Case 13-52

Manufactures dashboard instruments for heavy equipment. Operates several divisions in Americas, Asia and Europe. Vietnam Division manufactures two types of electrical panels: the high-density panel (HPD) and low density panels (LPD). HPD is used in the most sophisticated instruments whereas LPD is used for less-complicated instruments.

Lpd Unskilled Labor Skilled Labor: Lpd (.25 hour @ $20) hpd (1.5 hour @ $20) Raw Materials 5 3 4 $5

Hpd $5

30 8

Purchased components
Variable overhead Total variable cost

5
5 $22

12
15 $70

 The annual fixed overhead in the Vietnam Division is $1,000,000. Skilled labor is limited in the area and the division must constrain its production to 40,000 hours of skilled labor each year. This became a problem for Thuy Anh Tran, the division manager. Tran increased the demand for the LPD where it became unlimited. LPD sells for $28. Hpd sells anywhere up to 6,000 units per year for $115. General Instrumentation operates its Volkmar Tachometer Division and its main product is a sophisticated tachometer known as TCH-320.

Unskilled labor (.5 hour @ $9) Skilled labor (.3 hour @ $17) Raw material Purchased component Variable Overhear Total Variable Cost

$ 4.50 51.00 11.50 150.00 11.00 $228.00

 The cost of purchased components includes a $14 control pack currently imported from turkey. Fixed overhead in the Volkmar Tachometer Division runs about $800,000 per year. THC-320 sells for $270. Bertram Muelller, the Division manager of the Volkmar Tachometer Dicision and Thuy Anh Tran had a conversation that Vietnams Divisions THC-320 might be a viable substitute for their control pack. Mueller asked his chief engineer to look upon that matter and had the following conversation.

Schmidt: Theres no question that Vietnam Divisions HDP unit will work in our TCH-320. In fact it could save us money. Mueller: Thats good news but if we can buy components within the company, well help General Instrumentations bottom line without hurting ours. Also, it will look good to corporate management if they see us working hard to integrate our division into General Instrumentations overall production program. Schmidt: Ive also been worried about reliability of supply of the control pack. I dont like being dependent on such a critical supplier that way. Mueller: I agree. Lets look at your figures on the HDP replacement.

Schmidt: If we replace the control pack with the HDP from Vietnam, well avoid the $145 control pack cost were now incurring. Also, well save $5.50 on the basic raw materials. There is one catch, though. The HDP will require some adjustments in order to use it in the TCG-320. We can make adjustments here in Berlin. Im guessing it will require an additional 2 hours of skilled labor to make the necessary modifications. I dont think that variable overhead would be any different. Then there is a transporting cost to Berlin of $4.50 per unit. Mueller: Sounds good. Ill give Thuy Anh Tran a call and talk this over. We can use up to the 10,000 of the HDp units per year given the demand for the TCH-320. I wonder what kind of transfer price Vietnam Division will want.

1. Draw a simple diagram depicting the two divisions and their products. Also show the two alternatives that the Volkmar Tachometer Division has in the production of its TCH-320.
General Instrumentation Company

Vietnam Division

Volkmar Construction Division

LDP

TCH - 320

Control pack (from Turkey)

Alternatives: Vietnam Division is to produce HDP to be a component of TCH 320. HDP will be transferred to Volkmar Construction Division and will be a substitute of the control pack acquired from Turkey. Purchase control packs from Turkey.

2. From the perspective of General Instrumentations top management, should any of the TCH-320 units be produced using the high-density panel? If so, how many?
Products (alternatives) TCH 320 (with HDP (sell) LDP (sell) HDP) $270 $115 $28 4.50 5 5 85 30 5 6 8 3 5 12 4 11 15 5 70 4.50 42 $42 1.5 $28 2nd 10 000 units $45 1.5 $30 1st 6 000 units $6 .25 $24 3rd No limit

Selling Price Less: Variable Costs: Unskilled labor Skilled labor Raw Materials Purchased components Variable Overhead Variable cost transfer of HDP Contribution Margin of purchasing control pack *Contribution Margin ($270-228) # of hours per unit CM/hr Ranking: (priority) Maximum # of units produced

Alternatives: 40 000 hours 1st: HDP (sell) 6 000 units x 1.5 hrs= Remaining 2nd: TCH 320 (with HDP) or transfer HDP 10 000 units x 1.5 hrs= Remaining 3rd: LDP (sell) No limit (16 000hrs/.25hrs)= 64 000 units= Remaining 9 000 hours 31 000 hrs.

15 000 hrs. 16 000 hrs.

16 000 hrs. 0

3. Suppose Vietnam Division transfers 10,000 HDp units per year to Volkmar. From the perspective of General Instrumentations top management, what effect will the transfers price have on the companys income?

Answer:
The transfer price will be an income to Vietnam Division (the selling division) and will be a cost for Volkmar construction Instruments (the buying division). It will affect both divisions profit and the evaluation of performance. As for General Instrumentation Company, there is no effect because both divisions are under it.

4. What is the minimum transfer price that the Vietnam Division would find acceptable for the HDP?

Vietnam Divisions minimum transfer price would be: Outlay cost

Opportunity cost: [CM of LDP x( 1.5 hrs to produce an HDP/ .25 hrs to produce an LDP)]

$70 + 36 $106

($6 x 6 units) Transfer price

5. What is the minimum transfer price that the Volkmar Tachometer Division would find acceptable for the HDP?
Savings: Purchase Price of control pack Reduction in Raw Materials cost Total savings: Less: costs Transportation cost Skilled Labor (2 hours x $17) Savings for transferring HDP $ 145 5.50 $150.50 4.50 34 38.50 $112

6. As the corporate controller for the General Instrumentation, recommend a transfer price.

Answer:
The transfer price of $106 is already a goal congruent transfer price for the whole General Instrumentation Company. It is the minimum transfer price the Vietnam Division could offer to Volkmar Construction Instruments Division.