Question

Slagle Corporation is a large manufacturing organization. Over the past several years, it has obtained an important component used in its production process exclusively from Harrison, Inc., a relatively small company in Topeka, Kansas. Harrison charges $90 per unit for this part:

Variable cost per unit	$40
Fixed cost assigned per unit	30
Markup	20
Total price	$90

In hopes of reducing manufacturing costs, Slagle purchases all of Harrison’s outstanding common stock. This new subsidiary continues to sell merchandise to a number of outside customers, as well as to Slagle. Thus, for internal reporting purposes, Slagle views Harrison as a separate profit center.

A controversy has now arisen among company officials about the amount that Harrison should charge Slagle for each component. The administrator in charge of the subsidiary wants to continue the $90 price. He believes this figure best reflects the division’s profitability: “If we are to be judged by our profits, why should we be punished for selling to our own parent company? If that occurs, my figures will look better if I forget Slagle as a customer and try to market my goods solely to outsiders.”

In contrast, the vice president in charge of Slagle’s production wants the price set at variable cost, total cost, or some derivative of these numbers: “We bought Harrison to bring our costs down. It only makes sense to reduce the transfer price; otherwise the benefits of acquiring this subsidiary are not apparent. I pushed the company to buy Harrison; if our operating results are not improved, I will get the blame.”

In your initial post, answer the following questions:

• Will the decision about the transfer price affect consolidated net income?
• Which method would be easiest for the company’s accountant to administer?
• As the company’s accountant, what advice would you give to these officials?

Answer 1

We were asked three questions

1.

The decision of transfer pricing will not affect the consolidated net income. This is because the cost of one division will be income of other division, so both of them will offset each other in value. The same will happen at any transfer price. So the decision on transfer price will kpr affevt the consolidated net income

2.

For the company accountant, it would be easy if the transfer price is set at normal selling rate of $90 (similar to outsiders selling rates) as before. This is because he need not distinguish the sales made by New division to the Slagle' sothwr division and to outsiders. If the transfer price is different, both the transfers have different prices and hence accountant must be careful is recognising income to new division which will depend on to whom the sale is made and what will be the rate

3.

The transfer will not affect the Company's Total Income as a whole.

At what rate the transfer price must be fixed will be depending on the factors like

1. Whether the divisions are treated as profit centres or nor and whether the manager's or supervisor's salary or bonus is dependent on the income generated from such divisions.

If there are no bonus like that, the company can fix transfer price at any amount. If the bonus or other laynenti are linked to the profit generated by each division, then the transfer price must be fixed by discussing with both the division heads (this price will depend on the below factor)

2. Whether there is any idle capacity

If there is no idle capacity in new division and all the components produced are sold in market, then the transfer price will be the Sale price to outsiders. In other case where there is idle capacity, the transfer price will be fixed at some where between Sale price to outsiders and Variable Cost per unit (usually, Variable cost + Fixed cost per unit recovery + small margin). This rate is decided after discussion of both department heads and corporate head.