The federal government vs. York County: a transfer pricing case for managerial accounting students.

Chambers, Valrie ; DiGregorio, Dean ; Royce, Abigail 等

CASE DESCRIPTION

The primary subject matter of this case concerns transfer pricing. Secondary issues examined include opportunity costs, sunk costs, the use of progressive levels of critical thinking skills, the application of classroom knowledge to real life situations, and effective communication skills. The case has a difficulty of level of two and is appropriate for sophomore-level students in managerial accounting classes. The case is designed to be taught in a 1.25 hour class and is expected to require 2.5 hours of outside preparation by students, preferably working in small groups. Alternatively, the case could be assigned as a project that requires minimal classroom time.

CASE SYNOPSIS

During their college experience, students are exposed to facts and theories in many different subject areas. By the time they graduate, students are expected to have developed critical thinking skills. They should be able to apply what was learned in the classroom to real life situations and be able to effectively communicate their analysis and conclusions. This case is derived from an actual situation occurring between the federal government and York County, Pennsylvania in 2003, as described on National Public Radio's Morning Edition. The case requires students to assume the role of a consultant to York County. They need to identify the conflict, consider relevant theories, analyze the situation from both parties perspectives, and suggest a reasonable solution to the conflict.

INSTRUCTORS' NOTES

Recommendations for Teaching Approaches

This case can be discussed in class and/or assigned as a project to be completed outside of class. The suggested student questions are designed to help students analyze the situation in a logical manner. A prior version of this case was administered to managerial accounting classes at a regional state university. Written responses to the student questions generally indicated that students working in groups of 2-3 earned higher grades than either individual students or those working in larger groups.

Students can be provided with the opportunity to improve their analytical and written communication skills by requiring that answers be turned in before class discussion. Discussing the case in class offers students the opportunity to improve their verbal communication skills and exposes them to alternative ways of analyzing the situation.

The student questions were formulated after considering the Issues-Theory-AnalysisConclusions (ITAC) model by Wolcott and Lynch (2002) which adapts critical thinking theory to business situations.

STUDENT QUESTIONS AND SUGGESTED SOLUTIONS

Observe the Situation and Identify the Conflict

1A. What is the primary dispute in this case?

INS wants to reduce what it pays York County to house detainees from $60 to $38 per person per day and York County does not want to accept the offer.

1B. Identify typical materials, labor and overhead costs that would be incurred by York County to house INS detainees?

Materials: food, medical supplies. Labor: guards, supervisors, translators, medical personnel. Prison facility overhead: Depreciation, interest, payments in lieu of real estate taxes, insurance, utilities, maintenance and repairs. Administrative overhead: administrative salaries, office salaries, professional fees, office supplies, telephone, utilities, depreciation of office furniture and equipment.

Consider Relevant Theories

2A. What managerial theories or concepts specifically relate to pricing decisions between somewhat related parties?

Transfer pricing, opportunity costs, sunk costs. Transfer pricing theory provides guidance to determine "a fair transfer price" when one division of an organization (in this case, the government) provides products or services to another related division of the same organization (Horngren, 2002: 397). Opportunity costs are the cost of a foregone benefit when choosing between mutually exclusive opportunities. Sunk costs are costs that have been incurred in the past.

2B. What is the general decision rule for the identified theories?

A transfer price should fall within a range. The buyer should not pay the seller more for the product or service than it would cost to buy the product or service from other providers. If a seller is at full capacity, it should not accept an amount less than it can obtain from other buyers. If the seller has excess capacity, it should not accept an amount less than the incremental costs of providing the additional products or services. Within the above range, relative bargaining power and skill will determine how the profit will be divided. The upper and lower price levels represent opportunity costs. Sunk cost are irrelevant in future decisions.

Analyze the Situation from Both Parties Perspectives

3A. What motives might INS officials have to renegotiate the daily cost to house INS detainees?

The officials might be acting for personal gain or to meet the agency's needs. For example, individual officials might be trying to make themselves look good in order to get a promotion. Alternatively, INS may be facing budget cuts or have written guidelines that do not optimize behavior in this particular situation.

3B. Should York County automatically assume that INS wants to reach an agreement with them?

No. INS may want to centralize its operations and close smaller or more distant locations. There is also the possibility that the prisoners are being moved to another state or location in order to pump federal funds into that area and reward prior political support.

3C. If York County refuses to renegotiate the daily rate to house detainees for INS, what four main options does the federal government have?

The federal government can either accept the $60 per day rate, move some or all of the inmates to another facility, release the inmates, or leave them in the York County prison and refuse to pay the higher rate.

3D. If York County refuses to renegotiate the daily rate to house detainees for INS, what additional costs and benefits would be incurred by the federal government under each of its four main options?

If the federal government pays the $60 rate it will maintain the status quo. If the federal government moves some or all of the detainees, then it will incur moving costs and will likely have to pay higher daily housing fees per detainee at alternative facilities. There are no financial benefits to INS for making the move unless it is made for political reasons.

If the federal government releases the prisoners (as is sometimes done when jails become overcrowded), it will save the cost of holding the prisoners but will likely incur social costs due to increased crime and bad publicity.

