PortCo Products is a divisionalized furniture manufacturer. The divisions are autonomous segments, with each being responsible for its own sales, costs of operations, working capital management and equipment acquisition. Each division serves a different market in the furniture industry. Because the markets and products of the divisions are so different, there have never been any transfers between divisions. The commercial division manufactures equipment and furniture that is purchased by the restaurant industry. The division plans to introduce a new line of counter and chair units that feature a cushioned seat for the counter chairs. John Kline, the divisional manager, has discussed the manufacture of the cushioned seat with Russ Fiegel of the office division. They both believe a cushioned seat currently made by the office division for use on its deluxe office stool could be modified for use on the new counter chair. Consequently, John has asked Russ for a price for 100 units lots of the cushioned seat. The following conversation took place about the price to be charged for the cushioned seats. Russ: John, we can make the necessary modification to the cushioned seat easily. The materials used in your seat are slightly different and should cost about 10 percent more than those used in our deluxe office stool. However, the labor time (0.5 direct labor hour/DLH) should be the same because the seat fabrication operation basically is the same. I would price the seat at our regular rate full cost plus 30% markup. John: Thats higher than I expected, Russ. I was thinking that a good price would be your variable manufacturing costs. After all, your capacity costs will be incurred regardless of the job. Russ: John, I am at capacity. By making the cushion seats for you, Ill have to cut my production of deluxe office stools. Of course, I can increase my production of economy office stools. The labor time freed by not having to fabricate the frame or assemble the deluxe stool can be shifted to the frame fabrication and assembly of the economy office stool. Fortunately, I can switch my labor force between these two models of stools without any loss of efficiency. As you know, overtime is not a feasible alternative in our community. Id like to sell it to you at variable cost, but I have excess demand for both products. I dont mind changing my product mix to the economy model if I get a good return on the seats I make for you. Here are my standard cost for the two stools and a schedule of my manufacturing overhead. Office Division: Standard Costs and Prices Deluxe Office Stool Economy Office Stool Materials, framing $8.15 $9.76 Cushioned seat, padding 2.40 Vinyl 4.00 Molded seat (purchased) 6.00 Direct labor 1.5 DLH @ $7.50 11.25 0.8 DLH @ $7.50 6.00 Manufacturing overhead 1.5 DLH @ $12.80 19.20 0.8 DLH @ $12.80 10.24 Total standard cost $45.00 $32.00 Selling price (30% markup) $58.50 $41.60 Office Division: Manufacturing Overhead Budget Overhead Item Nature Amount Supplies Variable at current market prices $420 000 Indirect labor Variable 375 000 Supervision Nonvariable 250 000 Power Use varies with activity; rates are fixed 180 000 Heat and light Nonvariable light is fixed regardless of production while heat/air conditioning varies with fuel charges 140 000 Property tax and insurance Nonvariable any change in amounts/rates is independent of production 200 000 Depreciation Fixed dollar total 1 700 000 Employee benefits 20% of supervision, direct and indirect labor 575 000 Total overhead $3 840 000 Capacity in DLH 300 000 Overhead rate/DLH $12.80 John: I guess I see your point, Russ, but I dont want to price myself out of the market. Maybe we should talk to corporate management to see if it can give us any guidance. Required: 1. John and Russ did ask PortCos corporate management for guidance on an appropriate transfer price. Corporate management suggested that they consider using transfer price based on variable manufacturing costs plus opportunity cost. Calculate a transfer price for the cushioned seat based on that. 2. Which alternative transfer pricing system full cost, variable manufacturing cost, or variable manufacturing cost plus opportunity cost would be best as the underlying concept for an intra-company transfer pricing policy? Explain your