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ACC202 Management Accounting - Kings Own Institute

Topic: Management accounting problem

Question: Prepare a report to the CEO outlining your recommendations in relation to the transfer pricing and performance measurement approach which would help optimise the performance and efficiency of the company. Clearly outline the benefits and challenges of your suggested approach.

Executive Summary

This paper is a research analysis which deals with an concept which explains the aspect of the explaining two main concepts which being the operational divisions and the transfer pricing concepts . It explains both the concept in a inter correlated manner to ensure that the concept is completely understood and explained the whole paper is divided and analyized in following heading. It beings with the introduction which provides all the concepts and theory of the case study. The next section is that which explains the Comparisons between the Cost Based Pricing and the Market Based Pricing and defines the problem as the name suggest. Later part is that to explain the Various Transfer Pricing Approaches which explains which approaches are better as compared to the other approaches. The other part is that the excel computation which helps in defining the Revised Transfer Income Statement as per the Contribution Margin Approach. The paper close on two aspect one being the recommendation analysis which defines which option is better and reason for the same and thereby closing the paper at the conclusion analysis.

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Introduction

This paper is a case study which is based on the practical analysis of the management accounting concept which deals with an management accounting problem which defines that the company is an Raven Industries which runs three division which being theCarpet divisions, Furniture Division and the Cushion Division and the manager has to decide upon various practical problem which includes the transfer price analysis as well as the operational profit approach to decidewhich option is better and beneficial for the company reports and analysis in nut shell which leads to better profits and revenue margins and promising results.

Question: Robert Cleveland believes that the transfers from the Cushion Division to the Furniture Division should be at market price rather than at cost, for performance measurement.

a) Is Cleveland correct? Explain your answer.

b) Describe another approach that the company could use to set transfer prices, other than manufacturing cost and market price.

Solution:

Comparisons between the Cost Based Pricing and the Market Based Pricing

This aspect helps in defining the segment the analysis of weighing as to whether the transfer between the cushion division and the furniture division needs to made on the aspect market transfer price or the cost transfer price to ensure the performance is made on appropriate measurement level.

Cost Price Transfer -
This system only includes the element of production cost or actually the cost of production, in this perspective the organisation deals with an aspect where the company sells at a no profit and no loss zone. This is a situation where the division leads to a position where the main motive is not personal interest but to think about the overall profit of the organisation as a whole. It only takes into account the aspect that the units produced are sold without any motive of providing a monetary gain. On the more, the cost price is not at all beneficial in case where the divisions are marked separately in terms with division profits, incentives as well as the employee appraisal (Monsenego, 2015). Mostly in the organisation where divisions are considered as separate units and marked on profit oriented working culture and the responsibility of accounting are profit centers the cost-based transfer pricing are the least choice of thedivision's managers.

Market based Price Transfer
This system includes all the element of costing which being the production cost, administration cost, other allied costs as well as various profit margin. In this system the goods or the services are transferred within the division mainly on account with the cost plus some mark up value, however such mark up must include or be equal to the market value. Primarily, the market value means the average price of the product or services charged or traded in the general by various other competitors.This is a situation where the division leads to a position where the main motivepersonal divisions interest and not the overall profit of the organisation as a whole. It only takes into account the objective oriented aspect that the units produced are sold with single motive which being providing a monetary gain(Monsenego, 2015). On the more, the market-based price isall thebeneficial in case where the divisions are marked separately in terms with division profits, incentives as well as the employee appraisal. Mostly in the organisation where divisions are considered as separate units and marked on profit oriented working culture and the responsibility of accounting are profit centers the Market-based transfer pricing are the best and the most rewarding choices of the division's managers.

By reviewing the overall explanation on account with the market transfer price and the cost transfer price Robert Cleveland is correct by stating that the transfer among the Raven Industries must be made on account with the market transfer price. Further, it clearly states that the cushion divisions are highly profitable than other divisions and the reason it showing lesser results is mainly because it supplies to other division on the cost-based pricing. Thereby, leading to a condition where the managers must opt for market-based strategy to obtain better promising results.

