Case 2 (20 Marks)
Parent Inc. has two subsidiaries, A and B Inc.
“Things seem to be humming along nicely!” president of Parent Inc. exclaimed John
Forsythe at the company’s quarterly review, “Both divisions are humming along nicely
and profitability has never been better.”
“Not so fast! I have tons of backlogged orders and my only component supplier went out
of business.” exclaimed Pauline Roy, Divisional Controller of B Inc.
“Fine. Maybe we can work out a deal whereby Gerald Fortier (Divisional controller of A)
– can divert his output to division B.”
“I’ll want at least $10 per component or no deal.” exclaimed Gerald.
“I can’t pay that and turn a profit – I may as well shut my division.” continued Pauline.
Division A produces a component which it sells externally for $10 per unit. This
component has a variable cost of $5 per unit.
Division B uses a similar component which it buys from an external supplier for $4 per
unit and adds $10 of its own variable costs and sells its product externally for $22. Both
products have a fixed overhead per unit of $2.
Required:
Assume the role of John Forsythe. How would you go about resolving the current
impasse? Be sure to suggest a transfer pricing policy approach as well as the effects this
would have on corporate reporting. (20 marks)