18th December 2014
Professor Jeremy Fernando
Group E, Stream 2
Alaine Sung | Hadrien Jacomino | Mokhtar Ibrahim |
Nikhil Gangwani | Ronami Ogulu | Yana Kim
Q1 What, if anything, should John Powell do about Frank Duffy’s reluctance to use
KEA-priced linerboard manufactured by a Del Norte Paper Company mill in the
Transfer pricing: is the setting of the price for goods and services sold between controlled (or related) legal entities within an enterprise. Hence, the major role of the management accounting system is to assign a dollar figure to transactions between different responsibility centers.
Purposes: The main purpose is to induce optimal decision-making in a decentralized organization (i.e., to maximize the profit of the entire organization). However, there are other reasons such as;
Creating independent profit figures for each division and thus assessing the performance of each division distinctly.
Assist with the synchronization of production, sales and pricing decisions of the various divisions (through the use of suitable transfer prices). Further, these prices alert the managers to the value that goods and services have for other segments of the firm.
Not only will the transfer price have a significant effect on the reported profit of each profit center, additionally, it will influence the allocation of an organizations resources.
Unnecessary for physical money to be exchanged between the two divisions.
This price is solely for in-house records.
The results of the formula (Transfer Price × quantity of goods exchanged), acts as an expense for the purchasing division center and a revenue for the selling division.
Del Norte Paper Company is a fully integrated paper manufacturer. This case primarily involves transfer pricing amongst:
• DNP Paper Mill
• International subsidiaries o DNP Italia o DNP Deutschland.
The following ‘Figure 1.1’ describes the situation as given in the case study:
The bids are placed by 22 companies in the range of $340-$550, with most of them within 5% of $400 per ton.
DNP Italia places the winning bet of $400 by using the SPOT market cost estimate of linerboard ($220/ton).
DNP Deutschland places the bet of $550 by using DNP Paper-Mill cost estimate of linerboard as ($360/ton)
Criteria for winning the bet: Lowest bid from a firm viewed as being capable of meeting the customers’ desired delivery and quality standards.
The following table illustrates the analysis for the bids placed by the two subsidiaries:
* The cost of linerboard per ton of corrugated box sold is $235. The actual cost per ton of linerboard used is $220. Thus the relevant conversion ratio is (235/220) = 1.07
for Del Norte Porte Paper Mill Linerboard:
* $385 represents the linerboard cost per ton of corrugated box sold. The actual cost per ton of linerboard used was $360. Thus the relevant ratio is (385/360)=1,07
In this case we assume that both DNP Italia and DNP Deutschland place a bid of $400 for the African sale, and then further analyse the profit contribution to DNP in all the
4 cases. The conclusion we have from this is that DNP Deutschland is more efficient as a company because their conversion cost is lower ($75) when compared to DNP
Italia’s conversion cost ($90).
DNP Deutschland could have added more contribution to the company if they would have bought from the Spot Market and placed a bid of $400. Also analysing the two situations it is clear that it is more profitable to buy from the spot market because of