Whengon Manufacturing makes elec tronic hearing aids. Department A manufactures 10,000 units of part HR-7 and Department B uses this part to make the finished product. HR-7 is a specific part for a patented product that cannot be purchased or sold outside of Whengon, so there is no outside demand for this part. Variable costs of making HR-7 are $12 per unit. Fixed costs directly traced to HR-7 equal $30,000.
Upper management has asked the two departments to negotiate a transfer price for HR-7. The manager of Department A, Henry Lasker, is worried that Department B will insist on using variable cost as the transfer price because Department A has excess capacity.
Lasker asks Joe Bedford, his management accountant, to show more costs as variable costs and fewer costs as fixed costs. Lasker says, “There are grey areas when distinguishing between fixed and variable costs. I think the variable cost of making HR-7 is $14 per unit.”
1. If Lasker is correct, calculate the benefit to Department A from showing a variable cost of $14 per unit rather than $12 per unit.
2. What cost-based transfer-price mechanism would you propose for HR-7? Explain briefly.
3. Evaluate whether Lasker’s comment to Bedford about the variable cost of HR-7 is ethical.
Would it be ethical for Bedford to revise the variable cost per unit? What steps should Bedford take to resolve the situation?