PROBLEM 12-15. (Appendix) Decentralization and Transfer Pricing

The City of Medina Park operates a plumbing and electrical maintenance department, responsible for maintaining all water and electric service functions in buildings owned by the city. The city administration is concerned about the rising costs of the maintenance department, which is currently organized as a cost center. Charlotte Daugherty, the manager of the maintenance department, says that many of the department's service calls are strictly nuisance calls. She cites examples of numerous calls for defective electrical outlets, which turn out to be unplugged equipment, burned-out lightbulbs (which can easily be changed by the users), and drains clogged by coffee grounds.

In Charlotte's opinion, these nuisance calls would be avoided if the departments using her department's

Services were "billed." Essentially, Charlotte suggests that there be a transfer price related to using her department's services and that the price should approximate the cost of these services in the market ($50-$65 per hour of service time). This would turn her operation into a profit center, and, she believes, her department would operate more efficiently because demand for services would decline and she would need fewer employees.

Question:

Evaluate Charlotte's proposal. Do you support use of a transfer price for maintenance services? If so, should the price approximate the market price of service or should it be based on cost?