Pricing agreement | Good Grade Guarantee!
Technovia, Inc., has two divisions: Auxiliary Components and Audio Systems. Divisional managers areencouraged to maximize return on investment and EVA. Managers are essentially free to determinewhether goods will be transferred internally and what internal transfer prices will be. Headquarters hasdirected that all internal prices be expressed on a full cost plus basis. The markup in the full-cost pricingarrangement, however, is left to the discretion of the divisional managers.Recently, the two divisional managers met to discuss a pricing agreement for a subwoofer that would besold with a personal computer system. Production of the subwoofers is at capacity. Subwoofers can besold for $31 to outside customers.The Audio Systems Division can also buy the subwoofer from external sources for the same price;however, the manager of this division is hoping to obtain a price concession by buying internally. The fullcost of manufacturing the subwoofer is $20. If the manager of the Auxiliary Components Division sellsthe subwoofer internally, selling and distribution costs of $5 can be avoided. The volume of businesswould be 250,000 units per year, well within the capacity of the producing division.After some discussion, the two managers agreed on a full cost plus pricing scheme that would bereviewed annually. Any increase in the outside selling price would be added to the transfer price bysimply increasing the markup by an appropriate amount. Any major changes in the factors that led to theagreement could initiate a new round of negotiation; otherwise, the full cost plus agreement wouldcontinue in force for subsequent years.
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