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Homework answers / question archive / When working on this assignment please make sure you explain fully your argument
When working on this assignment please make sure you explain fully your argument. There are so many answers to this problem I just want your answer, no plagiarism, I will be checking. Thank you so much!
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.
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.”
Answer the following questions:
1. The decision about the transfer price will not affect the consolidated net income of the company as a whole because transfer prices are used by one division to charge to another division for internal transfer. At the overall company level the internal transfer gets eliminated because the income for one division is expense for another division and thus decision about the transfer price will not affect the consolidated net income. Example: A company has two divisions X and Division Y. If Division X has transferred 10,000 units at $5 to Division Y, the revenue of Division X is $50,000 and expenses of Division Y are $50,000. At the company level the net income is zero because revenue and expenses gets consolidated. So revenue- expenses = net income. $50,000-$50,000 = 0
2. The cost based transfer pricing would be easiest for the company’s accountant to administer because the cost details are available in the firm and it does not require any external benchmarking. The cost based transfer pricing is based on variable cost and fixed cost incurred in each division and thus the details are easily available for the company’ accountant to administer. The other methods of transfer pricing such as market price based is not easy for the company’s accountant to administer because the details are not easily available unlike cost details internally. Also there is negotiation involved in the market price based transfer pricing thus making administration difficult.
3. Advice to the officials
The internal transfer pricing from one division to another division plays an important role in evaluating the profitability of the division. The golden rule for internal transfer pricing should be
· When there is excess capacity – The minimum transfer price should be equal to the variable cost incurred in internal transfer. It includes variable manufacturing cost – direct material, direct labor and variable manufacturing overhead
· When there is no excess capacity- The minimum transfer price should be equal to the variable cost incurred plus the opportunity cost forgone. The opportunity cost forgone is the contribution margin forgone on the lost sales due to not selling the units externally to outside customers.
