Chapter 19 – Strategic Performance Measurement: Investment Centers
19–84
19–57 Transfer Pricing; Strategy (45–50 minutes)
1. At first glance, the overall strategy seems to be one of cost leadership,
due to the competitive conditions in the global market and the
competitive cost and price reductions referred to in the case. However,
there does not appear to be an important element of differentiation due
to quality or innovation within the industry. This is a medical products
company and it is reasonable to expect that customers will be looking for
reliability and functionality as key values of the products. Perhaps we
have here an example of the “confrontation” type of strategy as
described by Cooper (re: target costing in Chapter 13). Alternatively, we
might view the competition by product line. Some of the firm’s products
may be very commodity-like in nature, and cost/price competition is how
the firm has and will continue to be successful for these products. But for
other products, differentiation will continue to be the key success
strategy.
From a manufacturing standpoint, the firm is moving part of
manufacturing overseas to reduce overall product cost – taking
advantage of lower wage costs in some countries. This is very
consistent with the overall strategy, and makes sense given the
commodity-like nature of the firm’s products.
more of their health care needs. Also, a strategy to increase sales
worldwide would be more consistent with BLP’s competitive strategy of
cost leadership. Growth in sales will facilitate the economies of
production and distribution which are desirable in the cost-leadership
strategy.
Chapter 19 – Strategic Performance Measurement: Investment Centers
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19–57(continued)
2. The principal issue in this case is the manner in which transfer prices
are determined. A major objective of responsibility accounting systems,
and of transfer pricing, is to set in place the policies and procedures so
that managers will, acting in their own self-interest, also act in the best
interests of the firm. That is, top management has a hands-off policy
perceived fairness of the system. In particular, the lowering of transfer
prices to Jorge’s division is making it hard for him to meet profit targets
and compensation goals. There is also a potential ethical/legal concern
here in that transfer pricing practices may not be in compliance with
international laws and in addition, could violate the management
accountant’s ethical responsibility for integrity (see the IMA code of
ethics(Chapter1, and
http://www.imanet.org/resources_and_publications/ethics_center_helpli
ne.aspx).
Since the objectives of minimizing tariffs and autonomous transfer
pricing are in conflict in this case, BLP should consider which objective
is more important, and design a system around that objective. For
example, if the savings from tariffs are critical, as it seems they are from
the company’s actions, then Jorge’s division should be considered a
cost center rather than a profit center and be evaluated solely on
an application of “dual pricing.”The latter transfer price would not be
changed to reduce taxes or tariffs, but would reflect a market or
negotiated price.
Chapter 19 – Strategic Performance Measurement: Investment Centers
19–86
19–58 Strategic Performance Measurement; International; Strategy;
Service Industry (50-60 minutes)
This case is primarily concerned with the effect that changes in
exchange rates have on reported income. The effect can be illustrated
with a simple example. Assume that a British subsidiary had the
following results when recorded in pounds:
Sales 5,000,000 pounds
Expenses 4,000,000
Net Income 1,000,000 pounds
If the exchange rate at the end of the period was one pound = $2.33,
the income reported in the parent’s consolidated income statement
would be:
But if the exchange rate drops to one pound = $1.20, these results
would translate to:
Thus, if the subsidiary’s budget was set at one million pounds when the
exchange rate was one pound = $2.33, but the exchange rate turned
Chapter 19 – Strategic Performance Measurement: Investment Centers
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19–58 (continued-1)
FASB Statement 52 [FASB ASC 830 Foreign Currency Matters] calls for
two different types of consolidation for a foreign subsidiary into a parent’s
financial statements. If the foreign unit’s operations are relatively self–
contained and independent of the parent, as in the case of Security
Systems Corporation, the functional currency (the currency used to
translate the foreign financial data) is the currency of the foreign country. In
this example the functional currency is the British pound sterling. When
equity account in the firm’s consolidated balance sheet. These adjustments
do not affect the consolidated income statement.
Most accountants and managers would agree that a subsidiary’s
performance should be measured in terms of its local currency. Actual
results should be compared in local terms against the unit’s budget and
prior years’ performance. This point of view treats exchange rate
fluctuations as an uncontrollable factor. Others disagree. Others argue that
changes in exchange rates should alter the opportunities available to the
subsidiary (particularly if it sells some of its products to U.S. customers). In
Domestic shareholders, of course, want the firm to achieve or surpass the
EPS targets as expressed in U.S. dollars. Thus, management must attempt
to maintain its overall earnings target. One approach that management can
consider is currency hedging. Currency hedging is used to protect a firm
against foreign exchange losses. A limitation of hedging is that FASB
Statement 52 [FASB ASC 830 Foreign Currency Matters] requires that
hedging costs flow directly through the income statement.
Chapter 19 – Strategic Performance Measurement: Investment Centers
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19–58 (continued-2)
There are also opportunities to hedge by moving debt around from
country to country. Gains and losses from specific monetary transactions
flow through the income statement per GAAP regarding foreign currency
matters.
The firm recognized that it has responsibilities to both its stockholders and
its management. For its stockholders, the firm must measure its overall
their local currency targets, to adopt hedging, or whatever means under
their control to make up for any adverse changes in local exchange rates.
Chapter 19 – Strategic Performance Measurement: Investment Centers
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CHECK FIGURES
19–21 ROS: Division X = 10%; Division Y = 10%; Sales, Division Z =
$3,750,000; Income, Division Z = $18,750; Return on Investment
(ROI): Division X = 25.00%; Division Z = 0.75%
19–22 ROS: North Atlantic Division, 2.77%; Mid-Atlantic Division, 2.76%;
15–32 1. Net cost (Benefit) if Division A buys outside = $100,000. 2. Net
Cost (Benefit) if Division A buys outside = ($100,000). 3. Net Cost
(Benefit) if Division A buys outside = ($100,000).
19–90
15–33 Net Cost (Benefit) if Division A buys outside = ($550,000) (i.e.,
total cost savings to the firm would equal $550,000).
15–34 Effect on total (corporate-level) income tax expense = $65,000
19–37 2. ROIs: Year 1 = 6.67%; Year 2 = 22.00%; Year 3 = 72.80%. 3.
ROIs using Present-Value Depreciation: Year 1 = 20.00%; Year 2
= 20.00%; Year 3 = 20.00%. 4. Residual Income (RI): Year 1 =
$3,000; Year 2 = $2,400; Year 3 = $1,440. Estimated NPV of
19–39 No check figure available.
19–40 No check figure available.
19–41 No check figure available.
Chapter 19 – Strategic Performance Measurement: Investment Centers
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Customer Retention = 0.735. Sample regression results: ROI on
customer retention and QSV: R-squared statistic, 0.7063;
Standard Error of the Regression, 3.5155; Coefficient for
Customer Retention Variable = 0.5010; Coefficient for QSV
variable = 1.4750.
19–43 1. Contribution margin per unit = $10.39. 2a. ROI = 12.2%; 2b.
Residual Income (RI) $2,577,500.
division buy from Advanced Micro; the best transfer price is the
selling division’s market price: $205 per unit. 2. Unit cost to FMI =
$206.10; correct transfer price = $205 per unit.
19–53 2. Divisional Contribution Margins: Mining Division, $15,200,000;
Metals Division, $9,600,000. 3. Likely transfer price range:
between $85 and $90 per unit.
19–54 1. No effect (tax rates between countries are the same). 2. Tax
19–57 No check figure available.
19–58 No check figure available.