Managerial Control of a Company - Essay Example

Introduction Anderson Customized Security (ACS) is a group of companies which consists of Birmingham Corporation, Reading company and Millwall company. All the companies work and operate as independent companies and there is no considerable relationship between them and when there is such a situation and these companies do a transaction then it is called transfer pricing (Duft). Every company has its own resources and the management of every company is involved in selling, working capital management, evaluating cost of the operations and other operations of the business. The performance of every division is evaluated through its Return on Investment (ROI) (Jensen, and Meckling, 1976, 306) and this is the same with ACS as well. Millwall Company has been awarded the contract for a specific project. The project requires the component which is manufactured by Reading company. The Reading Company is operating less than full capacity. Millwall has requested to buy the component for his project from Reading. As there is no transfer pricing policy of ACS therefore Reading offered Millwall the component at regular price less selling and distribution expense. But this offer was not accepted by Millwall and it has proposed to pay Reading the price which was less than cost of the component. The corporate management of ACS has tried to negotiate between the two companies and offered Reading $10.12 for component. The figure was evaluated by the combination of standard full manufacturing cost plus 15 percent markup. However this suggestion was not accepted by both companies. The effect that each proposed price might have on the attitude of Reading’s management toward intra-company business Reading regularly sells the component at $13 to outsiders. However Millwall estimated the cost figure of the component at $7.60. Reading offered to supply that component to Miilwall at $11.20 which was extracted from regular price i.e. $13 less variable and distribution expenses i.e. $1.20. The figure shows that reading would have profit of $1.80 if it supplies the component to Millwall at $11.20. The acceptance of the Reading’s proposed price by Millwall might have positive effect on the attitude of Reading’s management toward intra-company business. Firstly, Reading’s proposed price would be accepted by one of the intra-company of Anderson Customized Security (ACS) as it is always better to sell goods to intracompany. Secondly, Reading can also have a profit of $1.80. Though this would be less profit as Reading could have earned more by selling the component to outsiders but the company has to play its part in supporting the other companies of the same group. This also leads to enhance the image of the company in the group. Moreover, Reading’s manufacturing operation is well below its utilization capacity so it would be better for Reading to manufacture more and improve its performance. Millwall, on the other hand, proposed Reading to supply the component at standard variable manufacturing cost plus 20 percent. The price which Millwall offered was $7.68 which is almost 23% less than the cost Reading incurs in manufacturing the component. Therefore Reading might have problems in selling the component at price less than cost. The Reading’s management attitude might not be positive towards intra-company business as they cannot bear loss. The price which was offered by corporate vice president of finance is equal to the standard full manufacturing costs which include both variable and fixed manufacturing cost and 15 percent markup. The cost figure that was offered by vice president is $10.12 which is just above the cost of the component that Reading manufactures. The figure is also inappropriate for Reading as it will have to sell the component at cost price. Therefore Reading’s management might not be happy with this deal. However, the corporate management priced fair for component because Reading is operating under full capacity and it is better for it to manufacture more components even for a minor profit. Furthermore, the fixed cost for each component would decrease with the increasing number of production of components. But every division wants to make itself strong through their performance as they are evaluated through ROI. Therefore, no company is agreeing on one point. Whether negotiation of a price between Millwall and Reading is a satisfactory method to solve the transfer price problem It is not the permanent method to solve the transfer price problem between the two companies (Brauner, 2008). Transfer pricing is when two divisions or two intra-companies of the same group are undergoing a transaction (Robertson, 1996, 1; Christopher, 1994, 44). However in the current situation where both the companies are not agreeing on one point, the price negotiation technique can be adopted to solve the problem (Stoughton, and Talmor. 1994, 145). But it is not appropriate to adopt this technique every time. Anderson Customized Security (ACS) has three companies which work independently but has never thought before about formulating transfer price policy for companies. Therefore the group needs to devise a proper transfer price policy so that conflict could not arise between companies in future and smooth transactions can be ensured between them. It has become imperative for the group of companies to have well established transfer price policy (Currie). The policy must be designed by considering the interest of all the companies. The effective policy helps to bind the companies to fulfill the requirement of the other company according to the rules and regulations mentioned in the policy. Also with these defined policies, companies would be mentally prepared to deliver the products to other company at a price given in the transfer price policy. The policy also reduces the conflict among the companies arise by the financial matters. However, there should not be any kind of favoritism for a specific company and the policy must be equally applied for all the companies in a same group. Whether corporate management should become involved in this transfer pricing controversy It is the responsibility of corporate management to involve in transfer price policy controversy (Chan, Landry, and Terrance, 2004) otherwise the conflict between companies could reach to its peak as presented in the case. The corporate management should not leave companies alone in the ground and let them decide the negotiation price. Obviously every company would be thinking of its own interest and hence conflict would arise between them which eventually leads to poor performance and productivity. The corporate management should take part in negotiating the price between two companies if there is no transfer price policy but this is not better way to solve the problem every time. The corporate management should come up with effective transfer price policy so that one company does not have any issue to sell the product to other company. If companies are not controlled through policy, it would be difficult for the corporate management to resolve the disagreement between them. Conclusion Anderson Customized Security (ACS) is a leading security company with many divisions. However the group is unable to establish transfer price policy for its companies. The group should establish the policy immediately so that the conflict between companies could not rise in future. The policy must be made in considering the interest of all its companies and it must be implemented properly. It should be equally applicable for all the companies and there should not be any kind of favoritism in designing the policy. ACS evaluates its companies using Return of Investment therefore the policy should not lead to damage the performance of any company. The negotiation between Reading and Millwall is the responsibility of corporate management. It played its part and offered a negotiation price but both the companies disagreed on the price as everyone is thinking for their own benefit. However, Reading should have accepted the offer proposed by corporate vice president of finance because the company is operating under capacity and it can manufacture more components easily. Moreover, the fixed costs for each component decrease with the increasing number of Production so it was very fair deal for Reading. Bibliography Brauner, Yariv. 2008. Value in the Eye of the Beholder: The Valuation of Intangibles for Transfer Pricing Purposes. http://scholarship.law.ufl.edu/facultypub/18 Chan, Canri, Steven P. Landry, and Terrance Jalbert. 2004. “Effects of Exchange Rates in International Transfer Pricing Decisions.” International Business and Economics Research Journal 3(3): 35-48. Christopher, Pass. 1994. “Transfer Pricing in Multinational Companies”, Management Accounting – London 72(8): 44-50. Currie, John. “Transfer Pricing”. Department of Accountancy & Finance, National University of Ireland Galway. http://www.cpaireland.ie/UserFiles/File/students/Articles/Transfer_Pricing_Article_by_John_Currie1.pdf Duft, Ken. “When You Buy From Yourself, How Much Should It Cost?.” AgriBusiness Management. Washington State University & U.S. Department of Agriculture Cooperating. http://www.agribusiness-mgmt.wsu.edu/ExtensionNewsletters/price-cost/buy_cost.pdf Jensen, Michaell and William Meckling. 1976. “Theory of the Firm: ‘Managerial Behavior, Agency Costs and Capital Structure’.” Journal of Financial Economics 3: 305-360. Robertson, Sandra. 1996. “Transfer Pricing Solutions in the Global Economy.” Annual Survey of International & Comparative Law 3(1): 1-16. http://digitalcommons.law.ggu.edu/annlsurvey/vol3/iss1/8 Stoughton, Neal, and Eli Talmor. 1994. “A Mechanism Design Approach to Transfer Pricing by the Multinational Firm.” European Economic Review 38(1): 143-170. Read More