ACCT2195 Accounting, Behaviour and OrganizationsTopic 4: Transfer Pricing

ROBSEN FURNITURE COMPANY CASE

Robsen Company is a medium-sized business, which produces and sells a range of quality commercial furniture and shop fittings. The company has a number of divisions, including the Glass Division, Components Division and the Furniture Division. The role of these divisions is as follows.

Glass DivisionThe Glass Division purchases raw materials and processes them into glass sheets. The Glass Division supplies the Components Division with its glass requirements. It also sells a substantial portion of its glass production to external customers.

Components DivisionThe Components Division manufactures a range of furniture components, including timber and glass doors, which are used by the Furniture Division in the manufacture of a number of Robsen’s furniture items.

The Components Division also performs work for outside firms, in particular, selling its glass and timber doors on the external market. In the past, this has been very profitable. However the Division has recently experienced a decline in outside sales.

Furniture DivisionThe Furniture Division undertakes the final manufacture of the furniture, which is then sold to external furniture retailers. While the Furniture Division often purchases its furniture components from the Components Division, it also uses outside companies to source these items.

Decentralisation and Performance MeasurementEach division has a divisional manager in charge of operations. For several years each division and manager has been evaluated on the basis of profit – i.e. each division has been treated as a profit centre. Divisional managers receive a substantial bonus if divisional profit targets are met.

Top management has implemented a policy of decentralising responsibility and authority for all decisions except those relating to overall company policy. The company’s board of management believes that the concept of decentralisation has been implemented very successfully, and that the company’s competitive position has definitely improved.

The IssueEarly in 2010, the Furniture Division designed a new item of furniture, a jewellery display cabinet. The cabinet was to have two identical glass and timber doors at its front. The Furniture Division worked on the design of the cabinet, in consultation with the Components Division. The glass doors were an unusual design, and as a result the Components Division spent considerable time and effort perfecting the design, manufacturing method, and materials to be used. An agreement was reached between the two divisions that the

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Components Division would be reimbursed by the Furniture Division for the full cost of its design and development work.

Each manager at Robsen Furniture is free to purchase from whichever suppliers he or she wishes; it is expected that each division is able to operate efficiently enough to match the current market price on its products. Therefore, after the design of the doors was finalised, the Furniture Division asked for bids on the glass doors from both the Components Division and an outside company – Kayte Company. The two bids were as follows;

Components Division $177 per glass doorKayte Company $160 per glass door

The Components Division BidThe Components Division was extremely keen to win the bid for the glass doors. Recently the Division had been having difficulty maintaining its external sales. It was common knowledge at Robsen Furniture that the Components Division had not been operating at full capacity for several months. In fact it was expected that the Division would have enough spare capacity to satisfy the production demands of the Furniture Division into the foreseeable future.

If the Components Division were successful in attaining the order from the Furniture Division, Jensen Samuels, Manager of the division, has indicated he would like to source the glass required for the doors from the Glass Division, rather than from an outside manufacturer, who would offer the glass for $54.00 per sheet. Jensen believed based on past experience, that the Glass Division would offer a competitive quote and a high quality product; therefore he did not feel the need to look for other sources.

Consequently, before finalising the bid for the Furniture Division, the Components Division asked the Glass Division for a quote on the glass.

The Glass Division had been operating at full capacity for a number of months, and this was expected to continue into the foreseeable future. As a result it did not need the Component Division’s business. However Sarah Black, manager of the Glass Division, knew that her company preferred its divisions to undertake internal transfers, rather than outside purchases, as often as possible. She was therefore willing to supply the glass requirements, even though it would mean missing out on external sales, as long as her division did not lose on the transfer.

Each door required one sheet of high quality glass cut to a specified size. Sarah provided a quote for the supply of the glass, which was equivalent to the current market price of $55 per sheet. Information relating to these glass sheets is contained in table 1.

Jensen Samuels was disappointed with this price, as it was higher than the external price he could get in the external market. He noted that 50c in packaging costs (included in “other materials”) and $3.00 in administration costs would not be incurred on an internal transfer.

Table 2 provides details of the Component Division’s additional costs (other than the cost of glass) associated with the manufacture of each door.

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Kayte Company BidKayte Company had purchased glass from Robsen Furniture’s Glass Division in the past, and was one of its best customers. In an attempt to make its bid more appealing to Robsen Furniture, Kayte Company offered to purchase its glass requirements for this contract from the Glass Division. It would supply its own timber and other materials in the manufacture of the glass doors.

The Glass Division indicated that it was willing to supply the glass to Kayte Company at a selling price of $52 per glass sheet per door. This was less than the prevailing market price of $55, to take into account the importance of Kayte Company as a long-term customer.

Costs associated with the provision of the glass sheets to Kayte Company would be the same as those contained in table 1.

When Janek Khan, the manager of the Furniture Division received the two bids, he was dismayed at the discrepancy in the two prices. While he knew he had decision making autonomy over the sourcing of his components, he also knew that it was looked on favourably by his superiors if his division used internal sources of materials where possible. As a consequence, he was disappointed to see that the Components Division bid was significantly higher than the Kayte bid. He was also surprised that the Components Division Manager decided to add the usual mark-up on out-of-pocket costs, when determining the transfer price.

Janek knew that sourcing the glass doors from the Components Division would afford his Division with certain advantages the other two suppliers may not be able to provide. In particular, as his division had spent a lot of time in consultation with the Components Division on the design of the glass doors, he was sure he would receive a high quality product. Furthermore he knew he could rely on the Components Division for quick delivery and service.

Despite this, Janek felt he had little choice, given that he was evaluated and rewarded primarily on his division’s profit performance. He felt obligated to accept the substantially lower bid submitted by Kayte Company.

Table 1Glass Division

Information relating to the transfer of glass sheets to the Components Division

Selling Price per sheet (based on current market prices) $55.00

Costs per Glass SheetSilica $13.00Other materials $5.00Conversion costs $4.50Fixed manufacturing cost allocation $3.00

Administration costs (70% variable) $10.00

Corporate head office allocation $7.00

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Table 2 Components Division

Costs (in addition to glass requirements) per Glass Door

Timber $30.00Other materials $12.00Conversion costs $20.50Fixed manufacturing cost allocation $7.00Administration costs (80% variable) $5.00Corporate head office allocation $12.00

REQUIRED:

1. Determine the appropriate sourcing decision for:

a) The Glass Sheets.

b) The Glass Doors.

2. Identify the factors that have caused transfer pricing to be an issue for the divisional managers of Robsen Company.

3. Determine the appropriateness of the current transfer prices used in the transfer of;a) Glass Sheets from the Glass Division to the Components Division;b) Glass Doors from the Components Division to the Furniture Division.

Within your discussion you should refer to the following; The behaviours that are likely to occur as a result of the current transfer

prices;

The impact of these behaviours on the company’s interests as a whole;

Whether you believe the attitudes of both Janek Khan and Jensen Samuels towards the current transfer price offered by the Components Division is reasonable.

4. Recommend alternative transfer pricing options for;i. Glass Sheetsii. Glass Doors

You must fully explain and justify each of your recommendations. You should refer to the following in your discussion;

The behaviours that are likely to occur as a result of the transfer prices you recommend;

The impact of these behaviours on the company’s interests as a whole.

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