Question

Kathy Kraven is the CEO and president of Legal Solutions, Inc. She oversees the company’s two divisions—Human Resources and Litigation. The Human Resources division provides legal services to personnel departments at various clients who need help creating personnel policies and manuals. The Litigation division provides legal services to support clients in litigation. Litigation often asks for help from Human Resources when faced with issues surrounding personnel policies but also has the option of seeking help outside the firm. Currently, Human Resources is below capacity and uses variable cost as its price for providing services to Litigation.
Since each division is evaluated by how much profit it generates, Human Resources would like to increase the price charged to Litigation. Litigation is steadfast against any such change. Kathy Kraven has stepped in and established the following policy: effective immediately, Human Resources will charge Litigation variable costs plus 20 percent for any services rendered internally.

Required:

Why is the Human Resources division manager concerned about the price it charges to Litigation?

Why is the Litigation division manager concerned about an increase in price charged by the Human Resources division?

Do you think Kathy’s plan is effective? Explain.

What other options are available for establishing transfer pricing?

Answer 1

1. The human resources manager is concerned about the price because they are providing the services at variable costs and since their department is evaluated by the profit they generate, this is not providing them any profits.

2. Litigation department manager is concerned since increased price from human resources department will increase their costs and decrease their profits.

3. Cathy's plan can be effective if the litigation department is not getting the human resources services from outside at a rate lesser than the one charged by internal human resources department.

4. Other options can be pricing equal to market pricing, pricing at a certain discount from market etc.