Medoc Company
Introduction
Medoc Company is faced with some problems in its transfer pricing policy between 2 of its 15 investment centres within the firm, namely the Milling Division and the Consumer Products Division. The transfer price set by the firm actually created some friction between these 2 divisions. Dealing with warehousing, shipping, billing, advertising and other sales promotion efforts for the consumer products and a fraction of the flour produced by the Milling Division, the Consumer Products Division complained that it was charged an inappropriate cost for all the items transferred from the Milling Division and thus it had little motivation to pursue more aggressive marketing efforts given that it had to do it at the expense of reducing its own average profit margin. And there are still several other complaints from the Consumer Products Division in relation to this as well. The transfer price charged to the Consumer Products Division was based on the full cost approach where every unit was charged at actual cost including material, labour, variable overhead and non-variable overhead with an additional charge of 75 percent of the investment in Milling Division. This caused three main identifiable problems: Managers’ goals are not aligned with the company’s goal as the cost behaviour is altered after transferring to the Consumer Products Division. Consumer Products Division's is charged 75 percent of investment of Milling Division despite the fact that they had no control over Milling Division. The inefficiencies of the Milling Division could be passed on to the Consumer Products Division through the transfer prices charging at actual cost. To solve these problems, the firm had examined different transfer pricing approaches but it was hard to decide on which method to use due to the different compositions of the products and the market price of is not readily available and could not be measured accurately. Also, the
Medoc Company is faced with some problems in its transfer pricing policy between 2 of its 15 investment centres within the firm, namely the Milling Division and the Consumer Products Division. The transfer price set by the firm actually created some friction between these 2 divisions. Dealing with warehousing, shipping, billing, advertising and other sales promotion efforts for the consumer products and a fraction of the flour produced by the Milling Division, the Consumer Products Division complained that it was charged an inappropriate cost for all the items transferred from the Milling Division and thus it had little motivation to pursue more aggressive marketing efforts given that it had to do it at the expense of reducing its own average profit margin. And there are still several other complaints from the Consumer Products Division in relation to this as well. The transfer price charged to the Consumer Products Division was based on the full cost approach where every unit was charged at actual cost including material, labour, variable overhead and non-variable overhead with an additional charge of 75 percent of the investment in Milling Division. This caused three main identifiable problems: Managers’ goals are not aligned with the company’s goal as the cost behaviour is altered after transferring to the Consumer Products Division. Consumer Products Division's is charged 75 percent of investment of Milling Division despite the fact that they had no control over Milling Division. The inefficiencies of the Milling Division could be passed on to the Consumer Products Division through the transfer prices charging at actual cost. To solve these problems, the firm had examined different transfer pricing approaches but it was hard to decide on which method to use due to the different compositions of the products and the market price of is not readily available and could not be measured accurately. Also, the