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
Fixed cost assigned per unit
In hope 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.”
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?