Activity 6 Transfer pricing For the scenario assigned: 1. Consider the transfer pricing strategy being used. 2. How does the strategy impact management and the company as a whole? 3. What advice would you give to the company? Scenario 1 Thomas, a division of Brite Ltd., manufactures light bulb bases the metal base of a light bulb that screws into the socket. It costs Thomas $0.70 to produce a base ($0.25 direct material, $0.20 direct labour, $0.10 variable overhead, and $0.15 allocated fixed overhead). The bases are then sold for $1.00 each to light bulb manufacturers to use in creating light bulbs. In order for light bulbs to be sold to homes everywhere, the bases come in several standard sizes. Light, another division of Brite, purchases bases from Thomas to use in the manufacturing of its bulbs. Recently, Light has been considering purchasing bases from outside of the Brite company as it can procure them for a lower price of $0.90. Light's management is evaluated based on profits, and is therefore motivated to save costs where it can. Thomas currently sells 80% of its production to Light. Light bulb base providers are plentiful in the industry and Thomas operates with excess capacity. Management of Thomas is also compensated based on profits; as such, Thomas sells bases to Light at the same price ($1.00) it sells to external parties.

Scenario 2 Conglomerate Co. owns businesses around the world. Two of its subsidiaries, Gold and Jewelry, frequently do business together. Gold is a mining company that extracts gold and sells it on a commodity exchange. Jewelry crafts high-end jewelry using a variety of precious metals and gems. Gold and Jewelry have always performed transactions at market price. Each company is evaluated separately and there are no cost savings as a result of having the same parent. Scenario 3 DIY Furniture (DIY) sells a wide array of furniture at a variety of price points that are attractive to a wide audience, from students furnishing their first apartment to professionals remodelling a kitchen. The furniture is provided to the customer unassembled at a lower cost than the more expensive assembled furniture from competing furniture stores, and assembly instructions are included. To make assembly easier, all hardware is provided and the furniture can be put together with minimal tools. The hardware is often custom for this reason. There is currently some tension between the bolts division and the retail division of DIY. The bolts division makes a variety of bolts and nuts for the furniture. It is all custom and specific to the needs of DIY. There is no external market. The retail division buys all bolts from the bolt division. There is no external provider. The CEO of DIY is new. At her former company, an electronics retailer, all divisions were operated as profit centres and this really motivated management to increase the overall profits of the company. She believes this is the best way to ensure costs are kept low and revenues high. Upon starting at DIY, she changed the evaluation of each department to that of a profit centre. As a result, bolts increased its transfer price to add a 25% markup to cost.