Cirrus Industries, Inc., has two major operating divisions, the Cabinet Division and the Electronics Division. The company’s main product is a deluxe console television set. The TV cabinets are manufactured by the Cabinet Division, and the Electronics Division produces all electronic components and assembles the sets. The company has a decentralized organizational structure.

The Cabinet Division not only supplies cabinets to the Electronics Division, but also sells cabinets to other TV manufacturers. The following unit cost breakdown for a deluxe television cabinet was developed based on a typical sales order of 40 cabinets:

Direct materials .................................................... $32.00

Direct labor ............................................................. 15.00

Variable overhead .................................................. 12.00

Fixed overhead ....................................................... 18.00

Variable selling expenses ........................................ 9.00

Fixed selling expenses ............................................. 6.00

Fixed general and administrative expenses.......... 8.00

Total unit cost .....................................................$100.00

The Cabinet Division’s usual profit margin is 20 percent, and the regular selling price of a deluxe cabinet is $120. The division’s managers recently decided that $120 will also be the transfer price for all intracompany transactions.

Managers at the Electronics Division are unhappy with that decision. They claim that the Cabinet Division will show superior performance at the expense of the Electronics Division. Competition recently forced the company to lower its prices. Because of the newly established transfer price for the cabinet, the Electronics Division’s portion of the profit margin on deluxe television sets was lowered to 18 percent. To counteract the new intracompany transfer price, the managers of the Electronics Division announced that effective immediately, all cabinets will be purchased from an outside supplier, in lots of 200 cabinets at a unit price of $110 per cabinet. The company president, Joe Springer, has called a meeting of both divisions to negotiate a fair intracompany transfer price. The following prices were listed as possible alternatives:

Current market price ................................................$120 per cabinet

Current outside purchase price

(This price is based on a large-quantity

purchase discount. It will cause increased

storage costs for the Electronics Division.) ..............$110 per cabinet

Total unit manufacturing costs plus a 20

percent profit margin: $77.00 + $15.40 ....................$92.40 per cabinet

Total unit costs excluding variable selling

expenses plus a 20 percent profit margin:

$91.00 + $18.20 .........................................................$109.20 per cabinet

1. What price should be established for intracompany transactions? Defend your answer by showing the shortcomings of each alternative.

2. If there were an outside market for all units produced by the Cabinet Division at the $120 price, would you change your answer to 1? Why?