Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 24

Cost Data for Managerial Purposes

Ringer Company makes a variety of products. It is organized in two divisions, East and West. West Division normally sells to outside customers but, on occasion, also sells to the East Division. When it does, corporate policy states that the price must be cost plus 15 percent to ensure a “fair” return to the selling division. West received an order from East Division for 600 units. West’s planned output for the year had been 2,400 units before East’s order. West’s capacity is 3,000 units per year. The costs for producing those 2,400 units follow.

	Total	Per Unit
Materials	$ 240,000	$100
Direct labor	115,200	48
Other costs varying with output	76,800	32
Fixed costs	1,008,000	420
Total costs	$1,440,000	$600

Based on these data, West’s controller calculated that the unit price for East’s order should be $690 (= $600 × 115 percent). After producing and shipping the 600 units, West sent an invoice for $414,000. Shortly thereafter, West received a note from the buyer at East stating that this invoice was not in accordance with company policy. The unit cost should have been

Materials	$100
Direct labor	48
Other costs varying with output	32
Total	$180

The price per unit would be $207 (= $180 × 115 percent).

Required

If the corporation asked you to review this intercompany policy, what policy would you recommend? Why? (Note: You need not limit yourself to the East or West Division’s calculation.)

Step 1 of 4

This problem demonstrates the ambiguity in measuring “costs.”

West Division’s controller included the “per unit” fixed costs, which were calculated for allocation purposes under normal production volume, when he or she calculated the per unit cost of the additional production. The controller charged East Division on that basis, ignoring the differential costs as a basis for interdivision sales.

Possible options available are as follows:

A.?Use the full per unit cost for normal production of 2,400 units.