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Various Transfer Pricing Approaches
Transfer pricing can be computed through various methods and computational analysis which can be listed as below: -

1) Comparable uncontrolled price (CUP) method - This method explains that the prices are computed on the basis of the un manageable or an un controlled deals between the various comparable entity and the manage prices and marked prices by not managing the aspect through external markup as well as the internal markup(Monsenego, 2015). In Simple words the compares the price in a controlled transaction to comparable uncontrolled transaction in comparable circumstances.

2) Resale price method - This method is also known as the Resale Minus Method. In such a case of transfer pricing resale price method ensures that the price of the goods or the services or the both are done on an aspect where the enterprise marks the prices of the products and services at which the third party or any other outsiders are sold. On the more, this method is broadly applied to ensure that the ultimately define the sales prices found in connection with the controlled prices and the related transactions. This being a complicated method is not mostly applied and preferred as it may result to variations margin the questions and the answers and thereby avoidable.

3) Transactional net margin method (TNMM) - This is a method which ensures that the pricing in case of transfers of divisions, this is an indicator where the computation is a single analyized method and mainly be utilized in connection where the transactions are less complicated and are a simple and manageable(Zhang, and Xia, 2017). This is a computation method which deals with comparing the profits which are usually earned through anon-arm length transaction which being not a transfer pricetransaction. To the transactions which are the arm length transactions which being a transfer of price, thereby analyzing the profit on a much appropriate and a balanced format.

4) Transactional profit split method - As the name suggest it deals with an aspect where the profits and the income are shared and separated on the concept purely and largely based on the arm's length price. Primarily, it is a condition where the controlled transactions given in a desirable situation leads to a position where the profits are considered common are led to distribute in a correct manner which will lead to a much correct and a reasonablemanner(Monsenego, 2015). It all deals in marking the aspect as well as performing those in much similar manner and a designated manner.

Thus, after analyzing all the transactions it is evident that the other possible method to be applied to the Cushions Divisions in context to the Robert Cleveland is the CUP method or the comparable uncontrolled price method. Majorly, because this will help the divisions to maintain an average price as similar to the market and also help in promoting a reasonable level of prices to quote such transfer and lead to a leveled based profit(Zhang, and Xia, 2017).

Using transfer prices based on market prices, prepare a revised profit statement, by division, for Raven Industries that will facilitate the evaluation of divisional performance. Use the contribution margin approach.

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Revised Transfer Income Statement as per the Contribution Margin Approach

It is first essential to understand the contribution marginapproach where the income and losses of the manufacturing companies is defined through margin contribution approach it will deal with describing the difference on account with the sales which are distinguished on account of revenues and variables which deals with the production expenses as well as the selling and distribution expenses.

There is a standard approach which deals in computing the income statement and the same is expressed as below: -

Revenue (Subtract) Variable production expenses which may include such as materials, supplies, and variable overhead (Subtract) Variable selling and administrative expenses (Equal to) Contribution margin (Subtract) Fixed production expenses which may include or mostly contains the overhead expenses (Subtract) the Fixed Selling and Administrative Expenses (Equals to) the Net Profit or Loss(Ondrušová, 2016)

The contribution is defined by the aspect where the Sales only keeps into account the variables expenses to define the contribution and later with respect to the help of the contribution expenses and the fixed expense the breakeven point is defined. Further, this approach is more modern and helps in justifying the aspect in terms with the costing analysis and perspective rather the old way down where each and every element was justified purely in terms of expenses and income without providing much difference to the fact as to what is the fixed cost and variable cost and how it effects the profit margin on an overall basis.

Raven Industries


Profit statement for the year ended 31 December


 

Division

 Carpet Davison

Furniture Division

Cushion Divisions

Total




Particulars

In Millions


Sales Revenue (a)


 $   3.00

 $   3.00

 $   4.00

 $ 10.00


Variable Expenses 1

 

 

 

 

 


Direct Material 2

 

 $   0.50

 $   1.00

 $   1.00

 $   2.50


Direct Labour 3

 

 $   0.50

 $   0.20

 $   1.00

 $   1.70


Variable Overhead

 

 $   0.75

 $   0.05

 $   1.00

 $   1.80


Production Variable Expenses (b) (1+2+3)

