West Island Products (WIP) is a divisionalized furniture manufacturer. The divisions are

autonomous segments with each division responsible for its own sales, cost of operations, and

equipment acquisition. Divisional performance is evaluated annually based on ROI. Each division

serves a different market in the furniture industry. Because the markets and products of the

divisions are so different, there have never been any transfers between divisions.

The Commercial Division of WIP, manufacturers furniture for the restaurant industry. The

Commercial Division plans to introduce a new line of counter chair units featuring a cushioned

seat. Roberta Katz, the Commercial Division manager, has discussed the manufacturing of the

cushioned seats with Nathan Danielson of the Office Division. They both believe a cushioned

seat currently made by the Office Division for use on its deluxe office stool could be modified for

use on the new counter chair. Consequently, Katz asked Danielson for a price for 100-unit lots of

the cushioned seats. The following conversation took place about the price to be charged for the

cushioned seats.

Danielson: “Roberta, we can make the necessary modifications to the cushioned seat easily.

The raw materials used in the new counter chair seat are slightly different and

should cost about 10 percent more than those used in our deluxe office stool.

However, the labor time should be the same because the seat fabrication

process is the same. I would price the cushioned seat at our regular rate: full cost

plus a 30 percent mark-up. According to my calculations, that would be $2,053

per lot of 100 seats.”

Katz: “That’s higher than I expected, Nathan. I was thinking that a good price would be

your variable manufacturing cost. After all, your fixed costs will be incurred

regardless of this job. In addition, I have received a quote from one of the

Commercial Division’s regular suppliers to provide us with the counter seats at

$1,900 per lot of 100 seats.”

Danielson: “Roberta, I am at full capacity. By making the cushioned seats for you, I have to

cut my production of deluxe office stools. The labor time freed by not having to

fabricate the frame and assemble the deluxe stool can be shifted to the

production of the economy stool. I’d like to sell the cushioned seats to you at my

variable cost, but I have excess demand for both products. I don’t mind changing

my product mix to the economy model and producing the cushioned seats for

you as long as I don’t change my division’s overall profitability. Here are my

standard costs for the two stools and a schedule of my manufacturing overhead.”

(See Exhibits 1 and 2.)