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Inestment Centre Zain Packagers
Inestment Centre Zain Packagers
com/hub/Managerial-Accounting-Investment-Centers-Transfer-Pricing
BRIEF PROFILE: We have been established since 1964 as a Private Limited Company. Our CEO is Mr. Shamoon Yaqoob Ali and Mr. Shabbir Yaqoob Ali Karimi is our Director of Finance. Our line of business is Printing & Packaging (Paper & board). Specialization in Cartons for Pharmaceuticals, Cigarettes and Foods. Our corporate bankers are National Bank of Pakistan, Karachi, United Bank Limited, Karachi, Habib Metropolitan Bank. We have a team of 32 Managers and Executives.
By hafeezrm
Zain Packages Ltd has three divisions i.e. Paper, Printing and Packaging Division. The company makes cartons, boxes, packets, bags and wrappers. If the company earns a profit, each of the three divisions would brag of its efforts. If the company incurs a loss, each division would pass on the buck to others. The Chief Executive can decide on his or her own but it would be fraught with suspicion from those whose work was not appreciated. In order to inseminate some transparency in the performance appraisal, each division can be turned into an autonomous unit called Investment Center. Each would be headed by a manager who would be responsible to incur costs, fix prices and buy additional fixed assets. Eventually, there would be a separate P&L Account for each division and so it would be clear as to who has contributed what in the total profit of the company. But it is not so simple as it seems as the divisions are interlinked. The paper division is responsible for producing quality paper which is passed on to Printing Division for making printed sheets of different sizes. The Packaging Division collects the printed sheets and converts them into packages for various industries particularly cigarettes and food processing units. The question arises at which price the products (paper and printed paper sheets) would be sold internally to the next division. That calls for Transfer Pricing which is the subject matter of this hub.
If ROI is made a criteria, managers would be reluctant to make additional investment in fixed assets as it may bring down the ROI. In previous example, a manager was happy with an ROI of 20%. If an
additional sum of Rs.12 million is made which would bring incremental return of Rs.1.2 million, this would bring down overall ROI to 18.4% {(8 m+ 1.2 m) / (40 m + 10 m)}.
But RI would give results in monetary term which would show an increase. Supposing, Cost of Fund (minimum required returns) was 10%, RI in the foregoing example, before additional investment, would be Rs.4 million {(8m - (40 m x 10%)}. With additional Investment and the returns, it would increase to Rs.4.2 million (8m+1.2m) - {(40 m + 10m) x 10%}. Thus RI would increase by Rs.200,000 which is a good sign.
y y y y y
Performance evaluation of each manager based on the contribution made by the sub-unit. Coordination of all sub-units for achieving the organisational goals. Deciding what to charge for transfer a product or service to the next department. to preserve autonomy of a sub-unit. Motivation of the managers as they would certainly get rewards for good performance through a transparent system.
In an ideal situation, a sub-unit would have an option to sell directly to the maket should a reasonable transfer price is not agreed upon. Same is the case with the buying department.
2) COST PLUS MARKUP y Sub units can fix a markup on cost to get a reasonable return which would enable them to achieve the required ROI. Such a markup may be based on variable cost or full cost. It would make no difference except that basing on variable cost would be convenient.
Supposing variable and full costs of a department are Rs.300 and Rs.500 respectively. Suppose further that the manager thinks a fair price for his or her product to be Rs.600. So in case of variable cost, the markup would be 100% and in case of full cost 20%. Same results would be achieved in both the cases.
3) NEGOTIATED PRICES y If there is no outside market, the buying and selling department may negotiate prices.
Summary
A good accounting system should promote goal congruence among its employees. In other words, all employees should work and take decision keeping in view objectives of the company. Various techniques have been used for this purpose such as Management By Objectives. The accounting system can make its contribution by segregating profitability of each division or sub division through declaring each division as an Investment centre. ROI, RI and EVA are used as performance indicators but the transfer mechanism has to be addressed. An example was given of a Packaging Company. While its Package Unit sells in the market and earns revenues, this was not the case when paper was transferred to Printing Unit and printed sheets were passed on to Packaging Division. Here comes the question of Transfer Pricing. As a general rule, a transfer price should be equal to opportunity cost for the product. With a sound system of Transfer Pricing, it become easy to prepare unit wise P&L account and to observe non-financial factors to evaluate performance of an individual unit. With such a transparency and accountability, overall results of company would be smooth achieving targets set at the start of the year.