Susan Willard, the CEO of Troy Industrial Designs (TID), has called a meeting to evaluat...

Susan Willard, the CEO of Troy Industrial Designs (TID), has called a meeting to evaluate the present method of charging the two offices at Washington and Rochester for the shared services of the Creative Design Group (CDG). She wants to discuss the present transfer price system and suggest a better one.

TID is a reputable firm in the industrial design sector. It bids for design contracts from different firms. When a bid is accepted, TID either makes prototypes based on the client’s blueprints, designs new products out of existing designs, or draws designs for a product the client has in mind. TID charges clients a fixed figure upon completion of the job and 1 percent of sales accruing to the client every year for the first seven years for the use of TID designs.

The two offices of TID are independently run by different managers and are both profit centers. Each manager assigns account executives to individual accounts. The account executives are paid a fixed salary, but a large part of their compensation is their bonus, which is based on the revenues accruing from the jobs they manage. Once receiving a job, each account executive informs George Scott, the head of CDG. They meet with the client and discuss the details of the job, including specifications, requirements, and expected completion time. The client is consulted when the account executive receives the preliminary design. As soon as the job for a client is finished, the account executive makes a detailed report explaining the work done, the number of designers employed for the job, the number of hours worked on it, the amount billed to the client, and any follow-up needed. Designing is a one-time job, and additional follow-up is rarely required. Account executives are responsible for any follow-up on the jobs done by them. If the client comes back with another project, it is treated as a separate job.

TID centralized the design departments of the two offices to take advantage of the specialized knowledge of the designers. Though CDG is only five years old, it employs the best talent and uses the latest technology. This has had a positive impact on customers, and because of this, TID has grown rapidly in the past few years. The two offices have a lot of confidence in the Creative Design Group and use it for all their design needs. The rapid growth has caused top management to rethink the transfer pricing procedures and other organizational aspects of the business.

CDG is totally responsible for the designing part of the job. It interacts with the client only at the design stage; all other aspects of the job are done by the appropriate account executive. CDG works in small teams, each led by a supervisor who reports to Scott daily. Scott is evaluated on the excess of revenues collected from the two offices over the costs of his department. The transfer price charged to each office is decided before the designing job is taken by CDG. Before the client is brought in for the discussion, the account executive and Scott decide what fees CDG will charge the office for the services. Revenues for CDG come from the predetermined fees charged to the two offices.

Willard suggests that CDG should provide its services free of charge. Under this proposal, Scott would receive a fixed salary and a bonus based on overall firm profits (i.e., a percentage of the combined profits of the two offices). She thinks that as the cost of the department is finally consolidated with the costs of the firm, there should be no transfer prices for the department. Removal of the transfer price will help reduce the work of the accounting department and streamline the department to cope with the firm’s rapid growth. Willard says that the firm is committed to designing the best products and that transfer prices really do not matter.

Required:

Will the resources of the Creative Design Group be efficiently utilized under the new plan? Why? What are the merits and demerits of the existing plan? Is the proposed plan better than the existing one? Why or why not?