Case 5-3

General Appliance Corporation Approach The case can be solve by using two kind of methods. Fisrt method is to use the Stove Top Problem and the other is Thermostatic Control Problem and Transmission Problem. A. Stove Top Problems This is a very difficult case because (as usual in transfer price problems) there is no really satisfactory answer. 1. The vice president of the Manufacturing Staff has been assigned line responsibility by the president and has exercised this responsibility. Thus, a limitation has been placed on divisional autonomy. 2. We do not know whether the action taken was in the best interests of the company. The Electric Stove Division would oppose paying for the change in quality even if it believed it to be necessary. If the division agreed to the change, it would have to pay for it. By opposing it, it may get out of paying for it. (One of the problems with decentralization is that frequently people are not above playing games to increase divisional profitability.) 3. The controller must settle the dispute. Consequently, the solution to the problem cannot be to fire the manufacturing vice president or something equally drastic. The real issue is whether the change in quality should have been made or not. One possible would be to have a group consisting of a representative of the Electric Stove Division, the Chrome Products Division, and the Manufacturing Staff restudy the decision and decide whether the change in quality standard was necessary or not. If the group decides positively, then the Electric Stove Division pays for it. Otherwise, the production processes revert to the old quality standards. This may not be feasible, however, because such a study has presumably already been made. The Electric Stove Division representative would have to follow the position already taken by the division. Likewise, the Manufacturing Staff representative could hardly contradict his boss. As controller, therefore, perhaps the only solution is to look at it this way: 1. 2. 3. 4. Either the action was correct or it was not. If it were the correct action, it would be equitable to charge the Electric Stove Division for the better quality. If it were not the correct action, it should be charged to the division best able to change the decision. In this case, it was the Electric Stove Division. Consequently, charge the Electric Stove Division for the quality change. If this division sincerely believes that the quality difference is not worth the cost, they would be able to get it changed as soon as the emphasis on quality is relaxed.

B. Thermostatic Control Problem In the classification given in the text, the thermostatic control unit would be a Class 3 part. It would, therefore, be priced at $2.40 because this is the long-range competitive price. This price, however, would appear to be unjust to the Refrigeration Division because, if it had not agreed to buy the part inside, it could still obtain it on the outside for $2.15. If the Refrigeration Division pays $2.15, it does not seem to make much sense for the Laundry to pay $2.40 when its requirements are five times as great as the Refrigeration Division.

The answer to this case depends on the transfer price policy of General Appliance and this case will force the company to meet this issue squarely. If the policy is long-term competitive price levels, the price would be $2.40, with possibly some relief to the Refrigeration division. (For example, the price could be $2.15for the next year. After that it would go to $2.40.) If the policy is to transfer parts within the company at short-term competitive prices, the price to the Refrigeration Division would be $2.15. The problem would be rationalizing a system that uses two different prices for the same product, with the higher price being paid by the division with the largest requirements. I personally prefer a transfer policy similar to that described in the text. Under this policy, the price would be $2.40. The Refrigeration Division would have to accept the fact that there are other advantages to being part of General Appliance that offset the disadvantage of being unable to profit from a temporary depression in prices. C. Transmission Problem This case involves the question of whether or not a penalty should be asses against the Laundry Equipment Division for failing to speak out when they were quoted as agreeing to a transfer price that was the basis for a capital investment decision. However, the Gear and Transmission Division was also not without fault. They must have known that the $12 price would be unacceptable to the Laundry Equipment Division and, consequently, they should have made more of an effort to negotiate a price that was acceptable. The first consideration is whether or not a mistake had been made. That is to say, would the plant have been build if a valid transfer price had been used If the investment would have been approved even using the lower transfer price in the capital investment analysis, then the solution to this problem is easy. The transfer price would be $11.25 because that is the price that would have resulted if everything had been done correctly. Neither division would be suffering a penalty. If, however, the plant would not have been built, had the correct transfer price been used in the capital investment analysis, the problem becomes more difficulty. There is a penalty and the question is: Who should absorb this penalty? It is my opinion that the penalty should be divided equally between the two divisions. That is, the price should be halfway between $11.50 (the $12 price minus the $.50 error) and $11.25. Splitting the difference is the most unsatisfactory way to settle transfer price disputes but, in this case, both divisions appear to be at fault in creating a mistake. Obviously, company policy should be changed to require formal approval of any transfer price included in a capital investment proposal.