A Canadian corporation has several divisions. Division Abroad (DA) is located outside Canada, and it produces units of product Q321, which are imported into Canada by Division Canada (DC).

All DC products are sold in the Canadian market. DC sells other products in addition to Q321.

Paul Querbes is the director of DC. He is examining the financial statements, especially the profit and loss statement of his division. He is concerned that the profits are low again this year and that he may not be able meet the threshold to get his annual bonus. The bonus of the division is based on return on investment (ROI). If ROI is above 12%, the manager receives a bonus.

One major concern for Paul is the corporation’s transfer pricing policy. The transfer price for product Q321 is determined by the taxation department at the head office. The department has the mandate to minimize income tax. DA is located in a country where income tax rates for corporations are much lower than in Canada. Paul believes that the price of Q321 is too high and that it affects the profitability of his division. Almost 40% of DC’s sales come fromQ321, and this should remain the same for the coming year. What makes the situation difficult for Paul when dealing with this transfer pricing problem is that there is no market price abroad for the products.

DA can produce 3,000 units of Q321. It is now producing 2,500 units and sells all its production to DC for $250 per unit.

The costs for this production are the following:

Material. $90
Direct labour $45

Variable overhead $35

Fixed overhead $55

Total $ 225

DC sells Q321 on the Canadian market at a price of $300 per unit after incurring packaging costs of $10 per unit.

DC made $350,000 in profit last year. DC’s net operating assets are $3,500,000.

Required

Provide Paul with a recommendation regarding DC’s transfer pricing policy, performance evaluation system, and compensation scheme.

Use the following case analysis format and section headings to address the requirements listed within each section:

1. Problems and issues: Identify and discuss issues with the company’s transfer pricing policy, performance evaluation method, and compensation scheme.

2. Data analysis: Compute the return on investment for DC using the amount of net operating assets in the context of the present transfer pricing policy. Determine the minimum transfer price for DA and the maximum transfer price for DC. How should the transfer price change in order for Paul to earn the bonus?

3. Alternatives: Identify three alternative transfer pricing policies that could be used by the corporation and the consequences of these choices.

4. Criteria: Identify the criteria that should be used when selecting a transfer pricing policy based on return on investment.

5. Analysis of alternatives and recommendation: Using the criteria developed in part (d), analyze the alternatives identified in part (c) and make your recommendations.

6. Identify factors that may affect the business when production is outsources abroad (risk analysis)

   (risk analysis).

Answer rating: 100% (QA)

The measurement of DCs performance is directly influenced by its transfer pricing strategy Because sales of product Q321 account for 40 of DCs income ... View the full answer