Anderson Customized Security - Essay Example

?Anderson Customized Security Introduction A problem involving Transfer Pricing has occurred between two subsidiaries of ACS at a time when there wasno set of corporate policies for management decision making guidelines. Managers of Reading Company, Millwall Company, and the VP Corporate Finance failed to arrive at an agreed upon Transfer Price although the bidding was finished and Millwall won. Based on the given case facts (See Appendix), hereunder are the effects of each alternative pricing. Quantitative Effects of Alternative Transfer Prices on the ROI of Reading Company: Reading Co.’s Offer = $ 11.80 Millwall Co.’s Offer = $7.68 VP Finance Offer = $10.12 Selling Price $ 11.80 Mftg. VC+FC ( 8.40) Gross Profit $ 3.40 S & A 0.00 NIBT $ 3.40 % NIBT./Capital = 40.48% Standard with Normal Operations = 30% Selling Price = $ 7.68 Mftg VC + FC = ( 8.40) Loss = ($0.72) S & A 0 Net Loss ($0.72) % Net Loss/Capital(8.57%) Selling Price = $10.12 Mftg.VC + FC = ( 8.40) Gross Profit = $1.72 S & A 0 NIBT =$1.72 %NIBT/Capital =20.48% Since the effects of Millwall Company’s buying price offer and the ACS Corporate VP Finance recommended buying price offer would certainly pull down the ROI of Reading Company, it will definitely be unfair for the provider of component. On the other hand, the offer of Reading Company seeks to take advantage of the situation of Millwall Company by demanding a price that will give Reading Company a much higher Return on Capital Invested before tax for the component orders of Millwall Company. The usual ROI before tax of Reading Co. is only 30%. And Reading wants 40% NIBT/Capital. The effect of selling at the price of Millwall’s proposal will certainly create management protest against dragging the performance of Reading down by an act of Millwall Co. management. Reading Co. management should have been consulted about the bidding cost for the component before the wrong cost was quoted. Apparently, the buying price offer of Millwall would make Reading Co. incur a loss per component amounting to ($ 0.72). Granted that the fixed cost will nonetheless be incurred whether or not there is an order from Millwall, Reading Co. management can reasonably argue that their practice is to assign each component the value of $ 2.40 fixed manufacturing cost. There was also a mistake on the part of Reading Co. when its management gave the variable cost information to Millwall Co., because the figure given should have been the total manufacturing cost, since the fixed manufacturing cost was also dependent on the number of units produced. Thus, Reading Co. caused Millwall Co. to make a mistake in the bidding. Immediate Solution for the Transfer Pricing Problem of Reading Co.& Millwall Co. The management of Reading Co. should realize the mistake of communicating to Millwall Co. a variable cost value intended for bidding. Clarifications should have been made prior to disclosing such a low variable cost, if it cannot be a basis for Transfer Pricing, Reading Co. should agree with the policy of not over pricing and limiting its profitability on the potential orders of Millwall to a maximum equivalent to what it is currently earning. That is 30%. Furthermore, since it disclosed that its variable cost is $7.60, Reading Co. management should compute its Transfer Price based on what they had communicated. For example, Transfer Price = X ; Mftg. VC = $ 7.60 ; therefore X - 7.60 = 30% of X. X – 30%X = 7.60 ; 70%X = 7.60 ; X = 7.6 / 0.7 = $ 10.85 should be the maximum price By asking for the maintenance of its profitability in terms of Returns on Capital Invested, the management of Reading Co. can be considered in good faith. That is, the management did not fool Millwall Co.. Millwall Co. management should also realize the mistake of submitting a bid not based on a negotiated Transfer Price of component coming from a subsidiary. The Transfer Price should have been finalized before quoting a price in the bidding. In the case wherein a bid was won based on wrong information, the problem will have to be escalated to Top Management. Millwall Co. should disclose at what price of the component will the subsidiary break-even? At the offered selling price, what will be the profitability of Milwall Co.? Why is the management of Millwall rejecting the offer of ACS VP for Corporate Finance? If Millwall Co. will lose as a result of the Transfer Price required by Reading Co., ACS Corporate Top Management should intervene. Perhaps by letting the management of Reading Co. know about the potential loss, the management of Reading Co. will be willing to settle for less than the 30% profitability. But there are missing information in this case. Certainly, Millwall Co. arrived at a quotation that would also maintain its profitability. Top Management also has a responsibility for the problem encountered. There are no Transfer Price Policies. And the ACS Corporate VP Finance does not have a basis for controlling both subsidiaries. Thus, top management should be flexible for this incident. In multinationals, prices are controlled by the parent company in Transfer Pricing Policies. And, according to Hendrik Vedder, it is because of the need for “consistency of the system of performance evaluation of the foreign subsidiaries, and their management, motivation, and goal harmonization…” 1 Immediate Impact on the Policies & Procedures of ACS ACS Corporate Management should prevent these same mistakes from