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Cost Based Transfer Price

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Introduction

Alternatives 1. Cost Based Transfer Price Maintain the status quo within the company. All cost methods require that standard costs be used; therefore each division is encouraged to meet standard cost levels, instead of working around actual costs. This will increase goal congruence. Currently, the price Southern is charging is based on the market but they are running under capacity and had excess inventory. Therefore, Thompson is charging market price even though he is running under capacity. If Southern's VC = 60% then the 40% represents OH and profit. To prevent conflicts in the future it must be clear that variable costs of one division are not actually fixed costs for the whole company. Thompson's VC = $400 some of that could be FC for the whole company. (Align this alternative with Rob's Analysis). Advantages: increases goal congruence, requires that the vice president perform a routine cost analysis, therefore requires little resources. Southern mostly supplies Northern therefore, a market based system would be difficult due to the intermediate nature of the materials being transferred, adding attractiveness to a cost based system. Disadvantages: will be very difficult to determine what profit markup will be. ...read more.

Middle

This would be worth it to Birch since there are many transactions between Thompson and Southern. Disadvantages: If they don't come to an agreement they are back where they began. It may not be worth it expend these kind of resources if there are very few transactions. Agreement among Business Units (Needed?) Set up a mechanism for the divisions to agree on outside selling prices and for profit sharing when there is significant upstream FC and profits. Advantage: this would solve the lack of communication and allocate upstream costs and profits. Disadvantage: it may not be worth their time and resources. 3. Market Price Six conditions must exist that make this alternative feasible. Competent People Since top management has implemented a profit center structure the company has improved its market position. It can be assumed then that the divisional mangers have both short-run and long-run interests in mind and therefore, are competent. Good Atmosphere Currently there are communication problems between divisions that if solved, will provide a good atmosphere. If a fair transfer price method is employed, goal congruence will increase as these managers will be motivated to meet both their divisional interests and the interest of the overall company. ...read more.

Conclusion

The resources needed to meet the conditions might not be justified. ANS: (part of it). The vice president should find out which costs are really fixed for the whole company and allocate them differently. Southern's cost structure should be reviewed to flush out the discrepancy between what Northern is expecting, and what is really happening. In this way communication between divisions will be increased to benefit the company as a whole. If he puts through an order of acceptance he will compromise both the main goal of the company (decentralisation) but also the morale of the divisions, therefore he should not put the acceptance order through, (An additional alternative) Arbitration and Conflict Resolution A single executive would be assigned to settle disputes between the divisions. The executive would talk to individual division managers and then a price would be set. More formally, a committee could be set up having three responsibilities 1) Settling transfer price disputes, 2) reviewing sourcing changes, and 3) changing the transfer price rules when appropriate. Advantages: a fair transfer price would result. Disadvantage: this situation is not serious enough nor does it constitute enough volume of any one division to justify the resources needed to facilitate a committee. ...read more.

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