Consider the following information:
Currently, all of the harvesting Division’s output is converted into juice by the Processing Division, and the juice is sold to large beverage companies that produce juice blends for resale. The Processing Division has a yield of 500 litres (Ltr) of juice per 1,000 kilograms of fruit. There are no shipping or marketing cost savings when transferring fruit internally (as compared to acquiring fruit from external suppliers). Cost and market price data for the two divisions are as follows:
200% of
Full Costs
Market Price
Transfer price per kilo ((A$0.10 + A$0.25) × 2)
0.70
Transfer price per kilo (A$0.60)
0.60
1. Harvesting Division
$
$
Revenues (400,000 kg × A$0.70)
280,000
Revenues (A$0.60)
240,000
Costs
Division variable costs (400,000 kg ×A$0.10 per kg)
40,000
40,000
Division fixed costs (400,000 kg × A$0.25 per kg)
100,000
100,000
Total division costs
140,000
140,000
Division operating profit
140,000
100,000
Harvesting Division manager's bonus (5% of operating profit)
7,000
5,000
2. Processing Division
Revenues (200,000 Ltr × A$2.10 per L)
420,000
420,000
Costs
Transferred-in costs
280,000
240,000
Division variable costs (200,000 Ltr × A$0.20 per L)
40,000
40,000
Division fixed costs (200,000 Ltr × A$0.40 per L)
80,000
80,000
Total division costs
400,000
360,000
Division operating profit
20,000
60,000
Processing Division manager’s bonus (5% of operating profit)
1,000
3,000
a) Discuss the goal congruence problem(s) that will arise if the company continues to mandate the use a transfer price of 200% of full cost.
b) Discuss the implications of introducing each of the following transfer pricing methods;
I. market price transfer pricing policy
II. negotiated (between divisions) transfer pricing policy
III. dual transfer-pricing policy (i.e. transfers out of harvesting are made at 200% and transfers into processing are made at market price)