 

 $   1.75

 $   1.25

 $   3.00

 $   6.00


Direct variable Administration expenses expense(4)

 

 $   0.09

 $   0.14

 $   0.04

 $   0.27


Direct variable Selling expenses expenses (5)

 

 $   0.48

 $   0.48

 $   0.40

 $   1.36


Total Variable Selling and Aministration Expenses © (4+5)

 

 $   0.57

 $   0.62

 $   0.44

 $   1.63


 

 

 

 

 

 


Contribution margin (a-b-c)

 

 $   0.69

 $   1.13

 $   0.56

 $   2.38



 

 

 

 

 


Fixed Overhead

 

0.25

0.05

0

 $   0.30


Direct expense fixed

 

0.085

0.21

0.12

 $   0.42


Head office expenses (all fixed)

 

0.13

0.15

0.24

 $   0.52


Direct FIXED Selling expenses expenses

 

 $   0.12

 $   0.12

 $   0.10

 $   0.34


Total Fixed Costs

 

 $   0.59

 $   0.53

 $   0.46

 $   1.58


 

 

 

 

 

 


Profit

 

 $   0.10

 $   0.60

 $   0.10

 $   0.80


After the contribution approach it is evident that the ranking of profits has completely changed as they cushion division ranks at third position as compared to the being at the first position. This analysis clearly proves the factor that the evaluation of divisional performance hold way more difference in terms with the contribution operation and the profit margin approach stating thatafter understanding the both the element it is evident that theRobert Cleveland is correct in being dissatisfying about the operational performance report as it not ranked first but as a matter of fact it leads to be last in true sense.


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Recommendations

This segment deals with an perspective on two basis one being defining the transfer pricing method and the other being the operational division method which must be applied in case for determine the profits of the organisation.

In terms with the first problem transfer pricing must be done on an arm length price which means the price of the product or services which are being traded within the branches must be accustomed to the fact that the are done on a general pricing open to the industry and other competitors. On the more, the difference must not exceed a margin of about five percent variation in increasing the price limit and the other one being that of the decreasing the price limit (Zhang,and Xia,2017). In this connection the segment the best method is neither the costing price strategy nor the market price strategy but in fact the CUP method which being comparable uncontrolled price method(Zhang, and Xia, 2017).

Here the prices are computed and calculated on the basis where the controlled prices markers the transfer pricing and its element it ensures as to how the price must be marked in case of uncontrolled or nor intercompany transfers and the same must be applied in the situation where the transactions are controlled on the basis of the controlled transaction's. On the more the fact being that in case of the comparability segment the reasonable accurate adjustments are on terms with the basis where the controlled segments can be marked on the basis of material differences and accordingly adjustments can be done to ensure the transactions are controlled.

The second segment being the operational profitability method and as per the above analysis it is evident that the income statement must be made on a contribution approach rather than the absorption approach or the marginal approach. The reason being the cost are divided into two segments one being the fixed costs and the other being the variable costs. On a basis where the divisional profits must ensure that the division is easily able to recover its variable costs as the fixed costs are waved off in a longer period of time and not on a short duration basis. On the more, it is evident that the division or the product which has a vast gap and the sales price and variable cost leads to reach higher profit margins as compared to any other products and services. On the fact, that the basis where the variable cost and its margin are the deciding pattern and not the total profit. Further, it is evident that the operational profit determined on the basis of any other mode will lead to a position where the results which will be not proving and lead to un satisfactory results as shown in above transaction's.

Conclusion

This paper is an analysis of the management accounting in the perspective of justifying the concept of transfer pricing and the operational division analysis. They paper defines two main elements a theoretical perspective of the management accounting concepts and the other being the excel computation which explains the numerical computation of the profit the profit margins on various basis. Thus, the paper defines the segments in a great perspective as to how the analysis needs to be made. On the more on an overall basis it proves the fact that the contribution method is best in this scenario as the company deals with determining the aspect which means the company is better off with fixed cost or the variable costing. On the other hand, it explains in case of inter divisional transfer the best method is neither the cost based pricing or the market based pricing in actual and true sense it is the CUP method which being the Comparable uncontrolled Price Method.

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