1. A. R. Oma, Inc., manufactures a line of men's perfumes and after-shave lotions. The manufacturing process is basically a series of mixing operations with the addition of certain aromatic and coloring ingredients. The finished product is packaged in a company-produced glass bottle and packed in cases containing six bottles.
A. R. Oma feels that the sale of its product is heavily influenced by the appearance and appeal of the bottle and has, therefore, devoted considerable managerial effort to the bottle production process. This has resulted in the development of certain unique bottle productionprocesses in which management takes considerable pride. he two areas (i.e., perfume production and bottle manufacture) have evolved over the years in an almost independent manner. In fact, a rivalry has developed between management personnel as to which ivision is more important to A. R. Oma. This attitude is probably intensified because the bottle manufacturing plant was purchased intact 10 years ago and no real interchange of management personnel or ideas (except at the top corporate level) has taken place.
Since the acquisition, all bottle production has been absorbed by the perfume manufacturing plant. Each area is considered a separate profit center and evaluated as such. As the new corporate controller, you are responsible for the definition of a proper transfer value to use in crediting the bottle production profit center and in debiting the packaging profit center.
At your request, the bottle division general manager has asked certain other bottle manufacturers to quote a price for the quantity and sizes (other suppliers) demanded by the perfume division. These competitive prices are:
|
Volume (Equivalent Cases")
|
Total Price
|
Price per Case
|
|
2 million
|
$ 4 million
|
$2.00
|
|
4 million
|
$ 7 million
|
$1.75
|
|
6 million
|
$10 million
|
$1.67
|
*An "equivalent case" represents six bottles each.
A cost analysis of the internal bottle plant indicates that they can produce bottles at these costs:
|
Volume (Equivalent Cases)
|
Total Price
|
Price per Case
|
|
2 million
|
$3.2 million
|
$1.60
|
|
4 million
|
$5.2 million
|
$1.30
|
|
6 million
|
$7.2 million
|
$1.20
|
(Your cost analysts point out that these costs represent fixed costs of $1.2 million and variable costs of $1.00 per equivalent case.)
These figures have given rise to considerable corporate discussion as to the proper value to use in the transfer of bottles to the perfume division. This interest is heightened because a significant portion of a division manager's income is an incentive bonus based on profit center results. The perfume production division has the following costs in addition to the bottle costs:
|
Volume (Cases)
|
Total Cost
|
Cost per Case
|
|
2 million
|
$16.4 million
|
$8.20
|
|
4 million
|
$32.4 million
|
$8.10
|
|
4 million
|
$32.4 million
|
$8.10
|
|
6 million
|
$48.4 million
|
$8.07
|
After considerable analysis, the marketing research department has furnished you with the following price-demand relationship for the finished product:
|
Sales Volume (Cases)
|
Total Sales Revenue
|
Price per Case
|
|
2 million
|
$25 million
|
$12.50
|
|
4 million
|
$45.6 million
|
$1 1.40
|
|
6 million
|
$63.9 million
|
$10.65
|
1. The A. R. Oma Company has used market price transfer prices in the past. Using the current market prices and costs, and assuming a volume of 6 million cases, calculate the income for
(a) The bottle division
(b) The perfume division
(c) The corporation
2.Is this production and sales level the most profitable volume for
(a) The bottle division?
(b) The perfume division?
(c) The corporation?
Explain your answer.
3.The A. R. Oma Company uses the profit center concept for divisional operation.
(a) What conditions should exist for a profit center to be established?
(b) Should the two divisions of the A. R. Oma Company be organized as profit centers?