Xbt Keyboards

Solution to XBT Keyboards (45 minutes) [Incentives to convert fixed costs to variable costs with variable cost transfer pricing] This problem illustrates that managers who are receiving variable cost transfer prices have incentives to convert fixed costs into variable costs.

a. The current incremental cost of manufacturing 2.5 million keys internally are: Per Key $0.06 0.08 Materials ($3.00/50) Direct Labor – keys ($4.00/50) $8 × $4.00/50) Variable overhead ( $16 * Injection molding ($10.00/50) Average unit cost per key 0.04 0.20 $0.38 *$16 = sum of direct labor of keys and assembly ($4 + $12) Therefore, if the keys are outsourced, instead of produced internally, the firm’s cash flows fall by $0.01 ($0.39 - $0.38) per key.

b. Ms. Litle will purchase the keys from the outside vendor in order to maximize division profits and her own compensation, even though the average incremental cost per unit ($0.38) is lower than the vendor's price ($0.39). The reason Litle takes this firm-value decreasing action is to convert a fixed cost (injection molding lease), which is not part of the variable cost transfer price she receives for keyboards included with XBT PCs, into a variable cost.

c. XBT Keyboard Division's pro forma income statement if manufacturing of all keys remains internal is: XBT Keyboard Division Pro Forma Income (all keys fabricated internally) Revenue: External sales (150,000 @ $100) Internal transfers (50,000 @ $60 × 1.2) Costs: Variable costs (200,000 @ $60) Fixed Costs: Key Injection molding (4 × $500,000) Fixed overhead (200,000 @ $18) Divisional Profits $15,000,000 3,600,000 $18,600,000 $12,000,000 2,000,000 3,600,000 $17,600,000 $ 1,000,000 If the outside vendor is used to manufacture the keys for units transferred for use with the XBT PC, the Keyboard Division profits are:

XBT Keyboard Division Pro Forma Income (2.5 million keys purchased outside) Revenue: External sales (150,000 @ $100) Internal transfers (50,000 @ $70.50* × 1.2) Costs:...