Management Control System

Case Analysis on Birch Paper Company

Written by:
Giordan Berwyn Tanoto
Hapsari Athaya Mulyanissa
Nabila Azzah Shafy Arkabintaan
Nadhira Azzah Shafy Arkabintaan
Elrica Meliany Wibowo
(17/408237/EK/21201)
(17/415854/EK/21594)
(17/411412/EK/21383)
(17/411413/EK/21384)
(17/408234/EK/21198)

INTERNATIONAL UNDERGRADUATE PROGRAM

FACULTY OF ECONOMICS AND BUSINESS
UNIVERSITAS GADJAH MADA
2019

Problem Identification
 Birch Paper Company is a medium-sized, partly integrated company that produces three
product lines; white papers, kraft paper, and paperboard. Northern and Thompson divisions
together designed box for Northern division. Thompson division was reimbursed by northern
division for it’s designing and development. After finalization, apart from Thompson's bid it also
get offers from two outside companies. In this case, there is a company policy where each division
manager had full freedom and discretion to buy from anywhere. Thompson’s gets the most
materials from within the company, but sales is mostly to outsiders. Thompson division felt that
they have not received profit for their development work, hence entitled to mark up on production
of box. Thompson bids for $480, whereas West bids for $432. Now, Northern division must accept
which bid is the best interest of the company

Case Analysis

1. Which bid should Northern division accept to minimize the cost and maximize the
profit in the best interest of Birch Paper Company ?

Quotes per 1000 boxes:

Thompson - $480/-
West Paper - $432/-
Eire Papers - $430/-
So prima facie Eire’s quote is the lowest

West Paper Company $430

Erie Paper Company $432
Contribution of profit from Southern
$90 x 40% = $36
Contribution Of Profit from Thompson
$30 - $25 = $5

Details of Thompson’s Quote:

Thompson’s Out of Pocket Exp. : $400.00
(Less) Supply from Southern Div, @70%: $280.00
Hence, Cost of Thompson: $120.00
Add: 20% OH + Profit: $80.00
Total Quote $480.00

Thompson Division $480

Contribution of profit from Southern
$400 x 40% x 70% = $112
Contribution Of Profit from Thompson
$480 - $400 = $80
 Total Cost = $288

Thus, Thompson division should accept bids on the boxes of Thompson Division since it will
minimize the cost of birch paper company.
2. Should Mr. Kenton accept this bid? Why or Why not?
Mr. Kenton should not accept the bid since their quote is higher than the other
competitive market price. We need to assume that the transfer price remains $480, and
their divisions have the full authority to chose their suppliers either from inside or outside
based on the market price. Since the decentralization policy is applied in this company
and each divisions profits are calculated and judged individually, then Northern div. Will
not increase its purchase cost due to the hidden inefficiencies of Thomson& Southern div.

3. Should the vice president of Birch Paper Company take any action?
It is necessary for the vice president of Birch Paper Company to take action to improve
and establish the procedures and policies for the determination of transfer pricing for
each division so that it is profitable for the company. If needed, top management can be
involved in making decision on which offer should be taken by the division and the
determination of transfer price for each division. This should be done in order to maintain
the company’s profitability as a whole and increase goal congruence between divisions so
there is no division that only wants to maximize its own without regard to the overall
profitability of the company. However, if the vice president does not intervene, then in
this case Northern division will go ahead and buy from Erie Papers. This will cause more
inefficiencies for Thomson.

4. In the controversy described, how, if at all, is the transfer price system

dysfunctional? Does this problem call for some change, or changes, in the transfer
pricing policy of the overall firm? If so, what specific changes do you suggest?
Ideally, the division should use the market price. However, Thompson used a cost-based
transfer price instead market price. While the cost-based transfer price should only be
used when company not just individual profit, each division. The transfer price system is
dysfunctional because it focuses too much on individual sectors making profit and return
on investment. Division’s focus should be shifted from individual department
profitability to Group profitability. The focus must be on overall or total profit and ROI
for the company as a whole, not only divisional. Each division has only a short-term
orientation that leads to the decision on maximizing current profit and ROI.
 The matter in the Birch transfer pricing is the system that allows each division to set their
own price which is aligned with the company's policy to decentralize responsibility and
authority. Decentralization will trigger conflicts and disagreements in daily basis since
every division only think about their own division benefit rather than a company as a
whole. By having a centralized policy, it will help the company to increase and encourage
every division to work together and be able to increase the total profit.

Conclusion
Birch company must evaluate their policy in transfer pricing system in order to increase
company profitability as a whole. Their transfer pricing needs to be evaluated because
decentralization makes each division is judged based on profits and ROI that cause an over-
emphasize on profits of each division and encourage each division only pursue short term profits
so they look better in company’s eyes. The company should assess them based on other non-
financial things like quality so as to divert the division's emphasis on profits. In addition, the
company should allow the divisions concerned to negotiate between themselves as they are the
ones closest to the situation, rather than just asking the divisions to meet the market price. In
addition, based on calculation Thompson division should accept bids on the boxes of Thompson
Division since it will minimize the cost of birch paper company because total cost is low
compared to other offers which is $ 288, if Birch paper produced by themselves. Each division
needs to pay attention to the cost without including the profit element from results of inter-
division transfers. Thus, the division goals will inline with company goals which increase the
overall profit as a whole, not divisional.