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ACCT2195 Accounting, Behaviour and Organizations

Topic 4: Transfer Pricing

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Robsen Company is a medium-sized business, which produces and sells a range of quality
commercial furniture and shop fittings. The company has a number of divisions, including
the Glass ivision, Components ivision and the !urniture ivision. The role of these
divisions is as follows.
)*ass +ivision
The Glass ivision purchases raw materials and processes them into glass sheets. The
Glass ivision supplies the Components ivision with its glass requirements. "t also sells a
substantial portion of its glass production to e#ternal customers.
Co,ponents +ivision
The Components ivision manufactures a range of furniture components, including timber
and glass doors, which are used by the !urniture ivision in the manufacture of a number of
Robsen$s furniture items.
The Components ivision also performs wor% for outside firms, in particular, selling its glass
and timber doors on the e#ternal mar%et. "n the past, this has been very profitable. &owever
the ivision has recently e#perienced a decline in outside sales.
$urniture +ivision
The !urniture ivision underta%es the final manufacture of the furniture, which is then sold to
e#ternal furniture retailers. 'hile the !urniture ivision often purchases its furniture
components from the Components ivision, it also uses outside companies to source these
+ecentra*isation and Perfor,ance 'easure,ent
(ach division has a divisional manager in charge of operations. !or several years each
division and manager has been evaluated on the basis of profit ) i.e. each division has been
treated as a profit centre. ivisional managers receive a substantial bonus if divisional profit
targets are met.
Top management has implemented a policy of decentralising responsibility and authority for
all decisions e#cept those relating to overall company policy. The company$s board of
management believes that the concept of decentralisation has been implemented very
successfully, and that the company$s competitive position has definitely improved.
The &ssue
(arly in *+,+, the !urniture ivision designed a new item of furniture, a -ewellery display
cabinet. The cabinet was to have two identical glass and timber doors at its front. The
!urniture ivision wor%ed on the design of the cabinet, in consultation with the Components
ivision. The glass doors were an unusual design, and as a result the Components ivision
spent considerable time and effort perfecting the design, manufacturing method, and
materials to be used. .n agreement was reached between the two divisions that the
Components ivision would be reimbursed by the !urniture ivision for the full cost of its
design and development wor%.
(ach manager at Robsen !urniture is free to purchase from whichever suppliers he or she
wishes/ it is e#pected that each division is able to operate efficiently enough to match the
current mar%et price on its products. Therefore, after the design of the doors was finalised,
the !urniture ivision as%ed for bids on the glass doors from both the Components ivision
and an outside company ) 0ayte Company. The two bids were as follows/
Components ivision 1,22 per glass door
0ayte Company 1,3+ per glass door
The Co,ponents +ivision Bid
The Components ivision was e#tremely %een to win the bid for the glass doors. Recently
the ivision had been having difficulty maintaining its e#ternal sales. "t was common
%nowledge at Robsen !urniture that the Components ivision had not been operating at full
capacity for several months. "n fact it was e#pected that the ivision would have enough
spare capacity to satisfy the production demands of the !urniture ivision into the
foreseeable future.
"f the Components ivision were successful in attaining the order from the !urniture ivision,
4ensen 5amuels, 6anager of the division, has indicated he would li%e to source the glass
required for the doors from the Glass ivision, rather than from an outside manufacturer,
who would offer the glass for 178.++ per sheet. 4ensen believed based on past e#perience,
that the Glass ivision would offer a competitive quote and a high quality product/ therefore
he did not feel the need to loo% for other sources.
Consequently, before finalising the bid for the !urniture ivision, the Components ivision
as%ed the Glass ivision for a quote on the glass.
The Glass ivision had been operating at full capacity for a number of months, and this was
e#pected to continue into the foreseeable future. .s a result it did not need the Component
ivision$s business. &owever 5arah 9lac%, manager of the Glass ivision, %new that her
company preferred its divisions to underta%e internal transfers, rather than outside
purchases, as often as possible. 5he was therefore willing to supply the glass requirements,
even though it would mean missing out on e#ternal sales, as long as her division did not lose
on the transfer.
