(Transfer prices) Cookie Delight Company has two divisions: Plain Cookies and Decorated Cookies. Lars Linden is the manager of Plain Cookies Division and Theresa Davis is the manager of Decorated Cookies Division. Company president Marie Strauss wants to develop a transfer pricing system that will instill goal congruence in the two division managers. Linden and Davis each get a bonus of 10 percent of the operating margins of his and her respective division. The following information is available:
Plain Cookies | Decorated Cookies | |
Sales (market price) | $2 per cookie | $4 per cookie |
Variable costs (excluding direct costs) | $ 0.50 per cookie | $0.75 per cookie |
Fixed costs | $300 per month | $500 per month |
Units sold to outside market | 3,000 per month | 800 per month |
Capacity (in units) | 4,000 per month | 850 per month |
a. Create a contribution margin income statement for each division and for the company in total, assuming that the Decorated Cookie Division buys cookies from out-side suppliers. Show both Linden’s and Davis’s bonuses separately.
b. Assuming there are no cost savings associated with the Plain Cookie Division selling directly to the Decorated Cookie Division, what is the lowest transfer price Linden should charge? What is the highest transfer price?
c. Prepare contribution income statements for each division and the company as a whole using the lowest and highest transfer prices computed in (b). What effect does each transfer price have on the two division managers?
d. How can Strauss encourage the division managers to agree to an arrangement that will be acceptable to them and also be the best price for the benefit of the company as a whole? Explain your answer.
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