Chapter 22, Problem 22.29P

Goal-congruence problems with cost-plus transfer-pricing methods, dual-pricing system (continuation of 22-28). Assume that Pat Borges, CEO of Cran Health, had mandated a transfer price equal to 225% of full cost. Now he decides to decentralize some management decisions and sends around a memo that states the following: “Effective immediately, each division of Cran Health is free to make its own decisions regarding the purchase of direct materials and the sale of finished products.”

1. A. Give an example of a goal-congruence problem that will arise if Cran Health continues to use a transfer price of 225% of full cost and Borges’s decentralization policy is adopted.
2. B. Borges feels that a dual transfer-pricing policy will improve goal congruence. He suggests that transfers out of the harvesting division be made at 225% of full cost and transfers into the processing division be made at market price. Compute the operating income of each division under this dual transfer-pricing method when 480,000 pounds of cranberries are harvested during June 2017 and processed into juice.
3. C. Why is the sum of the division operating incomes computed in requirement 2 different from Cran Health’s operating income from harvesting and processing 480,000 pounds of cranberries?
4. D. Suggest two problems that may arise if Cran Health implements the dual transfer prices described in requirement 2.