Question

Southern Glass manufactures glass bottles for a variety of products, including perfume bottles and liquor bottles. The company has two profit centers: production and labeling. The production department melts the raw materials, adding metal oxides to produce different colors if desired. It then uses a continuous rolling process to shape the bottles. Production then transfers the bottles to the labeling department at an average cost of $15 ($12 variable; $3 fixed) per case. The labeling department then paints or attaches labels on the bottles at an additional fixed cost of $1 and sells the labeled bottles on the external market at an average price of $30 per case.

Recently, a regional liquor manufacturer contacted the manager of the production department about purchasing ¼ of the 250,000 cases Southern Glass plans to make in April. The company would like production to start making their specially shaped bottles. They are willing to pay $28 per case. Making the special bottles would not affect the production department’s cost but it would require cutting current bottle production by ¼; therefore, the labeling department would only label and sell 187,500 labels in April.

(1) Will the production department prefer to sell all 250,000 cases internally or sell ¼ (62,500) cases to the liquor manufacturing and ¾ (187,500) to the labeling department?

(2) Will the labeling department prefer to purchase all 250,000 cases internally or allow production to sell ¼ (62,500) cases to the liquor manufacturing?

(3) Will company profits be maximized if the production department sells all 250,000 cases internally or sells ¼ (62,500) cases externally and ¾ (187,500) internally?

(4) Why is there a goal congruence problem (hint: does everyone want the same option)?

(5) Provide one specific policy change that can solve the goal congruence problem illustrated in this example (at a minimum, there are three changes – you only need to provide one). How does your policy change solve the problem?

These tables must be filled out before the questions can be answered.

Production Department Revenues and Costs

(1) If production transfers all cases to labeling
Revenues from transfers to labeling
Variable production costs
Fixed production costs
Net profit
(2) If production sells ¼ to ABC & transfers ¾ to labeling
Revenue from sales to ABC Mfg.
Revenue from transfers to labeling
Variable production costs
Fixed production costs
Net profit

Total Revenues and Costs for Southern Glass

(1) If production transfers all cases to labeling
Production dept. variable costs
Production dept. fixed costs
Label dept. external sales
Label dept. additional fixed costs
Net Profit*
(2) If production sells ¼ to ABC & transfers ¾ to labeling
Production dept. external sales
Production dept. variable costs
Production dept. fixed costs
Label dept. external sales
Label dept. additional fixed costs
Net Profit**

*This profit should equal: production net profit + labeling net profit for option (1) in the first two tables

**This profit should equal: production net profit + labeling net profit for option (2) in the first two tables

Labeling Department Revenues and Costs

(1) If production transfers all cases to labeling
Revenue from sales on external market
Transfer costs from production
Additional fixed labeling costs
Net profit
(2) If production sells ¼ to ABC & transfers ¾ to labeling
Revenue from sales on external market
Transfer costs from production
Additional fixed labeling costs
Net profit

Answer 1

Answer :

(1) Production Department should sell ¼ (62,500) cases to the liquor manufacturing and ¾ (187,500) to the labeling department, Because this would increase overall profit of Production Department by $ 812,500

(2)  labeling department should prefer to purchase all 250,000 cases internally, because this would increase the overall profit of Labeling Department by $ 3,500,000 - 2,562,500 = $ 937,500

(3) Company profits be maximized when the production department sells all 250,000 cases internally.

(4) There a goal congruence problem because everyone does not want the same option, Everyone thinks about their own profitability but overall profitability of company is more important.

(5) Policy change that can solve the goal congruence problem :

Total Profit to Production department by selling all cases to labeling = $ 0

Total Profit to Production department by selling ¼ to ABC & transfers ¾ to labeling = $ 812,500

If the Transfer price is changed from $ 15 to $ 18.25 then Production department's :

Revenues from transfers to labeling = $ 18.25 x 250,000 = $ 4,562,500

Variable production costs = $ 12 x 250,000 = $ 3,000,000

Fixed production costs = $ 3 x 250,000 = $ 750,000

Net profit = $ 4,562,500 - 3,000,000 - 750,000 = $ 812,500

So, if the Transfer price is changed from $ 15 to $ 18.25 then Production Department will have equal profit in both conditions. This can solve the goal congruence problem.

Notes :

Production Department Revenues and Costs

(1) If production transfers all cases to labeling

Revenues from transfers to labeling = $ 15 x 250,000 = $ 3,750,000

Variable production costs = $ 12 x 250,000 = $ 3,000,000

Fixed production costs = $ 3 x 250,000 = $ 750,000

Net profit = $ 3,750,000 - 3,000,000 - 750,000 = $ 0

(2) If production sells ¼ to ABC & transfers ¾ to labeling

Revenue from sales to ABC Mfg. = $ 28 x 62,500 = $ 1,750,000

Revenue from transfers to labeling = $ 15 x 187,500 = $ 2,812,500

Variable production costs = $ 12 x 250,000 = $ 3,000,000

Fixed production costs = $ 750,000

Net profit = $1,750,000 + 2,812,500 - 3,000,000 - 750,000 = $ 812,500

Total Revenues and Costs for Southern Glass

(1) If production transfers all cases to labeling

Production dept. variable costs = $ 12 x 250,000 = $ 3,000,000

Production dept. fixed costs = $ 750,000

Label dept. external sales= $ 30 x 250,000 = $ 7,500,000

Label dept. additional fixed costs = $ 1 x 250,000 = $ 250,000

Net Profit = $ 7,500,000 - 3,000,000 - 750,000 - 250,000 = $ 3,500,000

(2) If production sells ¼ to ABC & transfers ¾ to labeling

Production dept. external sales = $ 28 x 62,500 = $ 1,750,000

Production dept. variable costs = $ 12 x 250,000 = $ 3,000,000

Production dept. fixed costs = $ 750,000

Label dept. external sales = $ 30 x 187,500 = $ 5,625,000

Label dept. additional fixed costs = $ 250,000

Net Profit = $ 1,750,000 + 5,625,000 - 3,000,000 - 750,000 - 250,000 = $ 3,375,000

Labeling Department Revenues and Costs

(1) If production transfers all cases to labeling

Revenue from sales on external market = $ 30 x 250,000 = $ 7,500,000

Transfer costs from production = $ 15 x 250,000 = $ 3,750,000

Additional fixed labeling costs = $ 250,000

Net profit = $ 7,500,000 - 3,750,000 - 250,000 = $ 3,500,000

(2) If production sells ¼ to ABC & transfers ¾ to labeling

Revenue from sales on external market = $ 30 x 187,500 = $ 5,625,000

Transfer costs from production = $ 15 x 187,500 = $ 2,812,500

Additional fixed labeling costs = $ 250,000

Net profit = $ 5,625,000 - 2,812,500 - 250,000 = $ 2,562,500