Transfer-pricing methods, goal congruence. British Columbia Lumber has a raw lum

Question

Transfer-pricing methods, goal congruence. British Columbia Lumber has a raw lumber division and a finished lumber division. The variable costs are as follows: Raw lumber division: 100 dollars per 100 board-feet of raw lumber Finished lumber division: 125 dollars 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 200 dollars per 100 board-feet. Finished lumber can be sold at 275 dollars per 100 board-feet. Should British Columbia Lumber process raw lumber into its finished form? Show your calculations. Assume that internal transfers are made at 110% of variable cost. Will each division maximize its division operating-income contribution by adopting the action that is in the best interest of British Columbia Lumber as a whole? Explain. Assume that internal transfers are made at market prices. Will each division maximize its division operating-income contribution by adopting the action that is in the best interest of British Columbia Lumber as a whole? Explain.

Explanation / Answer

Particulars Amount Option 1: Sell as raw lumber for $200 per 100 board feet: Sales $                       200.00 Less: Variable costs $                       100.00 Contribution Margin per 100 board feet $                       100.00 Option 2: Sell as finished lumber for $275 per 100 board feet Sales $                       275.00 Less: Variable costs             Raw lumber                                   $100             Finished lumber                          $125 $                       225.00 Contribution Margin per 100 board feet $                          50.00 British Columbia Lumber will maximize its total contribution margin by selling lumber in its raw form. 2.      Particulars Amount Amount Transfer price at 110% of variable costs $110 per 100 board feet Sell as Raw Lumber Sell as Finished Lumber Raw Lumber Division       Revenues $                       200.00 $                                110.00       Variable costs $                       100.00 $                                100.00      Operating Income $                       100.00 $                                   10.00 Finished Lumber Division       Revenues $                                 -   $                                275.00       Transferred-in costs -- $                                110.00       Variable costs -- $                                125.00      Operating Income $                                 -   $                                   40.00 The Raw Lumber Division will maximize reported division operating income by selling raw lumber. The Finished Lumber Division will maximize division operating income by selling finished lumber. 3.      Particulars Amount Amount Transfer price at market price $200 per 100 board feet Sell as Raw Lumber Sell as Finished Lumber Raw Lumber Division       Revenues $   200.00 $ 200.00       Variable costs $ 100.00 $ 100.00      Operating Income $ 100.00 $ 100.00 Finished Lumber Division       Revenues $                                 -   $       275.00       Transferred-in costs -- $       200.00       Variable costs -- $       125.00      Operating Income $                                 -   $       -50.00 The Raw Lumber Division will maximize division operating income by selling raw lumber. Finished Lumber Division will maximize division operating income by not further processing raw lumber. No further processing is preferred by the company as a whole.

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