Constance Cordovilla
BUAD 603
Managerial Accounting
April 13, 2006
Birch Paper Company
Question 1: In the controversy described, how, if at all, is the transfer-price system dysfunctional?
Birch Paper Company's Northern division is faced with a choice between three bids, internal and external, for an upcoming project. As a decentralized profit center, it appeared that accepting the lowest bid would be the most logical step; however, from the stance of the company the higher price from the internal division could also be the best solution. The bids submitted produced a number of possible perspectives and alternatives and it was up to the sectors to work together to promote congruence between the separate divisions and the company goals.
At first glance, Northern would typically accept the offer presented by West Paper based solely on the numbers. As seen in the calculations, West submitted the lowest bid at $430/thousand, Eire papers were a close second to West with a bid of $432/thousand, while Birch subsidiary Thompson submitted the highest bid of $480/thousand. Since each division at Birch is judged independently on the basis of profit and return on investment, selecting the bid from West allows Northern to out perform Southern and Thompson divisions. From the profit center mentality, the higher prices produce no incentives for Northern, even if another selection would be better for the overall firm, because it damages Northern's bottom line and subsequently their "status" within the company's view.
The $480 Thompson bid is actually in the best interest of the firm. It may seem counter-intuitive that the firm actually benefits by paying a higher price, but accepting the Thompson bid results in cost savings of $192 t ...