Transfer Pricing Problem. Baltic National Bank of Vilnius, Lithuania, has a central computer facility which is used by several operating departments for data processing and problem-solving purposes. The facility's budget (in Lithuanian litas) for the current year is as follows:

It is estimated that 20,000 computer time units will be available. All of the costs shown in the budget are considered to be fixed, except for utilities and miscellaneous supplies which are variable.
During the past five years, the computer facility has not been operated at full capacity. The percentage of capacity has increased from 40 percent in the first year of operation to an estimated 70 percent for the current year.
A transfer price policy has been established which calls for the use of a full cost per unit of time. Thus, an operating department that needs one half of a time unit would be charged at the rate of 52.50 litas [1/2 \(\times(2,100,000\) litas \(\div 20,000\) time units)]. All operating departments do most of their own programming. The computer staff has four programmers who are used to solve special problems as they arise in the facility.
The associate director of the facility, Iluv Telshe, has approached Dora Litvak, the director, to revise the transfer price policy to include only the variable costs. His argument is that the operating departments would thereby be encouraged to make greater use of the facility. Litvak's response is that she sees no reason why this should be so. "After all," she points out, "the operating departments need only so much time anyway; and besides, the various managers cannot buy computer time outside of the bank. So how could the transfer price affect their behavior?"
The associate director's response is that he knows of several instances where the operating departments have secured outside programming services so that the program submitted would require less running time. "In fact," he says, "I know of one case where a commercial lending manager spent 300 litas on additional programming to save an estimated two time units of running time."
Litvak's response is, "He should have-after all, it cost us 105 litas every time we run the program!"
\section*{Required:}
1. Do you agree with the associate director or the director? Explain.
2. Was the behavior of the commercial lending manager (as described by the associate director) optimal as far as the bank is concerned? Why or why not?
3. Assuming that the additional programming effort could not have been done inside the bank, what is the maximum price that the commercial lending manager should have paid?

Transcribed Image Text:

Rentals... Payroll, operators 1,200,000 litas 260,000 Payroll, programmers 180,000 Payrol!, supervision and secretarial. 90,000 Miscellaneous supplies 120,000 Utilities Total 250,000 2,100,000 litas