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QUESTIONS
5. The four criteria (benefits received, causation, equity, and ability-to-bear) are all
relevant to making support department allocations and should, theoretically, be
applied equally. However, it is often not practical to apply the equity criterion
because it is too difficult to achieve agreement on what is fair. Ability-to-bear is
often not used because it may result in unrealistic or profit-detrimental actions.
Therefore, most support department allocations are based on the benefits-received
and causation criteria.
6. The direct method is the simplest method of allocation and does not take into
consideration the assistance provided among support departments. Thus, the direct
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method is the only method that does not allocate a support departments costs to
other support departments.
The step method does take into consideration assistance provided between support
departments, but does so sequentially based on a benefits-provided ranking.
Because of the necessity to rank benefits, all support department interaction is not
accounted for using the step method. This method is more difficult than the direct
method, but less difficult than the algebraic method.
The algebraic method, unlike the other methods, recognizes reciprocal (give-and-
take) exchanges of assistance among the support departments by providing a set of
simultaneous equations to solve for the effects of such exchanges. However, this
method is very difficult to use without the aid of a computer when more than two
or three departments are involved. If formulae are correct, the algebraic method
provides the most accurate measure of the usage of assistance among departments.
The only similarity among the methods is their ultimate objective: the assignment
of support department costs to revenue-producing areas.
8. Transfer prices are internally set and agreed on prices with which a selling
division transfers goods or services to a buying division. The objectives are goal
congruence, autonomy, motivation toward effectiveness and efficiency,
practicality, and credibility as a basis for performance evaluation.
In negotiating transfer prices among segment managers, the managers are
expected to work together (1) to make choices that will maximize the efficiency
and effectiveness of their respective divisions and (2) to contribute to overall
company performance. For example, when it is in the companys best interest for
a buying division to purchase goods or services internally from a selling division,
segment managers are expected to agree on a price to encourage such purchases.
If top management has properly trained, motivated, and evaluated segment
managers, the transfer price can be a device to promote such goal congruence.
In contrast, sometimes segment managers become myopic in their zeal to
maximize the apparent performance of their own divisions. For example,
sometimes buying segment managers will choose to buy externally at a price
lower than the transfer price because such purchases makes the division look
better even though analysis would reveal that the whole company would do better
if the acquisitions were made internally. This example illustrates the concept of
suboptimization.
9. The biggest problem involves how the term cost is defined. A cost can be
defined as any of the following: incremental or variable; absorption (product costs
only); or absorption plus some portion of the segments nonproduction costs
(selling and administrative). An amount for estimated opportunity costs for use of
the facilities can be added to any of the above. In some cases, arguments can be
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10.
Type of Center Recommended Type of Transfer Price & Usage
Cost-Selling Segment Cost-based: consistent with the objective of this
type of center, this use is a way of allocating the
centers cost to other centers.
Cost-Buying Preferably cost-based: consistent with the objective
Segment of this type of center, however, depending on the
selling segments demands, the transfer price could
be at any point between the lower limit
(incremental costs plus opportunity cost of
facilities) and the upper limit (lowest market price
the buying segment would have to pay externally);
goods or services received by the center are carried
at the transfer price for internal reporting purposes.
Revenue-Selling Market price: revenue from transfers of goods or
Segment services is recorded at the transfer price for internal
reporting purposes.
Revenue-Buying Transfer prices for goods or services should be
Segment between the lower and upper limits with the lower
limit giving this segment the greatest gross margin
on its internal sales; whichever transfer price is
chosen will be the cost of goods or services
purchased for this segment for internal reporting.
Profit or Investment- Transfer prices should be set between the lower and
Selling Segment upper limits; since these types of centers are
supposed to earn a profit, their managers will try to
negotiate a price closer to the upper limit;
whichever price is set becomes the revenue measure
for internal sales for internal reporting purposes.
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Profit or Investment- Transfer prices should fall between lower and upper
Buying Segment limits with managers of these segments arguing for
prices closer to the lower limits to afford their
segments the highest gross margin; whichever price
is set becomes the cost of goods or services
acquired by the center for internal reporting
purposes.
11. Dual pricing exists when the selling division is permitted to record one transfer
price (higher) and the buying division to record another (lower). This practice is
intended to minimize suboptimization and create goal-congruent incentives for
both divisions.
