Reference no: EM133020303

Question - Scenario - Thomas, a division of Brite Ltd., manufactures light bulb bases - the metal base of a light bulb that screws into the socket. It costs Thomas $0.70 to produce a base ($0.25 direct material, $0.20 direct labour, $0.10 variable overhead, and $0.15 allocated fixed overhead). The bases are then sold for $1.00 each to light bulb manufacturers to use in creating light bulbs. In order for light bulbs to be sold to homes everywhere, the bases come in several standard sizes.

Light, another division of Brite, purchases bases from Thomas to use in the manufacturing of its bulbs. Recently, Light has been considering purchasing bases from outside of the Brite company as it can procure them for a lower price of $0.90. Light's management is evaluated based on profits, and is therefore motivated to save costs where it can.

Thomas currently sells 80% of its production to Light. Light bulb base providers are plentiful in the industry and Thomas operates with excess capacity. Management of Thomas is also compensated based on profits; as such, Thomas sells bases to Light at the same price ($1.00) it sells to external parties.

1. What is the transfer pricing strategy being used?

2. How does the strategy impact management and the company as a whole?

3. What advice would you give to the company?