Question

Control, Decision Making, and Reporting

Control is a key issue for international companies, and the approaches used for decision making and reporting can have important implications for the effectiveness of strategy implementation and the extent to which performance goals are achieved.

Successful organizations must use controls to put their plans into effect, evaluate their effectiveness, make desirable corrections, and evaluate and reward or correct executive performance. The challenges of exercising effective control are more complicated for an international company than for a company operating in a single nation. This exercise examines issues associated with control, decision making, and reporting in an international company, including an examination of causes of subsidiary detriment and subsidiary frustration. The exercise uses an example of transfer pricing issues to illustrate key concepts.

Read the case below and answer the questions that follow.

Global, Inc., has received an order for 1000 widgets, with a total order value of $100 million, to be delivered to a customer in country Beta. The order was generated by Global's subsidiary in country Beta, called Global-B. Global-A, which is Global's subsidiary in country Alpha, produces the widgets and ships them to Global-B. Assume that there are no transportation or other expenses associated with moving widgets from Global-A to Global-B.

Global-A incurs direct costs of $50 million for producing 1000 widgets and there are no other variable costs associated with producing and delivering these 1000 widgets to Global-B. Global-B incurs $10 million in costs associated with marketing, sales, and support of this order, and has no other variable costs attributable to this order except the amount that they pay Global-A for the widgets. Country Alpha has a corporate income tax rate of 30 percent, and country Beta has a rate of 40 percent.

References

6.

If Global-A prices widgets at a special price of cost plus 20 percent, or $60 million for the entire order that it sells to Global-B, then what will be the after-tax level of profits for Global-A and for Global-B? Please show how you calculated this amount.

7.

Global-A suggests that its selling price to Global-B should be cost plus 40 percent, which is the same price level it used for a shipment of widgets to another company. What will be the implications for Global-A and Global-B if this change is made, in terms of taxes paid and after-tax profit? Please show how you calculated this.

8.

If the internal transfer price charged by Global-A is changed from cost plus 20 percent to cost plus 40 percent, what will be the implications for subsidiary Global-B?

Answer 1

6. Total COst for Global A is $50 million and the total sale price is $60 million. Thus the Profit is $10million. Thus tax payable is $3million and after tax, profit is $7million.

Total COst for Global B is $70 million ($60M+$10M) total sale price is $100M thus profit is $30M and total tax payable is $12M after-tax profit is $18M.

Total After-tax profit is $25M

7. Total COst for Global A is $50 million and the total sale price is $70 million. Thus the Profit is $20million. Thus tax payable is $6 million and after tax, profit is $14million.

Total COst for Global B is $80 million ($70M+$10M) total sale price is $100M thus profit is $20M and total tax payable is $8M after-tax profit is $12M.

Total After-tax profit is $26M. Thus profit increased.

8. Due to such change in the arrangement Profit after tax of Global B will decrease by $6M but the profit of the company will increase by $1M.