The following question presents hypothetical data concerning transfer of cotton between departments as part of the Cotton On Group's production processes. The textile department produces cotton for use by various other production departments within the Cotton On Group. The costs incurred by the textile department to produce cotton are provided below:

	Cost per square metre
Direct materials	$2.10
Direct labour	$0.50
Variable overhead	$0.25
Fixed overhead	$0.15

The textile department can also sell cotton to external customers for $5.00 per square metre. Sales staff from the textile department are paid a sales commission of $0.10 per square metre for sales to external customers. No sales commissions are paid for transfers to internal customers.

Required

1. Provide and discuss an example which illustrates how poorly set transfer prices for cotton could result in a lack of goal congruence .
2. Based on a consideration of the pros and cons of the general transfer price rule, negotiated pricing and cost-plus pricing, identify an optimal internal transfer price policy for cotton .