(ach door required one sheet of high quality glass cut to a specified size. 5arah provided a
quote for the supply of the glass, which was equivalent to the current mar%et price of 177 per
sheet. "nformation relating to these glass sheets is contained in table ,.
4ensen 5amuels was disappointed with this price, as it was higher than the e#ternal price he
could get in the e#ternal mar%et. &e noted that 7+c in pac%aging costs :included in ;other
materials<= and 1>.++ in administration costs would not be incurred on an internal transfer.
Table * provides details of the Component ivision$s additional costs :other than the cost of
glass= associated with the manufacture of each door.
-a.te Co,pan. Bid
0ayte Company had purchased glass from Robsen !urniture$s Glass ivision in the past,
and was one of its best customers. "n an attempt to ma%e its bid more appealing to Robsen
!urniture, 0ayte Company offered to purchase its glass requirements for this contract from
the Glass ivision. "t would supply its own timber and other materials in the manufacture of
the glass doors.
The Glass ivision indicated that it was willing to supply the glass to 0ayte Company at a
selling price of 17* per glass sheet per door. This was less than the prevailing mar%et price
of 177, to ta%e into account the importance of 0ayte Company as a long-term customer.
Costs associated with the provision of the glass sheets to 0ayte Company would be the
same as those contained in table ,.
'hen 4ane% 0han, the manager of the !urniture ivision received the two bids, he was
dismayed at the discrepancy in the two prices. 'hile he %new he had decision ma%ing
autonomy over the sourcing of his components, he also %new that it was loo%ed on
favourably by his superiors if his division used internal sources of materials where possible.
.s a consequence, he was disappointed to see that the Components ivision bid was
significantly higher than the 0ayte bid. &e was also surprised that the Components ivision
6anager decided to add the usual mar%-up on out-of-poc%et costs, when determining the
transfer price.
4ane% %new that sourcing the glass doors from the Components ivision would afford his
ivision with certain advantages the other two suppliers may not be able to provide. "n
particular, as his division had spent a lot of time in consultation with the Components
ivision on the design of the glass doors, he was sure he would receive a high quality
product. !urthermore he %new he could rely on the Components ivision for quic% delivery
and service.
espite this, 4ane% felt he had little choice, given that he was evaluated and rewarded
primarily on his division$s profit performance. &e felt obligated to accept the substantially
lower bid submitted by 0ayte Company.
Ta/*e 1
)*ass +ivision
&nfor,ation re*ating to the transfer of g*ass sheets to the Co,ponents +ivision
5elling ?rice per sheet :based on current mar%et prices= 177.++
Costs per )*ass !heet
5ilica 1,>.++
@ther materials 17.++
Conversion costs 18.7+
!i#ed manufacturing cost allocation 1>.++
.dministration costs :2+A variable= 1,+.++
Corporate head office allocation 12.++
Ta/*e 2
Co,ponents +ivision
Costs 0in addition to g*ass re1uire,ents2 per )*ass +oor
Timber 1>+.++
@ther materials 1,*.++
Conversion costs 1*+.7+
!i#ed manufacturing cost allocation 12.++
.dministration costs :B+A variable= 17.++
Corporate head office allocation 1,*.++
,. etermine the appropriate sourcing decision forC
a2 The Glass 5heets4
/2 The Glass oors4
*. "dentify the factors that have caused transfer pricing to be an issue for the divisional
managers of Robsen Company.
>. etermine the appropriateness of the current transfer prices used in the transfer of/
a= Glass 5heets from the Glass ivision to the Components ivision/
b= Glass oors from the Components ivision to the !urniture ivision.
'ithin your discussion you should refer to the following/
The behaviours that are li%ely to occur as a result of the current transfer
The impact of these behaviours on the company$s interests as a whole/
'hether you believe the attitudes of both 4ane% 0han and 4ensen 5amuels
towards the current transfer price offered by the Components ivision is
8. Recommend alternative transfer pricing options for/
i. Glass 5heets
ii. Glass oors
Dou must fully e#plain and -ustify each of your recommendations. Dou should refer to the
following in your discussion/
The behaviours that are li%ely to occur as a result of the transfer prices you
The impact of these behaviours on the company$s interests as a whole.