Terrace Chocolates manufactures specialty chocolates and sells them to fine candy stores. The company operates two divisions, cocoa and candy, as decentralized entities. The cocoa division purchases raw cacao beans and processes them into cocoa powder. The candy division purchases cocoa powder and other ingredients and uses them to produce gourmet chocolates.

The cocoa division is free to sell processed cocoa to outside buyers, and the candy division is free to purchase processed cocoa from other sources. Currently, however, the cocoa division sells all of its output to the candy division, and the candy division does not purchase materials from outside suppliers. The processed cocoa is transferred from the cocoa division to the production division at 110% of full cost. The cocoa division purchases raw cacao beans for $2 per pound. The cocoa division uses 1.5 pounds of raw cacao beans to produce one pound of processed cocoa. The division's other variable costs equal $2.00 per pound of output, and fixed costs at a monthly production level of 40,000 pounds of cocoa are $1.00 per pound. During the most recent month, 40,000 pounds of processed cocoa were transferred between the two divisions. The cocoa division's capacity is 45,000 pounds of output.

With the increase in demand for dark chocolate, the candy production division expects to use 42,000 pounds of cocoa next month. FillUp Foods has offered to sell 2,000 pounds of cocoa next month to the candy production division for $6.50 per pound.

Requirement 1. Compute the transfer price per pound of processed cocoa. If each division is considered a profit center, would the candy production manager choose to purchase 2,000 pounds next month from FillUp Foods? (Do not round intermediary calculations. Round the amount entered the nearest cent.)

The transfer price per pound of processed cocoa is ________ . Because this amount is (above / below) the purchase price of $6.50, the candy division manager would choose to purchase the 2,000 pounds from (Terrace / Fill-Up).

Requirement 2. What would be the cost to Terrace Chocolates if the 2,000 pounds had been produced by the cocoa division and transferred to the candy division? Is the external purchase in the best interest of Terrace Chocolates? What is the cause of this goal incongruence?

Since the cocoa division (is / is not) operating at capacity, the cost to produce the additional 2,000 pounds is _______ per pound.

Is the external purchase in the best interest of Terrace Chocolates?

The purchase (is / is not) in the best interest of Terrace because, if produced internally, the additional 2,000 pounds would cost the company _______ . If purchased from Fill-Up, the cocoa would cost _______ .

What is the cause of this goal incongruence? (Select all that apply.)

A. setting a transfer price based on full cost treats fixed costs as variable

B. purchasing the cocoa for less than the transfer price may put the production department in jeopardy

C. setting the price above full cost (110%) artificially inflates the cost to the purchasing division

D. producing close to capacity can put the entire company at risk of stock-outs

E. setting a transfer price based on market cost treats variable costs as fixed

Requirement 3. The candy division manager suggests that $6.50 is now the market price for processed cocoa, and that this should be the new transfer price. Terrace's corporate management tends to agree. The cocoa division manager is suspicious. FillUp's prices have always been much higher than $6.50 per pound. Why the sudden price cut? After further investigation by the cocoa division manager, it is revealed that the $6.50 per pound price was a one-time-only offer made to the candy division due to excess inventory at FillUp. Future orders would be priced at $7.00 per pound. Comment on the validity of the $6.50 per pound market price and the ethics of the candy manager. Would changing the transfer price to $6.50 matter to Terrace Chocolates?

$6.50 (is / is not) a valid market price because it (can / cannot) be replicated on future orders. ($6.50 / $6.60 / $7.00) is a more appropriate market price. The candy manager (was / was not) acting ethically in this situation because he or she was (providing / withholding) pertinent information from both upper management and the cocoa division manager and was promoting a position known to be (false / true). If the transfer price had been changed to $6.50, it (would / would not) have affected the company overall, but profit incentive rewards would have been shifted away from the (candy / cocoa) division manager and to the (candy / cocoa) manager.