ACCT101 Accounting And Financial Report

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16-07-2021

Questions:

Coffee Maker's Incorporated (CMI)

Two divisions of a CMI are involved in a dispute. Division A purchases Part 101 and Division B purchases Part 201 from a third division, C. Both divisions need the parts for products that they assemble. The intercompany transactions have remained constant for several years.

Recently, outside suppliers have lowered their prices, but Division C is not lowering its prices. In addition, all division managers are feeling the pressure to increase profit. Managers of divisions A and B would like the flexibility to purchase the parts they need from external parties to lower cost and increase profitability.

The current pattern is that Division A purchases 3,000 units of product part 101 from Division C (the supplying division) and another 1,000 units from an external supplier. The market price for Part 101 is $900 per unit. Division B purchases 1,000 units of Part 201 from Division C and another 500 units from an external supplier. Note that both divisions A and B purchase the needed supplies from both the internal source and an external source at the same time.

The managers for divisions A and B are preparing a new proposal for consideration.

Division C will continue to produce Parts 101 and 201. All of its production will be sold to Divisions A and B. No other customers are likely to be found for these products in the short term, given that supply is greater than demand in the market.
Division C will manufacture 2,000 units of Part 101 for the Division A and 500 units of Part 201 for the Division B.
Division A will buy 2,000 units of Part 101 from Division C and 2,000 units from an external supplier at $900 per unit.
Division B will buy 500 units of Part 201 from Division C and 1,000 units from an external supplier at $1,900 per unit.

Part	101	201
Direct materials	$200	$300
Direct labor	$200	$300
Variable overhead	$300	$600
Transfer price	$1,000	$2,000
Annual volume	3,000 units	1,000 un

Division C Data 2014 Based on the Current Agreement

Division A
	Current Situation			Proposal
	No. of Units	Purchase Price	Total Purchases	No. of Units	Purchase Price	Total Purchases
Internal purchases	3,000		$	2,000		$
External purchases	1,000			2,000
Total cost for part 101			$			$
Savings to Div. A						$

1.Memo

Write a 4- or 5-paragraph memo to the division manager explaining the analysis performed. Start with an introduction and end with a recommendation. Each of the four or five paragraphs should have a heading.

2.Short Essay

Start with an introduction and end with a summary or conclusion. Use headings.

Evaluate and discuss the implications of the following transfer pricing policies:

Transfer price = cost plus a mark-up for the selling division

Transfer price = fair market value

Transfer price = price negotiated by the managers

Why is transfer pricing such a significant issue both from a financial and managerial perspective?

Summarize the financial effects for the three divisions and the company as a whole in another table.

Answers:

1.Memo

Coffee Makers Division is an SME which produces Part 101 and Part 201. Both the parts are manufactured by its Division C which supplies its products to the other Divisions. Currently, Division C is earning a profit of $1700000 and supplies 3000 units of Part 101 to Division A and 1000 units of Part 201 to Division B.

If Division C switches in producing 2000 units of Part 101 and 500 units of Part 201 its profit will reduce by $700000. However, the cost saving from buying the parts from external market to Division A and Division B @$100 per unit on 1000 units of Part A and 500 units of Part 201 will come to $150000. Thus the overall profit for the company will reduce by $550000. Thus, company should not approve for the proposal.

Introduction-

The Coffee Makers Division has three divisions. Division A and Division B uses the manufacture of Division C. Division A uses Part 101 and Division B uses Part 201. Division C produces the requirements of both the parts and supplies to other divisions. Since the parts do not have a demand in the external market, the production of Division C is confined to the requirements of other divisions only.

Proposal-

Division A is recommended to buy 2000 units from Division C and 2000 units from external market and Division B is recommended to buy 500 units from Division C and 1000 units from external market. Both the parts are available in external market at a price lower by $100 from Division C.

Analysis and Recommendation-

Division C is using a mark-up on selling price of 30% on Part 101 and 40% on Part 201 which counts for $300 and $800 per unit respectively. However, the saving per unit for other divisions comes to $100 per unit only. Thus, the cost saving will not be able to cover the profit loss to Division C. Hence, the proposal is not acceptable from the overall perspective of the company.

2.Transfer pricing policy is an important aspect for every multi-divisional company which uses inter divisional products. With the increasing number of MNCs the intercompany transactions are also increasing. From the financial perspective, it is a very important decision as the prices help in absorbing the intercompany losses thereby reducing the tax impacts. Therefore, the transfer pricing has been given an important place in tax regulations also. For any enterprise, the prices of inter divisional products will decide the overall profit considering a number of factors. (Lohse, et al., n.d.)

Various methods of transfer pricing can be explained as under:-

Cost plus a mark-up for the selling division

This method of pricing a product is popularly known as mark-up pricing. The overall profit requirement for the company or the division is evaluated and then applied for pricing the products. This method assures a fixed profit for the concern. (Strategies, 1999)

Fair Market Value

Fair Value Method of pricing implies evaluating the market value for the products being supplied. The fair market value means the value at which the products manufactured by the concern are available in the market. This strategy can be considered as the competition strategy as it enables the concern to price its products according to the prices prevailing in the market. (Nissim & Penman, 2008)

Negotiated Price

The Negotiated Pricing includes the division wise and overall profitability consideration by the managers. The managers take into account each and every point of costing and evaluate different scenarios of cost and profitability. Here, the consideration for Divisional managers is the profit of their respective divisions and the company’s Managing Director is concerned about the overall profit to the company. Thus, negotiations held between the managers decide the prices of the products. (Alfredson & Cungu, 2008)

Bibliography

Alfredson, T. & Cungu, A., 2008. Negotiation Theory and Practice. [Online]
Available at: https://www.fao.org/docs/up/easypol/550/4-5_negotiation_background_paper_179en.pdf[Accessed 3 February 2017].

Lohse, T., Riedel, N. & Spengel, C., n.d. The increasing importance of transfer pricing regulations - a worldwide overview. [Online]Available at: https://www.sbs.ox.ac.uk/faculty-research/tax/publications/working-papers/increasing-importance-transfer-pricing-regulations-worldwide-overview[Accessed 3 February 2017].

Nissim, D. & Penman, S., 2008. Principles for the application of Fair value of Accounting. [Online] Available at: https://www0.gsb.columbia.edu/mygsb/faculty/research/pubfiles/3029/FairValue.pdf[Accessed 3 February 2017].

Strategies, A., 1999. Methods to Price Your Product. [Online]Available at: https://www.agmrc.org/media/cms/8452_B4C31E4164D0A.pdf[Accessed 3 February 2017].