The Moreno Company has several plants, one of which produces military equip¬ ment for the federal government. Many of the contracts are negotiated on a cost-plus basis. Some of the other plants have been only marginally profitable. The home office has engaged a consultant, Mr. Ladron, to meet with top man¬ agement. Ladron observes that the company isn’t using some of the more “cre¬ ative” accounting techniques to shift costs toward the plant serving the federal government and away from the marginally profitable plants. He notes that “transfer pricing and service department allocations involve a lot of subjectivity and there is plenty of room to stack the deck and let the taxpayer foot the bill. Taxpayers will never know and even if the government suspects, it can’t prove motive if we document the procedures with contrived business jargon.” One of the staff stated that “this would be a way to get back some of those exorbitant income taxes we have had to pay all these years.” The company president ended the meeting and asked for some time to consider the matter.

a. What is the purpose of setting transfer prices and making service department allocations?

b. Can or should transfer prices and service department allocations be used to shift income from one plant to another? If so, under what conditions?

c. Do you think that what the consultant is suggesting is legal? Ethical? Has it ever been done? Discuss your reasoning for each answer.