Problem $3$

Klein, Thompson's CFO, has determined that the Motor Division has purchased switches for its motors

from an outside supplier during the current year rather than buying them from the Switch Division. The

Switch Division is operating at full capacity and demanded that the Motor division pay the price charged

to outside customers rather than the actual full manufacturing costs as it has done in the past. The

Motor Division refused to meet the price demanded by the Switch Division. The Switch Division

contracted with an outside customer to sell its remaining switches and the Motor division was forced to

purchase the switches from an outside supplier at an

even higher price. Klein is reviewing Thompson's transfer pricing policy because she

believes that sub$-$optimization has occurred. While Klein believes the Switch Division made the correct

decision to maximize its divisional profit by not transferring the switches at actual full manufacturing

cost$,$ this decision was not necessarily in the best interest of Thompson. Klein has requested that the

corporate Accounting Department study alternative transfer pricing methods that would promote overall

goal congruence, motivate divisional management performance, and optimize overall company

performance. The three$-$transfer pricing

methods being considered are listed below. One of these methods will be selected, and will be applied

uniformly across all divisions.

Standard full manufacturing costs plus markup.

Market selling price of the products being transferred.

Outlay $($out$-$of$-$pocket$)$ costs incurred to the point of transfer plus opportunity cost per unit.

REQUIRED:

Identify and explain two positive and two negative behavioral implications that can arise from

employing a negotiated transfer price system for goods that are exchanged between divisions.

Identify and explain two behavioral problems that can arise from using actual full $($absorption$)$

manufacturing costs as a transfer price.

Identify and explain two behavioral problems most likely to arise if Thompson Corporation changes

from its current transfer pricing policy to a revised transfer pricing policy that it applies uniformly to all

divisions.

Discuss the likely behavior of both "buying" and "selling" divisional managers for each of the following

transfer pricing methods being considered by Thompson Corporation.

a$.$ Standard full manufacturing costs plus markup.

b$.$ Market selling price of the products being transferred

c$.$ Outlay $($out$-$of$-$pocket$)$ costs incurred to the point of transfer plus opportunity cost per unit.