In: Accounting
Automotive Bearing Systems Inc. (ABS), with headquarters in Aurora, ON, manufactures bearing systems that are sold to various car assembler plants. ABS has three divisions, each of which is located in a different country:
a. Argentinean Division—has the foundry and produces the different parts.
b. Brazilian Division—assembles the bearings, using the parts produced in the Argentinean Division.
c. Canadian Division—packages and distributes on a just in time schedule to all Canadian car assemblers plants of Honda and Ford.
Each division is run as a profit centre. The costs for the work done in each division that are associated with a box of bearings are as follows:
Argentine Division |
Variable costs = 150 Pesos |
Fixed costs = 270 Pesos |
|
Brazilian Division |
Variable costs = 90 Reales |
Fixed costs = 150 Reales |
|
Canadian Division |
Variable costs = 25 CAD |
Fixed costs = 50 CAD |
|
Argentinean income tax rate on Argentine Division’s operating income 35% |
|
Brazilian income tax rate on Brazilian Division’s operating income 25% |
|
Canadian income tax rate on Canadian Division’s operating income 30% |
Each box of bearings is sold to car assemblers in Canada for $700. Assume that the current foreign exchange rates are:
1.67 Real = $1 Cdn.
3 Pesos = $1 Cdn.
Both the Argentinean and Brazilian Divisions sell part of their production under a private label. The Argentinean Division sells the bearing parts to an Argentine bearing manufacturer for 600 pesos. The Brazilian division sells the finished bearings to a Brazilian car assembler 585 Reales.
Required
1. Calculate the after-tax operating income per unit earned by each division under each of the following transfer pricing methods: (a) market price, (b) 150% of full costs, and (c) 300% of variable costs. (Income taxes are not included in the computation of the cost-based transfer prices.)
2. Which transfer pricing method(s) will maximize the net income of ABS, Inc.?
Statements showing calculating the Transfer price and profit margin of each division |
Particulars | Argentinean Division | Brazilian Division | Canadian Division |
Variable cost | 150 Pesos | 90 Reales | 25 CAD |
Fixed Cost | 270 Pesos | 150 Reales | 50 CAD |
Total Cost | 420 Pesos | 240 Reales | 75 CAD |
Exchange rate | 3 pesos for 1 CAD | 1.67 reales for 1 CAD | NA |
Variable cost(CAD) | 50 | 53.89 | 25 |
Fixed Cost(CAD) | 90 | 91.62 | 50 |
Total Cost(CAD) | 140 | 145.51 | 75 |
Method-1( Market price) | ||||
Particulars | Argentinean Division | Brazilian Division | Canadian Division | Total |
Variable cost(CAD) | 50 | 53.89 | 25.00 | |
Fixed Cost(CAD) | 90 | 91.62 | 50.00 | |
Sub Total Cost(CAD) | 140 | 145.51 | 75.00 | |
Transfer price( market price)(CAD) | 0 | 200.00 | 350.30 | |
Total Cost(CAD) | 140 | 345.51 | 425.30 | |
Sales price(SP) | 200 | 350.30 | 700.00 | |
Tax rates | 35% | 0.25 | 0.30 | |
Profit before tax(SP-TC) | 60 | 4.79 | 274.70 | 339.49 |
Profit after Tax(PBT*(1-Tax rate)) | 39 | 3.59 | 192.29 | 234.88 |
Method 2(150% of full cost) | ||||
Particulars | Argentinean Division | Brazilian Division | Canadian Division | Total |
Variable cost(CAD) | 50 | 53.89 | 25.00 | |
Fixed Cost(CAD) | 90 | 91.62 | 50.00 | |
Sub Total Cost(CAD) | 140 | 145.51 | 75.00 | |
Transfer price( 150% of Total cost)(CAD) | 0 | 210.00 | 533.26 | |
Total Cost(CAD) | 140 | 355.51 | 608.26 | |
Sales price(SP) | 210 | 533.26 | 700.00 | |
Tax rates | 35% | 25% | 30% | |
Profit before tax(SP-TC) | 70 | 177.75 | 91.74 | 339.49 |
Profit after Tax(PBT*(1-Tax rate)) | 45.5 | 133.32 | 64.22 | 243.03 |
Method 2(300% of Variable cost) | ||||
Particulars | Argentinean Division | Brazilian Division | Canadian Division | Total |
Variable cost(CAD) | 50 | 53.89 | 25.00 | |
Fixed Cost(CAD) | 90 | 91.62 | 50.00 | |
Sub Total Cost(CAD) | 140 | 145.51 | 75.00 | |
Transfer price( 300% of variable cost)(CAD) | 0 | 150.00 | 161.68 | |
Total Cost(CAD) | 140 | 295.51 | 236.68 | |
Sales price(SP) | 150 | 161.68 | 700.00 | |
Tax rates | 35% | 25% | 30% | |
Profit before tax(SP-TC) | 10 | -133.83 | 463.32 | 339.49 |
Profit after Tax(PBT*(1-Tax rate)) | 6.5 | -100.37 | 324.33 | 230.45 |
2). Profit after tax will be maximum in case of Second method i.e., $ 243.03 |