12. Support departments can use transfer prices when (1) user departments of the
support department have significant control over the quantity and quality of
assistance provided and (2) a reasonable surrogate measure of assistance benefits
provided to users exists. In such circumstances, transfer prices can be an effective
way of promoting a more efficient use of resources and of reassigning support
department costs. Setting the transfer price depends on the nature of the (1)
support department (cost or profit center) and (2) assistance itself (whether it can
be acquired externally, is recurring and uniform, and is expensive).
Advantages of transfer prices over allocation include:
motivation of user departments to suggest improvements and monitor usage;
inclusion of costs in user departments performance report (if user department
controls the amount of assistance it buys);
potential to generate suggestions for services more beneficial to users;
the fact that the rationale for the transfer prices must be provided to the buying
department; and
transformation of a support department from cost center to profit center;
provides additional performance measures for the center and its manager.
13. In a multinational setting, transfer prices can affect the profits and inventory
values reported in multiple countries as well as the taxes paid to various
jurisdictions. As such, managers must be more aware of setting prices, within
legal and ethical limits, to minimize income taxes and tariffs. Also, in a
multinational setting, there would be various taxing authorities with which to
come to agreements on advance purchase agreementsshould the company
decide to enter into those.
14. Any companys green agenda must be a global undertaking; activities in one
segment may create costs and benefits for part or all of an organization. Such
interactions impact the function, asset, and risk profile of an MNE and, thus,
modify intraorganizational transactions or create new value interactions that must
be considered from a transfer pricing perspective.
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EXERCISES
15. a. C
b. D
c. C
d. D
e. C
f. C
g. C
h. D
i. D
j. C
k. D
l. D
m. C
n. D
16. a. A
b. N
c. A
d. A
e. A
f. D
g. D
h. A
i. N (authority can be delegated, but not responsibility)
j. A
17. Each student will have a different answer; however, some important
considerations follow.
Centralized model: all IT functions (strategy and planning, application
development and maintenance, and operations) report directly to a senior
executive. All assets (hardware, software, human resources and the budget) are
controlled by this organization.
Advantages of Centralization:
Hardware and software can be obtained with the largest economies of scale
(often resulting in a 10 to 15 percent cost savings).
Redundant functions, such as multiple help desk support groups, are
eliminated.
Organizational communications are simpler.
Activities are more aligned with overall company strategies.
A unified presence is provided to customers and suppliers.
Disadvantages of Centralization:
If operated as a cost center, ITs enormous budget is often a point of
contention.
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If costs are allocated back to other areas, managers in those areas may believe
they are being overcharged.
A very effective decision and resource allocation process is needed since each
business unit can have different or conflicting IT needs.
IT outages could cause an entire company to be crippled.
The key to a centralized organizations success is its ability to be responsive. If
the big, centralized operation can be responsive to the needs of the business, then
that approach can make sense. When companies decide to move away from
decentralization back to centralized functions, the most common reasons are
usually cost savings and ability to manage the function more effectively.
Decentralized model: created when companies adopt specific client/server
architectures or occurred during a merger because separateness was often the
quickest way to solve the problem of integrating disparate hardware and software
infrastructures.
Advantages of Decentralization:
The ability to integrate disparities after a merger is improved.
Managers have their choice of hardware and software acquisition.
Managers have the ability to allocate IT resources.
There is a perception of faster, more flexible responses to change.
Disadvantages of Decentralization:
There will be higher total hardware and software costs for the organization.
There will be duplication of support needs.
There is the possibility of incompatibility of systems.
There can be a lack of accountability for problems.
Other important information:
Type and size of company
Level of geographical dispersion
Management characteristics
Employee levels of motivation and responsiveness
19. a. P
b. R
c. I
d. R or P
e. I
f. C
g. R or P
h. R or P
i. R or P
j. R or P
k. C
l. R (or revenue and limited cost)
m. C or P (if recoveries were assigned to the unit)
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20. Each student will have a different answer. However, following are some of the
units that may be included.
