Case Study – Birch Paper Company

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  • Topic: Transfer pricing, Costs, Price
  • Pages : 8 (2789 words )
  • Download(s) : 399
  • Published : October 8, 2008
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Company Background
Birch Paper Company was a medium-sized, partly integrated paper company. It had four producing divisions, namely Northern Division, Thompson Division, Southern Division & one unnamed Division and a Timberland Division. Birch Paper was producing white and kraft papers and paperboard. A portion of its paperboard output was converted into corrugated boxes by the Thompson Division, which was also printed and colored the outside surface of the boxes.

Company policies
The management implemented a policy of decentralizing responsibility and authority for all divisions except those relating to overall company policy. Each division was judged independently on the basis of its profit and return on investment.

Present situation
Thompson division had provided services including package design and development on a special display box to Northern Division. Under the agreement, Thompson Division was reimbursed by the Northern Division for the cost of its design and development work, Thompson Division did not receive any profit on this project. Once all the specifications are ready, the Northern Division asked for bids on the box from the Thompson Division and from two outside companies.

Northern Division received the 3 bids as follows:
Bid No 1 – West Paper Company
The Northern Division received bid on the boxes of $430 a thousand from West Paper Company. Bid No 2 - Thompson Division
The bid offered from Thompson Division was S$480 a thousand of boxes. If Thompson Division got the order, it would buy its linerboard and corrugating medium from the Southern Division of Birch. About 70% of Thompson’s out of pocket cost of S$400 for the order represented the cost of linerboard and corrugating medium. Although Southern Division was running below capacity and had excess inventory, it quoted the market price, and it’s out of pocket cost on both liner and corrugating medium were about 60% of the selling price. Mr. Brunner, the manager of Thompson Division felt that he should be entitled to a good mark up on the production as Thompson had done the design and development work for Northern Division without any profit, he add the full 20% overhead and profit charge to his out-of-pocket costs. Bid No 3 – Eire Papers Company

The Northern Division received bid on the boxes of $432 a thousand from Eire Papers Company. If Eire Papers Company got the order, it would offer to buy from Birch the outside linerboard with the special printing already on it. The outsider liner would be supplied by the Southern Division at a price equivalent of $90 a thousand boxes, and it would be printed for $30 a thousand by the Thompson Division. Of the $30, about $25 would be out-of-pocket costs.

QUESTIONS

1.Which bid should Northern Division accept that is in the best interests of Birch Paper Company? 2. Should Mr. Kenton, the manager of Northern Division accept this bid? Why or why not? 3. Should the vice president of Birch Paper Company take any action? 4. In the controversy described, how, if at all, is the transfer price system dysfunctional? Does this problem call for some change, or changes, in the transfer pricing policy of the overall firm? If so, what specific changes do you suggest?

Q1) Which bid should Northern Division accept that is the best interest of Birch Paper Company?

If we only based on the bidding price from the 3 companies, the cost to Northern Division if it accepts the bid from Thompson, Eire Papers and West Papers are $480, S$432 and $430 respectively. On the first glance, Northern Division should accept the bid from West Papers as it is the lowest bid to Birch Paper Company.

Q2) Should Mr. Kenton accept this bid? Why or why not?
Our group thinks that Mr Kenton should make a thorough study on cost effectiveness of all transactions for every...
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