Delmar Foods has two divisions: (1) a Processed Meat Division and (2) a Frozen Pizza Division. Delmar’s frozen pizzas use processed meat as a topping. The company’s Processed Meat Division supplies the Frozen Pizza Division with all of its meat toppings. Delmar managers are paid bonuses based on their division’s profitability.
The manager of the Processed Meat Division argues for a transfer price based on a market value approach. The manager of the Frozen Pizza Division favors a transfer price based on a cost approach. Explain how Delmar’s bonus system may influence each manager’s opinion regarding which approach to use in establishing a transfer price.