This case study is about Timken Cooperation. The cooperation is the worldwide producer of anti-fiction bearings and steel. The company organized its business into three strategic business units such as Automotive Bearings, Industrial Bearings and Steel. The company used to sell variety of steels products to outside customers as well as supply to other two division of the company. Timken Cooperation is the public limited company and it was publicized in 1922.
Q1). The Automotive Division of Timken expressed concern that the transfer pricing policy for steel transfers did not allow the automotive division to exercise its considerable market power as a purchaser of bearings quality steel. Do you think their concerns were valid?
First of all, in order to answer this question it is necessary to understand the concept of transfer pricing policy.
Transfer Pricing Policy
Transfer pricing means the value or prices at which the transactions take place amongst related parties. It is a price at which an enterprise transfers physical goods and intangible property and provided services to associated enterprise. Transfer price gain significance because these can be used by the controlling party to their advantage to minimize tax incidence. It is observed that approximately 60% of the total transactions across the world are between related parties. If the transactions are across different tax jurisdictions, where tax rates are different, therefore, shifting is beneficial.
Transfer pricing policy of automotive division
The Automotive division of the company is the major supplier of roller bearings to automobile manufactures in all over the world. The flagship products of the company are Tapered roller. Each of the bearing consists of four principle components which include a cup, a cone roller and a cage. The major raw material of the automobile business basically relied on steel bar and seamless tubing; these are the major raw material components in the manufacturing bearings. The business manufactures large diameter bearing from seamless steel tubes whereas small diameter bearing from steel bars. Steel bar depends upon two factors that have relative cost advantages. First factor is the lower raw material cost of bar steel and other factor is less material scrap in connection of forgoing steel part (Appendix 1 &2).
Automotive business gets the market-based transfer prices as its description is based on the company’s statement on “Internal Controls and Company procedures”. The transfer policy for the automotive business should be reconsidered and the concern of the transfer pricing policy for steel transfers did not allow the automotive division to exercise its considerable market power as a purchaser of bearing quality steel. Their concern is valid because its past and current performance is not well enough as compared to the market and due to this the cost of the product increased.
It is assured that the automotive division uses its market power as a purchaser and purchases the raw material in low cost, however, the parent company will not allow to purchase from the market, therefore, the overall concern of them is invalid whereas Steel division should consider the negotiated transfer price.
Q2). Comment on the usefulness of the “Minimum Rule.”
Minimum rule means that the division gets the material in minimum quota price which is comparatively low from the market. The firm needs to be cognizant of the behavioral issues related to negotiated transfer prices and manager performance evaluation based on transfer prices. As it was stated earlier, that if the transfer prices were higher than the market price, then buying division would not purchase. If the transfer price is lower than the market price, then the selling division will not sell. If it is in the interest of the firm for the transfer to take place, the reward system must be structured so that the transfer takes place.
The usefulness of minimum rule is that if the steel division sends the raw material in minimum price, therefore, will increase the performance of the management of automotive division. In this case study, the company adopted a minimum rule. As the company used the minimum prices among all candidates, therefore, transaction prices came from both the factors such as sale of Timken Steel to the outside customers and from transaction prices between unrelated parties. The minimum rule if applied for the automotive department of the business would increase the revenue of the division. The revenue of the division would be increased because of low cost, as the cost incurred to material decreases from the steel department, therefore, it would also increase the earnings before interest and tax which would increase the value which comes from the performance measurement formula of the company. The formula suggested that in order to evaluate the performance of the manager of the company EBIT should be divided by the basic invested capital. By adopting the minimum rule, the performance of the division would become better. However, overall the company’s profitability would remain the same as it would increase the profit of division, however, the parent company would decrease its profit which would balance the minimum rule effect.
- Examine the margins of both the cone assembly C-400 and the cup CU-260 (Exhibits 9 and 10). Provide an estimate of the relevant cost of manufacturing these cups and cones both from the perspective of the automotive division and from the corporate perspective.
Analysis of C-400
The analysis of C-400 shows that the average sales price of the product is $2, whereas, raw material-steel and cage are the variable cost incurred in the production. Moreover, the fixed costs incurred in the product are green operations cost, Heat treatment & finish cost and rollers. The fixed cost associated with the product is irrelevant cost of production; whereas, variable cost associated to the production is a relevant cost.
Analysis of CU-260
The analysis of CU-260 shows that average sales price of the product is $1, whereas, raw material is the variable cost incurred in the production. Moreover, the fixed costs incurred in the product are green operations-costs and heat treat and finishing costs. The fixed cost associated with the product is an irrelevant cost of production; whereas, variable costs associated to the production are relevant costs.
Automotive division perspective
The automotive perspective of the company is that the cost associated with the product should be relevant while selling gross margin should be eliminated. In this case study (exhibit 9), all cost associated with the company are relevant according to the company’s perspective the relevant cost are variable and fixed cost. As well as estimated price calculated with automotive division perspective is shown in appendix 3 and 4 of both the products. On the other hand, the analysis shows that the automotive perspective states that the relevant cost is the variable cost only………
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