Cost centers: Career services, campus security, financial aid, information
technology, custodial, human resources, and accounting
Profit centers: Athletics, bookstore, residence halls, cafeterias, international
programs, university newspaper/radio station, and community workshops
22. Each student will have a different answer; however some important considerations
follow.
a. In multiple-doctor medical practices, setting up the recordkeeping system to
reflect each doctor as his/her own profit center will give insight into the
expenses each doctor is absorbing against revenue directly generated by
him/her. The data generated from this exercise give management another tool
in evaluating performance for salary adjustments, bonuses, and promotions.
b. The typical software accounting packages used by medical practices are
Peachtree, QuickBooks and Creative Solutions.
c. Some directly traceable costs include salary, malpractice insurance, fringe
benefits, conferences and seminars, vehicle expense, meals and entertainment,
patient refunds, insurance refunds, travel and lodging, licenses, supplies and
vaccines that are used by a specialist, and dues and fees.
d. Indirect expenses include building rent, depreciation, equipment lease
payments, interest expense, legal and accounting fees, office supplies, medical
waste disposal, pension expense, utilities, and staff salaries, taxes and fringe
benefits. Allocations bases would include gross revenues generated by doctor,
percent of cash receipts generated by doctor, percent of patients seen by
doctor, percent of occupancy space used by doctor, or equal allocation among
all doctors.
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27. Checking:
Administration (0.30 0.80) $540,000 $ 202,500
Human resources (0.30 0.80) $360,000 135,000
Accounting (0.40 0.80) $300,000 150,000
Direct costs 630,000
$1,117,500
Savings:
Administration (0.40 0.80) $540,000 $270,000
Human resources (0.20 0.80) $360,000 90,000
Accounting (0.20 0.80) $300,000 75,000
Direct costs 337,500
$772,500
Loans:
Administration (0.10 0.80) $540,000 $ 67,500
Human resources (0.30 0.80) $360,000 135,000
Accounting (0.20 0.80) $300,000 75,000
Direct costs 675,000
$952,500
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C = $357,576 + 0.1111B
0.99B = $414,000 + 0.11($357,576 + 0.1111B)
0.99B = $414,000 + $39,333 + 0.0122B
0.9778B = $453,333
B = $463,625
C = $357,576 + 0.1111($463,625)
= $357,578 + 51,509
= $409,085
A = $540,000 + 0.10($463,625) + 0.10($409,085)
= $540,000 + $46,362.50 + $40,908.50
= $627,271
Admin. HR Acctg. Check. Sav. Loans
Direct costs $ 540,000 $ 360,000 $ 300,000 $ 630,000 $337,500 $675,000
Admin. (627,271) 62,727 62,727 188,181 250,908 62,727
HR 46,363 (463,625) 46,363 139,088 92,725 139,088
Acctg. 40,909 40,909 (409,085) 163,634 81,817 81,817
Total costs $ 0 $ 0 $ 0 $1,120,903 $762,950 $958,632
S2 = $424,497 + 0.30S3
(2) S3 = $600,000 + $128,993 + 0.30S2
S3 = $728,993 + 0.30S2
32. a. D
b. A
c. D
d. A
e. D
f. A
g. A
h. D
i. N
j. A
k. A
l. D
$ 695,000
Operating profit = 15,000 $15 = $225,000
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This is the normal selling price less the normal variable costs excluding the
$3.00 variable selling expense.
b. Under these conditions, Peyvandi Co. could accept any price that at least
covers variable production costs: DM $9.00 + DL $11.40 + VOH $4.80 =
$25.20
c. $2,606,250 1.25 = $2,085,000 for 50,000 units = $41.70 per unit DM $9.00
+ DL $11.40 + VOH $4.80 + FOH $16.50 = $41.70
$1,575,000 1.25 = $1,260,000 for 50,000 units = $25.20 per unit DM $9.00
+ DL $11.40 + VOH $4.80 = $25.20
Joe Dhir was defining cost as variable cost, while Peyvandi Co. was defining
cost as absorption cost.
38. a. The rapid increase in food costs has created a significant difference between
the historical cost of items and the replacement cost of items. Because
transfers between stores are made at historical costs, the transferring store
loses in the transaction because it must replace the transferred item at
replacement cost. This situation creates an incentive for stores to misrepresent
the actual inventories on hand when transfers are requested by sister stores.
b. The transfer pricing policy could be changed to allow transfers to take place at
replacement cost rather than historical cost. Such a change would remove the
disincentive of the existing policy.
