Transfer Price - Research Paper Example

Evaluation Report If we close the Nottingham division and only make up 60% of the revenue then we would decrease revenues by about £65,000(see Scenario 1 in Appendices). We would also decrease costs by £41,000. The same scenario would decrease administrative expenses by £32,000 thereby creating an increase in profit of £16,000 which is twice the previous amount. This scenario would create more profit than if we kept the Nottingham division because it would eliminate the administrative costs. The only way that the administrative costs would not be eliminated would be if we added administrative employees to the Leicester and Loughborough locations. If this is done then we would split the £32,000 administrative costs between the two. This scenario could also lead to more costs based on how much an employee costs in these areas compared with the costs in Nottingham. If the costs in Nottingham are lower than Leicester and Loughborough then the administrative costs would be much higher. Closing a division would mean firing employees and this might not make the company look too good. If we close the division and outsource the raspberry jam then we would be paying £20.6 for each batch and our profit would be £11.4 per batch. If we still sold 6250 batches then our total profit would be £71,250. We would save the costs of fruit, sugar, labour, variable costs, and some overhead. This could equal up to £109,000 in savings and could lead to some significant profit. We could then use this profit for other things or even for expanding the other two products. Advertising would create more customer awareness and possibly increase the demand for the product. The first thing we would need to consider would be how much we will be spending on this campaign. We do not want to overspend and receive nothing in return. If we have a decent budget for the advertising campaign we can then choose where best to spend our money. We would also need to decide how to advertise. We could use the papers, magazines, radio, or even television. Of course television is the most expensive of the choices but might be the one that reaches the most people. If we could put together a good campaign then we would need to make sure that we increase the demand by enough to cover the campaign. It would be very difficult to figure out how much our sales would increase and if we are unable to predict how much sales would increase then we would have a hard time predicting how much our distribution costs will change. Even if the campaign increased sales by 20% this might not be enough to create an effective profit increase. Our distribution costs would also increase but not necessarily by only 20%. If we installed a transfer price system this would only raise costs unnecessarily. We are trying to keep costs down and adding to them with a transfer pricing system would not accomplish that. Employees will not be motivated because of increased costs but they will be motivated by decreasing costs and knowing that they have a job. The only choice is to buy above market or sell below market (Investopedia ULC, 2010). Either way we are increasing our costs and this will not do any good to either division. Another option would be that we move the home office and sales divisions. First off if the sales divisions are in each location then we could possibly sell more products. This would also make it possible that the home office would not need a big space and this could save money. For example, the home office currently is costing £155,000 per year. If we move the sales off then this could lead to the potential of paying less. If this amount decreases by £10,000 or more per year then it would be feasible to do so especially if it would not cause us to fire any employees. Even though the company is struggling we do not want to release any employees. Unfortunately, if we have to release employees it would only be as a last resort. The company should take a proactive stance to not fire or release any employees by not closing any divisions therefore we should move our home office before doing anything else. We can look into other locations and compare leasing prices to see if we would save enough. We could also move into a city adjacent to our current one to make sure that current employees are not commuting too far. If we do have employees commuting too far then maybe we can figure out a plan to allow them to work from home every now and then. Part 2 We will assume the worst case scenario as far as pricing of the materials is concerned. We assumed that strawberries increased by 5% and raspberries increased by 15%. It was also assumed that variable costs rose by 5% and fixed costs rose by 10%. Sales were assumed to increase by 20% but the volume was not enough for the fruit companies to begin to lower their prices to us. The standard cost cards would look something like the following: Everything was increased by the assumptions. Our previous profits were 12.6, 14.8, and 14.8 respectively. These new cards show a decrease in profit of 3.8%, 7.7%, and 3.4%. Considering that our profits were already low, we would experience a loss even if we did not increase the advertising budget. This will be show later. The budget would look something like the following: This budget would not assume any changes to advertising, local administration, and head office expenses. If these items changed then the budget might be even more negative. Local administration expenses would remain the same because their salaries would not increase. The same holds true with the head office. If we could find a way to lower the advertising budget by 50% but still maintain an increase in sales of 20% then we would make a decent profit. The profit would be larger than before. An examination into the ways that we are spending the advertising budget would make a large difference. We might be spending money on things that are not effective and this money can be better spent elsewhere. Part 3 a) b) Using the current system, the Leicester division is carrying the others. Their revenue was almost £400,000 and considering the increase in prices they performed very well. Hopefully we might be able to get the fruit companies to lower their prices based on this division’s performance and the hopes that demand will continue to increase on a quarterly and yearly basis. The gross profit of this division was £159,852 before allocations of the fixed costs. This is a solid basis for helping to pay the bills and for generating revenue. Their cost of goods produced and sold was 56.75% of total revenue which was a good starting point for them. The Nottingham division started off strongly with a gross profit of £102,750 however, due to increased distribution costs and allocations of advertising, local administration expenses, and head office costs, their gross profit was quickly removed. Their costs of goods produced and sold was 57.1875% of their sales revenue which on the surface, was a good starting point. The same holds true for Loughborough. They started off with a gross profit of £102,960 which is only £210 more than Nottingham. We could see early on that this gross profit was not going to fare any better than Nottingham. Their cost of goods sold and produced was 64.25% of their revenue which was not a good start from the beginning. c) The company should definitely change their approach from a traditional one to an activity based one. First off, some divisions use more resources than others and should therefore pay more. Leicester produces more goods and their distribution costs would probably be more than the rest of the divisions therefore the allocation here should be higher than the others. If the allocations were better than the overall picture would be clearer. The Leicester division is the money producer and this is a fact that should not be denied however because of this increase in production they should receive more costs allocated to them. The cost driver is the units produced and could be used as an activity to base the costs on. References Investopedia ULC. (2010, April 29). Transfer Price. Retrieved April 29, 2010, from Investopedia.com: 2010 Read More