happening again, in the interest of profitability for each of the subsidiaries. There should be common Transfer Pricing Policies if the parent company wants performance of subsidiaries to be comparable as mentioned by Shahrokh M. Saudagaran.2 The Policies and Procedures Manual should include the following policies: 1.All biddings for contracts must be submitted to Corporate Finance Management for review, in situations wherein the components can be produced by a subsidiary of ACS. 2.In no instance may a subsidiary submit a quotation that is not based on the Transfer Prices approved by the Corporate Finance Management, or negotiate a Transfer Price after submission of bids. This is in the interest of “overall” maximization of benefits for the parent company that __________ 1Hendrik Vedder, Performance Evaluation of Foreign Subsidiaries: A Critical Analysis. Germany: GRIN Verlag, December 14, 2008. p.10 2Shahrokh M. Saudagaran. International Accounting: A User Perspective. USA: CCH, February 2, 2009. p.126 can result from the transaction between subsidiaries.3 3. All subsidiaries must submit a list of all the components that can be supplied to the other subsidiaries, along with the competitive Transfer Price per component. The list must be updated on a monthly basis. In case a sudden price increase has to be reported, each subsidiary must communicate the price change via a memorandum to the Office of Corporate Finance. 4. All Transfer Prices submitted to Corporate Finance should be equal to or lower than those of competitors’ selling prices for the same components. In case, there is a problem with providing such competitive prices according to this policy, corresponding justifications must be submitted along with the Transfer Prices Listing. This policy applies only to components that have similar competing products in the market. Those without comparable components should be depending on the cost and/or negotiation of transfer prices.4 5. In no instance may any subsidiary purchase components from any competitor without the approval of Top Management whether or not it will be justifiable to purchase elsewhere. 6. At any given time, Transfer Prices must not exceed the profitability ratio when the same components are sold in the market. All subsidiaries are allowed to at least maintain the Return on __________ 3 V.S. Somanath. International Finance Management. India: K. International Pvt. Ltd., Feb. 1, 2011, p.753 4 Shahrokh M. Saudagaran.,p.135 Investment ratio upon selling of components at Transfer Prices in favor of other subsidiaries. At the very least, the Transfer Pricing must not be inequitable or it will cause conflict between subsidiaries that is against the corporate goal of harmony.5 7. All recommended Transfer Prices must take into consideration price fluctuations during the time that bidding procedures are taking place. The impact of fluctuations will be the accountability of subsidiary management. It should be noted that Transfer Pricing may be utilized to legally lessen the tax burden on the overall by increasing prices from one subsidiary and lowering prices in another. For example, if the Income of a subsidiary is about to reach a higher tax bracket, Corporate Management may decide to allow lower Transfer Prices to avoid a higher tax rate on the selling subsidiary.6 The government recognizes the fact that “market forces do not necessarily control transaction prices within a related group…which has resulted in both compliance and enforcement difficulties on a global basis.”7 5Shirin Rathore, International Accounting 2nd Edition. India: PHI Learning Private Ltd.,2009. p.322 6Jeff Madura. International Financial Management, 10th Edition. USA: South-Western Cengage Learning. September 25, 2009. p.449 7Marc M. Levey, C. Wrappe Steven, and Chung Kerwin. Transfer Pricing Rules and Compliance Handbook. USA: CCH Wolters-Kluwer Business. January 18, 2007.p. 1 Bibliography Levey, Marc M.; Steven, Wrappe C.; and Kerwin, Chung. Transfer Pricing Rules and Compliance Handbook. USA: CCH Wolters-Kluwer Business. January 18, 2007. Madura, Jeff. International Financial Management, 10th Edition. USA: South-Western Cengage Learning. September 25, 2009. Rathore, Shirin International Accounting 2nd Edition. India: PHI Learning Private Ltd.,2009. Saudagaran, Shahrokh M. International Accounting: A User Perspective. USA: CCH, February 2, 2009. Somanath, V.S. International Finance Management. India: K. International Pvt. Ltd., Feb. 1, 2011 Vedder, Hendrk. Performance Evaluation of foreign Subsidiaries: A Critical Analysis. Germany: GRIN Verlag, December 14, 2008. Levey, Marc M.; Steven, Wrappe C.; and Kerwin, Chung. Transfer Pricing Rules and Compliance Handbook. USA: CCH Wolters-Kluwer Business. January 18, 2007. Appendix Case Facts Assumed: >Own Sales Force >Own Production Facilities >Own Financial Management >Performance Basis= ROI >Own Sales Force >Own Production Facilities >Own Financial Management >Performance Basis= ROI Ave. Variable Cost of Component = $ 7.60 = Mftg. VC + Mktg. VC Selling Price of Component =$13 Offerred Selling Price of Component to MillWall = Selling Price – (Selling +Distribution Expenses) = $13 - $ 1.2 = $ 11.80 >Own Sales Force >Own Production Facilities >Own financial Management >Performance Basis= ROI Buying Price Offer to Reading Co. = Mftg. VC + 20% = $6.40 x 1.20 = $7.68 VP Finance recommended Buying Price = Mftg. FC + VC + 15% = ($6.40 + $2.40) x 1.15 = $10.12 => REJECTED Read More