40. Each student will have a different answer. No solution is provided. One recent case
that could be discussed involved GlaxoSmithKline, which settled a transfer pricing
dispute with the U.S. Internal Revenue Service in September 2006 for $3+ billion
and, as of early 2007, was preparing for litigation in the United Kingdom. The
companys 2006 annual report indicated the problem was related to the years 1994
and forward. See http://www.irs.gov/newsroom/article/0,,id=162359,00.html (last
accessed 1/2/12). Another case involved computer chip company Xilinx
(http://www.taxgirl.com/landmark-transfer-pricing-case-is-it-a-different-world/).
Also see http://ustransferpricing.com/decisions.html.
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PROBLEMS
41. a. The ethical problems are created when short-run gains can be maximized by
doing what is unethical rather than what is ethical. This situation is created by
the companys incentive system. By narrowly focusing performance
evaluation on profit-related measures, the firm is ignoring other important
critical success factors. By measuring achievement across a broader set of
critical success factors, the company could induce the managers to behave in a
more ethically acceptable manner. The managers are merely reacting, albeit in
an ethically questionable way, to the incentives that have been put in place by
the company.
b. By refocusing the performance evaluation measures on a broader set of critical
success factors, top managers can induce lower managers to behave more
ethically. Top managers need to develop performance measures that are more
long term; focus on customer satisfaction, product quality, and social
responsibility; and provide managerial training in ethical behavior.
(CMA adapted)
42. a. The primary cause of the trend was the availability of new technology that
was supposed to enhance communications such as wireless phones, notebook
computers, and handheld monitoring devices.
b. One of the major problems is still communications because the patients entire
medical team still needs to collaborate and interact. The decentralized stations
created a problem in that they often replaced the centralized stations, so nurses
and physicians had to meet in hallways for discussions often within the
hearing range of a patient who was not the patient being discussed, which
could create ethical dilemmas . . . and increasing the noise level that could
disturb a patients rest and ability to recover. Additionally, the decentralized
stations distanced the nurses from their colleagues, which limited the ability to
share professional expertise with one another as well as engage in the
socialization that is important to job enhancement and development of a
team perspective. The isolation made it hard to help out in emergencies or
even to know if a nurses station on the same floor might be short-handed. To
adjust the situation, hospitals are now reconfiguring floor layouts to have
decentralized stations as well as centralized stations; the latter tend to be
designed as data centers for a variety of equipment, interactive communication
stations, medicine-storage facilities, supply intake operations, and lounge
areas. Combining the decentralized and centralized concepts retain the patient
benefit of close contact, but eliminate the noise and overhearing possibilities
as well as encourage nurse interactions and promote team spirit.
43. a. The report is not in accordance with the concept of responsibility accounting,
in which each managers performance is judged by how well he/she manages
those items directly under his/her control. Responsibility accounting does not
recognize the allocation of common costs to segments. While including the
corporate costs may be useful in calling attention to these activities,
differences between budgeted and actual for these items are beyond the
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44. a. The most significant problem is that variances have been computed by
comparing a static budget to actual expenses. To evaluate cost control,
variances should be computed by comparing a flexible budget at the actual
activity level to actual costs. Also, the performance evaluation does not
contain auxiliary performance measures such as measures of customer service,
win/loss records, etc.
b. Flexible
Budget Actual Variance
Activity # of cases 2,970 2,970
Variable costs
Professional labor $2,970,000 $2,820,000 $150,000 F
Travel 148,500 120,000 28,500 F
Supplies 297,000 270,000 27,000 F
Fixed costs
Professional labor 1,200,000 1,215,000 15,000 U
Facilities 750,000 795,000 45,000 U
Insurance 240,000 234,000 6,000 F
Total $5,605,500 $5,454,000 $151,500 F
c. The variances that are most likely to be investigated are the ones that are
material and may be attributed to controllable factors. The most significant
variances are for those for professional labor (5 percent under the flexible
budget), travel (19 percent under the flexible budget), facilities (6 percent over
the flexible budget), and supplies (9 percent under the flexible budget).
