Contingency Theory Of Managements Accounting: Multinational Transfer Pricing And Airline Pricing Strategy

Multinational transfer pricing, global tax minimisation

Discuss about the Contingency Theory Of Managements Accounting.

Table 1: After-tax operating profit earned by the Australian and US Divisions of Derwent Limited

Despite the presence of various alternatives, it is noteworthy to mention that the transfer price, which minimises the overall import duties and income taxes of the organisation, would be either the market price of comparable exports or full manufacturing cost (Cooper, Ezzamel and Qu 2017). For instance, the first consideration that is made is to increase the transfer price by $1 each time by taking into account the full manufacturing cost of $800. Such consideration would change the expense per unit (Balakrishnan, Labro and Soderstrom 2014). The change per unit could be illustrated in the form of a table as follows:

Table 2: Change for each unit)

From the above table, it could be evaluated that the US tax is expected to increase by $0.35 per unit. The Australian import duty per unit would rise by $0.15 and decrease would be inherent in the Australian taxes by $0.46. The above changes would increase the import duty and tax payments amounting to $0.04 per unit (Warren, Reeve and Duchac 2015). For verifying this solution, the transfer price has been changed from $800 to $950, the effects of which are demonstrated briefly in the form of a table as follows:

Table 3: Net increase in import duty and tax payments per unit and decline in overall profit

The above table clearly inherits that the import duty and tax payments per unit have increased to $6. Across 10,000 units, decrease in total profits is inherent by $60,000. This corresponds precisely to the difference of $60,000 in the overall after-tax operating income evaluated in the first section. Hence, Derwent Limited would reduce income taxes and import duties by setting the transfer price at a minimal level of $800, which is the full manufacturing cost.

To,

The Directors of Eastcoast Airways,

Date: 15/05/2018

Subject: Airline pricing strategy

After evaluation of all the details obtained, it could be observed that Eastcoast Airways could expect to have 200 business travellers and 150 pleasure travellers, if the variable cost is $600. On the other hand, if the price is $1,350, it could expect to have 180 business travellers and 20 business travellers. For evaluating the two different pricing strategies in the context of Eastcoast Airways, the following calculations are made:

From the above table, it could be found that the variable cost per passenger is $65, if Eastcoast Airways charges a price of $600. This would lead to contribution margin of $535 to be received from each passenger. On the other hand, if the price charged from the passengers is $1,350, the variable cost per passenger would be $150. This would lead to contribution margin of $1,200 per passenger. However, contribution margins for two different types of passengers for the airline have been computed in this case. With the help of contribution margin, it is possible to identify the portion of revenue that the variable cost does not consume and thus, it contributes to the fixed cost coverage (Fullerton, Kennedy and Widener 2014). In addition, it is beneficial to ascertain the effects on profits of changes in sales.

Airline pricing

From the above table, it could be evaluated that Eastcoast Airways could maximise its contribution margin by charging $600 from each pleasure traveller and $1,350 from each business traveller. This is because the total contribution margin expected from the selling price per passenger for the business travellers is obtained as $216,000, if $1,350 is charged; which is greater than the contribution margin; in case, $600 is charged from each passenger (Kotas 2014).  In a similar manner, the total contribution margin from pleasure travellers if $650 is charged, would stand at $53,500, which is higher than the contribution margin of $24,000, if $1,350 is charged.

For determining between the alternate prices, the other costs like fuel costs, allocated yearly lease costs, allocated flight crew salaries and allocated ground services are consider irrelevant. This is because these costs would remain constant irrespective of the pricing strategy charged on the part of Eastcoast Airways (Lavia López and Hiebl 2014).

The concept of elasticity of demand could be used related to two segments of passengers, which drives the various demands of the travellers (Messner 2016). The business travellers are not price sensitive, as they need to arrive at their destinations in each week including the weekends and their companies incur all the costs of the flights. Hence, increase in fare from $600 to $1,350 would minimise only 20 business passengers from flying with Eastcoast Airways. On the contrary, this increase in fare would result in fall of pleasure travellers from 100 passengers to 20 passengers. This is because the pleasure travellers incur for their travels not like the business travellers. As a result, they might search for alternate vacation plans (Otley 2016).

The business travellers often intend to return within 7 days or less time, while the pleasure travellers prefer to stay in the weekends. Thus, it might include a night stay in Saturday in order to qualify for the $600 discount fare in the form of price discrimination. In this context, Subramaniam and Watson (2016) remarked that price discrimination is a pricing policy, which charges different prices for different customers for a particular product or service. The above price discrimination could be considered legal, since airlines are service organisations instead of manufacturing organisations. This is because such offers are not intended to eliminate competition from the marketplace (Warren and Jones 2018).

References:

Balakrishnan, R., Labro, E. and Soderstrom, N.S., 2014. Cost structure and sticky costs. Journal of management accounting research, 26(2), pp.91-116.

Cooper, D.J., Ezzamel, M. and Qu, S.Q., 2017. Popularizing a management accounting idea: The case of the balanced scorecard. Contemporary Accounting Research, 34(2), pp.991-1025.

Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2014. Lean manufacturing and firm performance: The incremental contribution of lean management accounting practices. Journal of Operations management, 32(7-8), pp.414-428.

Kotas, R., 2014. Management accounting for hotels and restaurants. Routledge.

Lavia López, O. and Hiebl, M.R., 2014. management accounting in small and medium-sized enterprises: current knowledge and avenues for further research. Journal of Management Accounting Research, 27(1), pp.81-119.

Messner, M., 2016. Does industry matter? How industry context shapes Management accounting practice. Management Accounting Research, 31, pp.103-111.

Otley, D., 2016. The contingency theory of management accounting and control: 1980–2014. Management accounting research, 31, pp.45-62.

Subramaniam, C. and Watson, M.W., 2016. Additional evidence on the sticky behavior of costs. In Advances in Management Accounting (pp. 275-305). Emerald Group Publishing Limited.

Warren, C.S. and Jones, J., 2018. Corporate financial accounting. Cengage Learning.

Warren, C.S., Reeve, J.M. and Duchac, J., 2015. Managerial accounting. Nelson Education.