Question :
Slagle Corporation is a big manufacturing organization. Over the past years, it has obtained a significant component used in its production process completely 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 buys 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. Therefore, 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 could charge Slagle for each component. The administrator in charge of the subsidiary needs to continue the $90 price. He believes this figure best reflects the division's productivity: "If we are to be judged by our profits, why could we be punished for selling to our own parent company? If that occurs, my figures may 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 needs the price set at variable cost, net cost, or some derivative of these numbers. "We bought Harrison to take our costs down. It only makes sense to decrease 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 changed, I will get the blame."
Will the decision about the transfer price affect consolidated total income? Which technique would be easiest for the company's accountant to administer? As the company's accountant, what advice could you provide to these officials?