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Original Flexible
Budget Budget Actual Variance
Revenues $ 90,000 $108,000 $102,000 $ 6,000 U
Variable costs:
Meals $ 9,540 $ 11,340 $ 13,041 (1,701) U
Lodging 23,850 28,350 28,350 (0)
Supplies 1,060 1,260 1,260 (0)
Contribution margin $ 55,550 $ 67,050 $ 59,349
Direct fixed costs:
Speakers (15,000) (15,000) (17,700) (2,700) U
Rent on facilities (3,600) (3,600) (4,200) (600) U
Advertising (4,000) (4,000) (4,900) (900) U
Segment margin $ 32,950 $ 44,450 $ 32,549
Allocated fixed costs (22,500) (27,000) (25,500) (1,500) F
Net operating income $ 10,450 $ 17,450 $ 7,049 $(10,401) U
By far, given that revenues exceeded the budget, the two biggest contributors
to the seminars decreased profitability were the failure to include the
speakers airfare in the original budget and the failure to include the gratuity
on the meals. Also contributing to the reduced profitability were higher than
expected fixed costs for rent and advertising. However, the flexible budget
shows that variable costs were budgeted correctly per participant, with the
exception of the gratuity.
47. a. CRM is typically defined as the process of finding, getting, and retaining
customers. CRM is also defined as tracking customer behavior to develop
marketing and relationship-building programs that bond consumers to a brand
often by development of software systems to provide one-on-one contact
between the marketing business and their customer. CRM is the core of any
customer-focused business strategy and includes the people, processes, and
technology associated with sales, marketing, and service.
b. Each student will have a different answer. No solution is provided.
c. Each student will have a different answer. No solution is provided. However,
contact centers that are engaged in answering customer questions and
providing help services will typically be cost centers; those that have been
designed to engage in product sales will typically be profit centers.
d. Each student will have a different answer. No solution is provided. However,
contact center costs could be allocated to revenue-producing areas based on
number of people, time spent on services related to a particular product,
dollars of revenues, etc.
e. Each student will have a different answer. No solution is provided. However,
the following measurements may be useful:
Average time to answer calls
Percent of calls abandoned
Percent of calls that needed to be referred to another representative
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b. The budgeted contribution margin was $120,000 6,000 or $20 per unit.
Since the companys sales volume was 1,000 units less than budgeted, the
total impact on the companys contribution margin would be a reduction of
$20,000 from what was budgeted.
c. To isolate the effect on operating income of an increase or decrease in market
share, the company must know its budgeted and actual market shares, the
actual size of the market share for November 2013, and the budgeted
weighted- average unit contribution margin. These computations may help
Folsoms managers determine whether the decline in sales was due to a loss of
competitiveness or a shrinkage of the overall market.
d. Performance evaluation would be limited, because in most instances,
managers are also responsible for managing some costs in their centers. In
Folsoms case, evaluation of the control over variable and fixed costs goes
beyond the sales price and sales volume variances.
Administration costs:
Surgery: $5,400,000 0.53 = $2,862,000
In-patient: $5,400,000 0.33 = $1,782,000
Out-patient: $5,400,000 0.14 = $756,000
Public relations cost:
Surgery: $1,100,000 0.20 = $220,000
In-patient: $1,100,000 0.36 = $396,000
Out-patient: $1,100,000 0.44 = $484,000
Maintenance and janitorial cost:
Surgery: $1,700,000 0.35 = $595,000
In-patient: $1,700,000 0.40 = $680,000
Out-patient: $1,700,000 0.25 = $425,000
Surgery In-Patient Out-Patient
Administration $2,862,000 $1,782,000 $ 756,000
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Note: The Administration column does not sum to zero because of rounding.
Cir. 13 19 195,223
$285,326
e. ADMIN. H. RES.
