Financial Analysis: Transfer Pricing at Raven Industries

This report provides a comprehensive analysis of transfer pricing methods within Raven Industries, a manufacturing company with carpet, furniture, and cushion divisions. The assignment explores the impact of different transfer pricing approaches, including cost-based, market-based, and negotiated pricing, on departmental and overall company profitability. It evaluates the opinions of company authorities regarding transfer pricing strategies, assesses the benefits and drawbacks of each method, and recommends the contribution-based method for calculating transfer prices to maximize profit. The report includes a revised profit statement based on market prices and discusses challenges associated with the chosen method, such as performance evaluation issues. Ultimately, the analysis emphasizes the importance of selecting a transfer pricing method that improves the company's overall cost structure and profitability, especially for departments involved in internal transfers.

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By student name
Professor
Date: 19th May, 2019.
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Executive Summary
The following assignment is based on the raven industries manufacturing department
where the company is having three different departments’ carpets, furniture and cushions in
three different departments. The company is looking for different transfer pricing methods in
which they can get the maximum profit and improve the overall performance of the company.
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Contents
Introduction................................................................................................................................................4
Analysis......................................................................................................................................................4
Conclusion.................................................................................................................................................6
References................................................................................................................................................7
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Introduction
The company is having three different departments that manufacture three different products
carpet division, furniture division and cushion division. The cushion division is also transferring
products to the furniture division at variable cost. As per the authorities the cushion division is
much more profitable then what is presented by the authorities and the methods that are
adopted by the authorities. It is mentioned that when it comes to transferring the cushions to a
particular division it is done at a cost but when it comes to selling it to the outside market, the
company will sell it at a certain mark up price and thus the profit in this case would be more.
This will also affect the overall performance of the division when the company will see the year
end performance of the company (Elimam, 2017). So the concern of the authorities is that when
the company is seeing the division of the carpet department then that should be seen when the
carpets are sold at the market price to the departments within the company also. So in this
assignment we shall see how transfer pricing works and how companies fix these transfer
prices and what affect does it have on the overall profitability of the company.
Analysis
1. a) Robert Cleveland is of the opinion that the transfer from the cushion department to the
furniture division should be at the selling price rather than at cost in order to judge the
performance of the department. This is not correct, as we see that transfer pricing is
different from the prices at the company is offering to the customer, and thus transfer
prices is not a measurement to judge the performance of the division. The contribution
lost between the transfer of products from one department to another and not to the
market is to be taken into consideration while checking the overall performance of the
department (Heuvel & Wagelman, 2017).
b) Transfer pricing is a method based on which the company fixes prices between
various departments. There are different methods of fixing the transfer pricing, like cost
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based market prices, market-based transfer prices, resale price method, transactional
net margin method, negotiated price method among others. In the given case the
management should opt for negotiated price method, apart from cost method and sale
price method. In this case the division shall negotiate such a price with the buying
division that will help in reducing the overall loss to minimum and the company is able to
maintain the price that is more than the overall cost. This method will help in improving
the performance of the company and that is better than other two methods that are cost
plus method and sales method (Jennings, et al., 2012).
2) Based on the transfer prices that is based on the market prices, the revised profit statement
for the company has been given below-
Question 2
Statement of profitability for the overall company
Carpet Division Furniture Division Cushion Division
Overall output 30,00,000 30,00,000 45,00,000
COGS 20,00,000 13,00,000 30,00,000
GP 10,00,000 17,00,000 15,00,000
OP. Expenses
administrative 3,00,000 5,00,000 4,00,000
selling 6,00,000 6,00,000 5,00,000
profit from operations 1,00,000 6,00,000 6,00,000
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3) Based on the overall analysis that has been stated above it would be better if the company
opts for the contribution method for calculating the transfer pricing between different
departments. Transfer pricing is a method in which the company is transferring products from
one department to other but it should be profitable to the company in some way or the other.
When it comes to overall performance evaluation of the various departments of the company,
the management should opt for such methods as per which the overall loss is less when
compared to the sale of same products to the outside customer at a mark up price (Lubensky,
2017). Given the analysis the company should opt for a price that is fixed on the contribution
based price between the two departments. The overall benefits of the given method would be
that the contribution earned by the company would be such that contribution would include the
variable cost and the fixed cost and thus the cost element of the company would be covered if
we consider contribution as the price based on which the transfer is done between two
departments (Maynard, 2017). Now when we see the challenges that are there in case of using
this method, the major challenge would be that when it comes to performance evaluation the
company will suffer a lot. One of the other drawback is that it does not necessarily promotes the
supply division to be efficient when it comes to manufacturing practices. In fact it would be less
efficient when it comes to limiting things like the overall labour, material and overhead
variances. The internal management can get lazy when they are receiving cost over time but
that is not really competitive pricing (Pape, 2017).
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Conclusion
Based on the overall analysis it can be said that the management of the company should
choose such a method that would help in improving the overall profit of the management of the
company especially the division that is transferring goods from one department to other. In case
this department is supporting the other departments so it is important that we should see that
the performance of this department should be of prime focus of the company as they are not
just supporting their own performance but also supporting the performance of other departments
also. Thus that should be the focus that overall profitability is improved. This can be done by
chossing alternative methods that would help in improving the overall cost structure of the
company and that would imperatively help in increasing the overall profit of the company.
Transfer prices based on contribution based method will help in getting more profit than using
cost as the basis for transfer pricing.
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References
Elimam, H., 2017. The Role of Small Businesses (Small Scale Economic Projects) in Alleviating the Acuity
of Unemployment. International Business Research, 10(3).
Heuvel, W. & Wagelman, A., 2017. A note on “A multi-period profit maximizing model for retail supply
chain management”. European Journal of Operational Research, 260(2), pp. 625-630.
Jennings, J., Stoumbos, R. & Tanul, L., 2012. The Effect of Organizational Complexity on Earnings
Forecasting Behavior..
Lubensky, D., 2017. A model of recommended retail prices. The RAND Journal of Economics, 48(2), pp.
358-386.
Maynard, J., 2017. Financial Accounting, Reporting, and Analysis. SECOND ed. s.l.:Oxford University
Press.
Pape, T., 2017. Value of agreement in decision analysis: Concept, measures and application. Computers
& Operations Research, Volume 80, pp. 82-93.
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