Transfer Pricing: Performance Evaluation Issues
Cochise Corporation’s Southern Division is operating at capacity. It has been asked by Northern Division to supply it a thermal switch, which Southern sells to its regular customers for $60 each. Northern, which is operating at 70 percent capacity, is willing to pay $40 each for the switch. Northern will put the switch into a kitchen appliance that it is manufacturing on a cost plus basis for the Army. Southern has a $34 variable cost of producing the switch.
The cost of the kitchen appliance as built by Northern follows:
|
Purchased parts—outside vendors |
$180 |
|
Southern thermal switch |
40 |
|
Other variable costs |
112 |
|
Fixed overhead and administration |
64 |
|
Total cost |
$396 |
Northern believes that the price concession is necessary to get the job.
The company uses ROI and dollar profits in evaluating the division and divisional manager’s performance.
Required
a. If you were Southern’s division controller, would you recommend supplying the switch to Northern? (Ignore any income tax issues.) Why or why not?
b. Would it be to the short run economic advantage of Cochise Corporation for Southern to supply Northern with the switch at $40 each? (Ignore any income tax issues.) Explain your answer.
c. Discuss the organizational and managerial behavior difficulties, if any, inherent in this situation.
As Cochise’s controller, what would you advise the corporation’s president to do in this situation?