Department Base % Base %
Admin. (A) N/A N/A 5 21
H. Res. (H) $ 145,850 10 N/A N/A
Adv. 381,200 26 6 25
Cir. 935,150 64 13 54
$1,462,200 24
A = $390,750 + 0.21H
H = $246,350 + 0.10A
A = $390,750 + 0.21($246,350 + 0.10A)
= $390,750 + $51,733.50 + 0.021A
0.979A = $442,483.50
A = $451,975
H = $246,350 + 0.10($451,975)
= $246,350 + $45,197.50
= $291,548
Admin. H. Res. Advertising Circulation
Direct costs $ 390,750 $ 246,350 $478,900 $ 676,300
Admin. (451,975) 45,198 117,514 289,264
H. Res. 61,225 (291,548) 72,887 157,436
$ 0 $ 0 $669,301 $1,123,000
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Chapter 13 392
59. Allocation of computer services costs should be made on an hours used basis to
permit a more efficient use of company resources. The charging basis should
encourage users to take advantage of the Computer Systems Departments
services but not permit the Computer Systems Department to pass on its
inefficiencies. For instance, a standard hourly usage rate should be developed
based on past experience, adjusted for efficiency considerations. Divisions would
be charged the standard rate for the hours of recorded usage.
(CMA adapted)
Selling Divisionfair value since most are produced and sold at this price
externally.
Buying Divisionprice is higher than outside vendor price so this would
make its performance report appear worse than by buying externally.
Total variable production cost ($4,200) + 20% = $5,040
Selling Divisioncontributes minimally to covering fixed costs, and
therefore, no profit is shown from these sales as opposed to external sales.
There is little incentive to sell internally if the selling division can sell all its
output externally.
Buying Divisionless than external purchase price, therefore it is more
beneficial to the bottom line of Ludmilla Company.
Total product ($6,000) cost + 20% = $7,200
Selling Divisioncovers some but not all costs for this division, therefore
incentive to sell internally isnt there if Engine Division can sell its output
externally.
Buying Divisionpurchase price below external so better for margin in this
division.
Bid price from external supplier ($9,280)
Selling Divisionallows for some profit which is an incentive to sell
internally unless it can sell all its output externally.
Buying Divisionno incentive to buy internally since it costs the same as to
buy from an external supplier.
b. Upper limit = $9,280
Lower limit = costs of $4,800 + Contribution margin of $5,664 = $10,464
Since the lower limit exceeds the upper limit, the company would be better off
not making the internal transfers.
c. Roll-Em-On SkyWheels
A/R (SW Div.) 272,000 Inventory 272,000
Intraco. Sales in A/P (REO Div.) 272,000
Excess of
Assigned Cost 368,000
Intraco. Sales 640,000
Worldly Travelers
Intraco. CGS 368,000
Finished Goods 368,000
d. Roll-Em-On SkyWheels
A/R (SW Div.) 368,000 Inventory 368,000
Intraco. Sales 368,000 A/P (REO Div.) 368,000
Worldly Travelers.
Intraco. CGS 368,000
Finished Goods 368,000
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Chapter 13 397
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Chapter 13 398
(CMA adapted)
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Chapter 13 399
66. To achieve CarryOn!s goals, the division manager should purchase the materials
needed at the lowest price available to CarryOn! Division at the present time. The
three possible prices are as follows:
Koenigs price $8.00
HIDEs price 9.00
Thompsons price 7.00
CarryOn! Division should purchase from Thompson.
For CarryOn! Division to achieve the overall company goals, the following
analysis is required to compare the costs of the three bidders:
Koenigs price $8.00
HIDEs price:
Sales price Profit margin = $9.00 (0.40 $9.00) 5.40
Thompsons price $ 7.00
However, the profit margin of Barrows Chemical
should be deducted = $7.00 (0.30 $2.00) (0.60) 6.40
From Eekaydos standpoint, the relevant costs for this decision are the variable
costs per square foot if there is available capacity and no additional fixed costs
would be incurred. For any division to achieve the overall company goals to
maximize profit, variable organizational costs must be minimized. In this case,
CarryOn! must choose the best price available to it. HIDE should consider
lowering its price to meet Thomsons competition.
(CMA adapted)
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Chapter 13 400
68. a. The main advantage that I-O-WoW might have is a cost advantage. It is likely,
because the division sells mainly internally, that the division incurs lower
marketing and promotion costs than other divisions. By selling mainly
internally, the division has no requirement to maintain the same marketing
capability as other divisions that sell their products externally. In addition, the
division may reap substantial savings on distribution costs because it does not
have to ship most of its output to other customer locations.
b. Because the division sells mainly internally, it would be possible to make the
I-O-WoW Division a cost center. Then, output of the division could be
transferred to other internal divisions at full or variable cost. The other logical
alternative is to allow the internal buying divisions to negotiate with I-O-
WoW for discounts from the usual market price so that the buying divisions
share in the cost savings.