If the federal government leaves the detainees in the York County prison and only pays the lower rate, it will put York County in the position of having to file a lawsuit or go to arbitration in order to collect the difference. This can result in future legal fees, bad publicity, and an inability to move additional prisoners to that facility.

3E. If the INS officials choose to act in an apparently irrational or unfair manner, what can the York County officials do about it?

York County officials can complain to their senators and representatives and have them apply political pressure at the federal level. They can also leak the story to the press. Either of these actions could be effective if the INS officials were intending to move the prisoners for personal or political reasons.

3F. If York County refuses to renegotiate the daily rate to house detainees for INS, how will each of the federal government's four main options affect York County?

If the federal government accepts the $60 per day rate to house detainees, then the status quo will be maintained and there should be little or no change in York County's revenues or expenses.

If INS moves some or all of the inmates to another facility, then York county revenues will fall by $60 per day for up to 550 current detainees. Some expenses will also decline. If the INS wing of the prison is empty, then expenses for food, medical care, guards, supervisors, translators, utilities, maintenance and repairs should decline proportionately. However, as the prison is also used for detaining other inmates, it is likely that there will be little change in the overhead related to the rest of the prison facility or the administrative overhead costs.

If INS releases the detainees, then revenues will decline as discussed above where INS moves all of the detainees. If the detainees stay out of trouble, the expenses will also change as discussed above. However, if the detainees get in trouble with local law enforcement departments, then it is likely that they will wind up back in the York County prison and the county will lose the revenues but will not be able to cut costs.

If the INS leaves the detainees in the York County prison and refuses to pay the higher rate, then York County will be put in the position of having to file a lawsuit or go to arbitration in order to collect the difference. This could take years and cost a lot of money to fight. If York County retaliates by releasing the prisoners, they will get the bad publicity and have the same problems as if INS released the prisoners.

If York County loses the INS prison revenues, there will be less money available to make payments in lieu of taxes to support local governments. There will also be increased local unemployment and reduced local spending. This could have a material negative effect on the local economies.

3G. If the INS does leave the prison, what alternatives does York County have regarding the prison?

York County can look for alternative sources of revenue. For example, it could contact other county or state prisons that are overcrowded and offer to house inmates for a fee. York County could also investigate the possibility of converting the facility to another use.

3H. If York County accepts the $38 per day per detainee offer by INS, what effect will this decision have on York County's expected revenues and expenses.

York County's revenues will drop by $22 per day, per detainee for 550 current detainees. Expense should not change unless York county reduces its level of security.

3I. If York County chooses to negotiate a new rate somewhere between the current rate and the INS desired rate, which costs identified in question 1B must be considered and which can be ignored to determine the lowest acceptable rate to charge INS?

York County must consider the incremental direct and controllable costs that relate directly to the INS detainees. These would include: 1) materials: food, medical supplies; 2) labor: guards, supervisors, translators, medical personnel; 3) and some of the prison facility overhead: additional insurance, utilities, maintenance and repairs.

The prison facility overhead related to depreciation and interest expense are in effect sunk costs. They will not change whether or not INS abandons the York County facility. Payments in lieu of real estate taxes are voluntary payments to local governments and can be terminated if necessary. In addition, the prison wing is over 20 years old and is probably close to fully depreciated and any related debt should be close to being paid off.

Most of the administrative overhead can be excluded from determining the lowest acceptable detainee rate. Administrative salaries, office salaries, professional fees, office supplies, telephone, utilities, and depreciation of office furniture and equipment are necessary to run the non-INS portion of the prison and will probably continue with little change.

Any amounts negotiated in excess of the incremental direct and controllable costs can be used to offset the overhead. In addition, if the prison operates at a higher occupancy rate, then the overhead rates will be less per detainee.

Choose a Course of Action and Justify Your Decision

4A. As a consultant, what do you suggest that York County do? Please explain your conclusions and limit your response to no more than three (3) paragraphs.

I would suggest a two pronged approach. First, I would test the resolve of the INS administrators to move the prisoners and ask my senators and representatives to apply political pressure to maintain the $60 per day per detainee rate. I would also make sure the press knew what is going on.

If I determined that the INS was very serious about moving the prisoners, then I would offer to negotiate a new rate. Ideally, the County and INS would divide the overhead in a mutually advantageous fashion. For example, reduce the $60 rate by no more than half of the overhead included in the rate. Both sides could still feel like they won something if they "split the difference."

EPILOGUE

Subsequent to the story's airing on NPR, the contract dispute caused the number of detainees to temporarily decrease. However, an agreement was eventually reached between the federal government and York County for $47.41 per detainee per day. The prison as of this writing was at capacity. The parties "split the difference" and increased utilization, which helped make up for the lower overhead rate.

REFERENCES

National Public Radio (2003). Morning Edition: INS may soon move detainees from York County Prison in Pennsylvania because officials in Washington say York County is charging too much to house the detainees. Retrieved from www.npr.org/programs/morning/3/3/03. Currently at http://www.npr.org/templates/story/story.php?storyId=1180617.

Valrie Chambers, Texas A & M University-Corpus Christi

Dean DiGregorio, Southeastern Louisiana University

Abigail Royce, Texas A & M University-Corpus Christi