Smart Chemicals Corporation not only had Hull Division manufacturing its high-quality Products, as there were 7 main Products sold to the market, each manufactured in a separate Division with its own manufacturing facilities. Susan was responsible of the Divisions production at Hulls manufacturing facilities of the generic X Product and all its variants.

Hull was selling most of its output to outside customers, but not only to outside consumers. Hull Division supplies the basic generic product X also to the Hingham Division, another of Smart Chemicals seven product divisions.

Hingham Division uses generic product X as a raw material in the manufacture of several products. Hull charges Hingham $1.80 a pound for the basic generic product X, 10 percent less than it charges outside customers.

Hingham has been happy with this arrangement for several years, but an outside supplier has just offered to supply a perfectly satisfactory substitute for the generic product X at a firm contract price of $ 1.60 a pound, delivered to the Hingham factory. The Hingham Division manager has proposed that the interdivisional transfer price of product X be reduced to $1.60 to meet the competing offer; otherwise, the contract will go outside. Then is when Susan called Steve.

You are to position yourself in Steves shoes, as the controller in the Hull Division. Your division manager Susan has just given you a copy of Hull Division's estimated monthly income statement for the generic product X (in US $ thousands) according to the following figures:

TABLE 3: HULL DIVISION GENERIC PRODUCT X (Thousands of USD)

Sales-outside (100,000 pounds at $2). $200 Sales-Hingham (50,000 pounds at $1.80). 90 Total sales. 290

Product-traceable costs: Variable manufacturing costs ($0.90 per pound)...$135 Sales commissions-outside sales 10 Depreciation . 20 Other traceable fixed costs .. 40 205 Product profit contribution.. 85 Share of divisional fixed costs .. 60 Income before taxes.. $ 25

Steve was also confirmed that the fixed costs traceable to the generic product X wouldn't be reduced if the production volume was reduced by a third.

The divisional fixed costs, allocated among the division's products at a flat 40 cents a pound, are even stickier. These costs would continue even if the Hull Division stopped making the generic product X entirely.

Steve arranged a meeting with Ann Baxter, her counterpart at Hingham as Divisional Controller, and ask her a few preliminary doubts to clarify his own report to Susan:

a. Ann (Student Group) to draft a short memorandum, outlining with Steve the points Hingham's management should make in trying to convince Hull's Divisional Manager to reduce the existing high transfer price. If the alternative was to be idleness, identify the incremental costs and calculate the pre-tax Income for Hull in the 2 scenarios, comparing Hulls income if Hingham buys from Hull vs Hingham buys from an outside supplier.

b. Is negotiation the right way to determine a transfer price in this situation? How would you point and explain the overall benefits, if any, for the Company, or instead the individual Divisions advantages, if any, in this situation?