlimited demand for its radios. What is the maximum
number of speakers that should be transferred from Boom Speaker Division? Show all
your computations. (3 ½ marks)
QUESTION ONE Solution (15 marks)
Part 1. (2 ½ marks)
Minimum transfer price:
Direct materials 8.00 ½ mark
Direct labour 6.00 ½ mark
Variable overhead 50% x 2.00 = 1.00 1 mark
Minimum transfer price 15.00
Maximum transfer price 28.00 ½ mark
Part 2. (3 marks)
With transfer:
Cost of units transferred 80,000 x 15 (cfwd) = 1,200,000 1 mark cfwd
Without transfer:
External purchase cost of units 80,000 x 28 = 2,240,000 1 mark
Savings (increase in operating income) with transfer 1,040,000
Or:
Saving (increase in operating income) with transfer = (28 - 15) x 80,000 = 1,040,000
1 mark cfwd 1 mark
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Yes, the transfer should take place. (1 mark, cfwd with quantitative analysis. No mark awarded
if a quantitative analysis is not completed)
Part 3. (i) (4 marks)
Revenues 5,300,000 ½ mark
Variable costs 4,095,000 - 1,040,000 cfwd = 3,055,000 1 mark
Traceable fixed costs 1,500,000 ½ mark
avoidable allocated corporate overhead 10% x 800,000 = 80,000 1 mark
Segment margin 665,000
If the transfer takes place Bellow Division should not be closed because it contributes $665,000
to Sound’s operating income.
1 mark, cfwd with quantitative analysis. No mark awarded if a quantitative analysis is not
completed.
Part 3. (ii) (2 marks)
Calculation of Bellow’s Segment Margin if the transfer does not take place:
Operating income (loss) (1,095,000
)
Add back unavoidable corporate overhead 90% x 800,000 = 720,000
Segment margin (375,000) 1 mark
If the transfer does not take place Bellow Division should be closed because it decreases Sound’s
operating income by $375,000.
1 mark, cfwd with quantitative analysis. No mark awarded if a quantitative analysis is not
completed.
Part 4. (3 ½ marks)
Minimum transfer price if Boom has no idle capacity:
Variable cost from part 1 15.00 1 mark cfwd
Lost contribution margin: $32 – 15 = 17.00 1 mark cfwd
Minimum transfer price 32.00
Maximum transfer price 28.00 ½ mark
As soon as regular sales are displaced, Boom will want to charge $32 but Bellow could use an
outside supplier for $28, which would be cheaper for both Bellow and the corporation.
Only the current idle capacity of Boom should be used to produce units for transfer, a total of
(400,000/80%) – 400,000 = 100,000 units. 1 mark
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