69. Each student will have a different answer. No solution is provided. URL
is http://www.ey.com/GL/en/Services/Tax/International-Tax/Transfer-Pricing-and
-Tax-Effective-Supply-Chain-Management/2011-Transfer-pricing-reference-guide
2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.
Chapter 13 401
(Should this link not be accessible, type in Ernst & Young 2011 Transfer Pricing
Reference Guide into search engine.)
71. Each student will have a different answer. No solution is provided. However, the
following may be helpful in the discussion.
Excerpted from Transfer Pricing in a Recession: What Companies Should
Consider (PricewaterhouseCoopers, 2009)
With rising unemployment comes reduced personal income taxes, and with
reduced corporate profits come reduced corporate revenue. The global tax base
has decreased and probably will continue to shrink. Even in a recession, a
discussion by any politician of increased taxes is risky. More money is needed to
keep funding current programs, and while taxes of many varieties may increase, a
less controversial option is for the Internal Revenue Service to collect more
revenue through increased enforcement and other means. Globally, taxing
authorities will increase their efforts to collect taxes needed to fuel their
governments spending.
A substantial increase in tax audits, including those focused on transfer pricing, is
expected. In addition to the increased number of audits expected globally, the
difficulty and complexity of such audits are expected to increase as taxing
authorities continue to become more sophisticated and open to sharing taxpayer
information. Issues that may have been overlooked before will be reconsidered.
Settlement positions arrived at in the past may no longer be accepted. All
possibilities are on the table.
In such uncertain economic times, how should multinational companies approach
defending past transfer pricing policies including those established under advance
pricing agreements during robust economic times? How should companies
prepare to go forward regarding their transfer pricing options? In addition to
ensuring they have adequately documented their transfer pricing to defend
historical positions, companies also must consider ways to optimize current and
future transfer pricing positions. This includes evaluating current transfer prices
under current structures as well as opportunities to modify current organizational
and tax structures. Multinational companies abilities to develop and sustain tax-
efficient structures (alongside required supply chain modifications) will have
significant implications for their abilities to reduce costs and remain competitive.
From David D. Stewart, Transfer Pricing Practitioners Find Challenges,
Opportunities in Economic Climate, Worldwide Tax Daily (May 22, 2009): Steve
Hasson with PwCs U.K. transfer pricing group discussed difficulties related to
pricing using comparables and adjusting to the current environment with existing
arrangements. Hasson noted that the data being used for determining comparables
are historic and lagged, resulting in a data set that does not reflect the current
economic environment. In short, what it means is that the data you are relying on
is drawn from boom years, and you probably dont want to benchmark your
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Chapter 13 402
pricing against that position or indeed you may not be able to, Hasson said. This
whole question of comparability has gotten a whole lot harder, he added.
According to Greg Ossi, a principal with PwCs transfer pricing group, companies
with a current APA will face challenges in the current environment, but
companies in negotiations for APAs could find opportunities. For companies
with current APAs, Ossi said that while it is unlikely tax authorities would be
willing to renegotiate the agreement based only on a decline in sales, it may be
possible to seek an extension of a current APA with renegotiated terms for the
remainder. For companies considering or in negotiations for an APA, Ossi
explained that the IRSs APA office is open to a range of techniques and
refinements employed in a new agreement. Among the techniques Ossi
suggested were using different pricing over several periods to reflect the current
downturn and expected recovery, shortening the APA term, or including special
critical assumptions in the agreement. I would characterize this as a work in
process at the APA office, Andrus said. They are clearly working on figuring it
out, but I dont think there is a fixed menu of things that they are willing to do in
any case or in every case thats carved in stone at this point.
72. Each student will have a different answer. No solution is provided. However, the
following may be helpful in the discussion: New OECD Project on the Pricing of
Intangibles, A World in Transition (March 2011); http://www.kpmg.com/Global/
en/IssuesAndInsights/ArticlesPublications/Documents/world-in-transition.pdf, p.
28ff (accessed 1/2/12).
2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.