Question

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 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.”

a. Will the decision about the transfer price affect consolidated net income?

b. Which method would be easiest for the company's accountant to administer?

c. As the company's accountant, what advice would you give to these officials?

Answer 1

1. Since Slagle owns all of the costs of Harrison Inc, the Intercompany sales transactions will be eliminated. Hence, the decision of transfer price will not affect the consolidated net income.

2. The easiest method from accounting point of view is making transfers at cost. It will be simple and easy to administer.

3. The sole purpose of acquisition of all shares of Harrison was to cut costs. On the other hand Harrison can offer the same goods that it sells to Slagle at $ 90 per unit to outsiders instead of $ 70. Hence considering both factors, it is advisable to fix the price at $ 90. This will satisfy needs of both parent when they consolidate and also subsidiary ie in spearate statements.