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Transfer Pricing: Performance Evaluation Issues

P19.34 Transfer Pricing: Performance Evaluation Issues. Tallahassee Division of Gulf South.

The Tallahassee Division (TO) of Gulf South Corporation, operating at capacity, has been asked by Jaydee division to supply it with electrical fitting no. 1726. TD sells this part to its regular customers for $15.00 each. Jaydee, which is operating at 50 percent capacity, is willing to pay $10.00 each for the fitting. It will put the fitting into a brake unit that it is manufacturing on a cost-plus basis for a commercial airplane manufacturer.
TD has a $8.50 variable cost of producing fitting no. 1726. The cost of the brake unit as built by Jaydee follows:

Purchased parts-outside vendors............................................. $45.00
KC fitting no. 1726 .................................................................. 10.00
Other variable costs ..................................................................... 28.00
Fixed overhead and administration .............................................. 16.00
Total...........................................................................................$99.00

Jaydee believes that the price concession is necessary to get the job. The company uses ROI and dollar profits to measure divisional and division manager performance.

Required
a. If you were TO's di vision controller, would you recommend that it supply fitting no. 1726 to Jaydee? Why or why not? (Ignore any income tax issues.)
b. Is it to the short-run economic advantage of Gulf South Corporation for TD to supply Jaydee with fitting no. 1726 at $10 each? Explain your answer. (Ignore any income tax issues.)
c. Discuss the organizational and managerial behavior difficulties, if any, inherent in this situation. As Gulf South Corporation 's controller, what would you advise the corporation's president to do in this situation?

Solution Preview

Required
a. If you were TO's di vision controller, would you recommend that it supply fitting no. 1726 to Jaydee? Why or why not? (Ignore any income tax issues.)

TD should not sell the fitting at $10 because it is at capacity so it will lose $5 per fitting to sell to them versus a customer. If they sell at $10, their ROI and dollar profits will be down by $5 x units transferred.

b. Is it to the short-run economic advantage of Gulf South Corporation for TD to supply Jaydee with fitting no. 1726 at $10 each? Explain your answer. (Ignore any income tax issues.)

Yes. While the overall organization gives up $5 per unit on external margin on the part, it gains because ...

Solution Summary

Your tutorial is 376 words and explains that in the short run, the transfer might make sense but not in the long term. Reasons are given.

$2.19