Cosmic Sounds is a record company with different labels. Each label has contracts with various recording artists. It also owns a recording studio called Blast Off. The record labels and the recording studio operate as separate profit centres. The studio earns revenue by recording artists under contract with the labels owned by Cosmic Sounds, as well as artists under contract with other companies. The studio bills out at $1,100 per hour, and a typical album requires 80 hours of studio time. A manager from Big Bang, one of Cosmic Sounds' record labels, has approached the recording studio manager offering to pay $800 per hour for an 80-hour session. The record label pays outside studios $1,000 per hour. The recording studio's variable cost per hour is $600.
Instructions
(a) Determine whether the recording should be done internally or externally, and the appropriate transfer price, under each of the following situations:
1. Assume that the recording studio is booked solid for the next three years, and it would have to cancel a contract with an outside customer in order to meet the needs of the internal division.
2. Assume that the recording studio has available capacity.
(b) The top management of Cosmic Sounds believes that the recording studio should always do there cording for the company's artists. On several occasions, it has forced the recording studio to cancel jobs with outside customers in order to meet the needs of its own labels. Discuss the pros and cons of this approach.
(c) Calculate the change in contribution margin to each division, and to the company as a whole, if top management forces the recording studio to accept the $800 transfer price when it has no available capacity