Question

answer to problem 22-19 Book Horngrens-Cost Acciunting A managerial Emphasis - 16 Edition

HEwgers u uie argar company 22-19 Transfer-pricing methods, goal congruence. Calgary Lumber has a raw lumber division and a fin- ishad lumber division. The variable costs are as follows Raw lumber division: $125 per 100 board-feet of raw lumber Finished lumber division: $145 per 100 board-feet of finished lumber Assume that there is no board-feet loss in processing raw lumber into finished lumber Raw lumber can be sold at $175 per 100 board-feat Finished lumber can be sold at $345 per 100 board-feet 1 Should Calgary Lumber process raw lumber into its finished form? Show your calculations 2 Assume that internal transfers are made at 130% of variable cost Will each division maximize its divi- sion operating-income contribution by adopting the action that is in the best interest of Calgary Lumber as a wholo? Explain 3 Assume that internal transfors are made at market prices. Will each division maximize its division oparating-income contribution by adopting the action that is in the best interest of Calgary Lumber as a whole? Explain ad

Answer 1

1) Alt. 1: Selling as raw lumber for $175 @100 board feet

Alt. 2: Selling as finished lumber for $345 @100 board feet

Alternative 1:
Revenue	175
VC	125
CM	$50 per 100 board feet
Alternative 2:
Revenue	345
VC:
Raw lumber	125
Finished lumber	145
CM	$75 per 100 board feet

Calgary Lumber will maximize its CM with processing raw lumber into finished lumber i.e. Alternative 2

2)

	Raw Lumber	Finished Lumber
Raw Lumber Division
Division revenues	175	162.5
Division variable costs	125	125
Division operating income	50	37.5
Finished Lumber Division
Division revenues		345
Transferred-in costs		162.5
Division variable costs		145
Division operating income		37.5

From above calculations we can conclude that the Raw Lumber Division maximizes reported division operating income with the selling raw lumber, although it is not the action preferred by the firm as a whole. The Finished Lumber Division maximizes operating income of division with the processing raw lumber further, which coincides with the action preferred by the firm as a whole

3)

	Raw Lumber	Finished Lumber
Raw Lumber Division
Division revenues	175	175
Division variable costs	125	125
Division operating income	50	50
Finished Lumber Division
Division revenues	0	345
Transferred-in costs		175
Division variable costs		145
Division operating income	0	25

Because the Raw Lumber Division would be indifferent among selling the lumber in raw form or finished form, thus the company will be willing to have the raw lumber processed further, as this is the action preferred as a whole by the company. The calculations reveal that the Finished Lumber Division would maximize division operating income with further processing of raw lumber and it is also preferred by the company as a whole. Therefore, transferring it at market price will lead in division actions which are also in the company's best interest as a whole