MKS and IKS Production Cost of Production

Oct 13, 2025 by recoveryshake.com 0 views

Application of Transfer Prices to Improve Division Performance at PT. Sumber Sawit Makmur Medan

Introduction

In today's competitive business landscape, companies are constantly seeking ways to maximize their profits and achieve their goals. One effective way to achieve this is by evaluating the performance of each division within the company. Division performance appraisal is crucial in ensuring that each segment works together synergistically to achieve the company's objectives. However, determining the transfer price between divisions can be a complex task, and if not done correctly, it can lead to distortion in the performance appraisal of each division.

The Importance of Division Performance Appraisal

Division performance appraisal is essential in maximizing company profit. When each division has a clear understanding of its role and contribution to the company's goals, they are more likely to work together to achieve these objectives. This is known as goal congruence. By evaluating the performance of each division, companies can identify areas of improvement and provide incentives to divisions that are performing well. This can lead to increased productivity, efficiency, and ultimately, higher profits.

The Problem with Determining Transfer Prices

PT. Sumber Sawit Makmur Medan, a leading company in the palm oil industry, has two main divisions: the garden division and the factory division. The garden division is responsible for producing oil palm (FFB), while the factory division processes FFB into palm oil (MKS) and the Palm Oil Core (IKS). However, determining the transfer price between these divisions using the cost of production of FFB can lead to distortion in the performance appraisal of each division. This is because the cost of production of FFB may not accurately reflect the true value of the raw materials being transferred.

Research Objectives

This research aims to:

Analyze the cost elements in assessing division performance.
Apply the method of determining transfer prices between divisions.
Identify the effect of the profit of each division before and after the application of the transfer price.

Research Methods

This study uses a case study approach with descriptive methods. The data used came from the company's financial statements in 1998 and reports per division. As a sample, this study took data from one garden unit (Tador Sea) from five existing garden units.

This study uses the contribution margin approach method to measure division performance. This method calculates profits based on the ability of divisions to generate profits after calculating variable costs.

To identify fixed and variable costs, the Least Squares Regression and The High-Low Method method is used. The Least Squares Method method was chosen because it uses all available data, making it more objective.

Results and Discussion

The results showed that the application of transfer prices based on market prices caused several significant changes:

MKS and IKS Production Cost of Production: The production cost of MKS and IKS increased after the application of transfer prices.
Margin Contribution: The factory division contribution margin decreased, while the margin of contribution of the garden division increased.
Selling Target: The selling target to cover the fixed cost of the factory division increased, while the target of selling the garden division declined.

Before applying the transfer price, raw materials were transferred with the production price of FFB of Rp153.67 per kg. After applying the transfer price, the price of raw materials increased to Rp 548.93 per kg.

This study uses the transfer price method based on market prices because it is considered more objective and generally accepted on the market.

Conclusions and Suggestions

Based on the analysis and discussion, this research concluded that:

The application of the transfer price results in a shift in profit. Before applying the transfer price, the factory division contributed the biggest profit. After applying the transfer price, the garden division contributed the biggest profit.
Performance appraisal is very important to create a common goal in maximizing company profit.
Application of transfer prices between the garden division and the factory division can increase the objectivity of performance appraisal.

Here are some suggestions to increase the effectiveness of the application of transfer prices:

Review the allocation of calculation of the cost of MKS and IKS production as a joint product.
Carefully identify the activities that occur at each cost that will be allocated to identify the cost driver that is really related to these costs.
Regularly review and update the transfer price to ensure that it remains relevant and accurate.

Conclusion

This study shows that the application of transfer prices can be an effective tool to increase the objectivity of division performance appraisal and create a common goal in maximizing company profit. However, further review and analysis need to be conducted to ensure that the application of transfer prices is in accordance with the conditions and needs of the company.

Recommendations for Future Research

Future research can build on this study by:

Conducting a more comprehensive analysis of the cost elements in assessing division performance.
Exploring the use of other transfer price methods, such as the cost-plus method or the market-based method.
Investigating the impact of transfer prices on the performance of other divisions within the company.

By continuing to research and refine the application of transfer prices, companies can ensure that their division performance appraisal is accurate, objective, and effective in achieving their goals.
Frequently Asked Questions (FAQs) about Transfer Prices and Division Performance Appraisal

Q: What is a transfer price?

A: A transfer price is the price at which one division of a company sells a product or service to another division within the same company. Transfer prices are used to allocate costs and revenues between divisions and to determine the profitability of each division.

Q: Why is it important to determine transfer prices accurately?

A: Accurate transfer prices are essential to ensure that each division is evaluated fairly and that the company's overall performance is accurately reflected. If transfer prices are not determined correctly, it can lead to distortion in the performance appraisal of each division, which can have negative consequences for the company.

Q: What are the different methods of determining transfer prices?

A: There are several methods of determining transfer prices, including:

Cost-plus method: This method involves adding a markup to the cost of production to determine the transfer price.
Market-based method: This method involves setting the transfer price based on the market price of the product or service.
Contribution margin method: This method involves setting the transfer price based on the contribution margin of the product or service.

Q: What is the contribution margin method?

A: The contribution margin method involves setting the transfer price based on the contribution margin of the product or service. The contribution margin is the difference between the selling price and the variable costs of producing the product or service.

Q: How does the application of transfer prices affect division performance appraisal?

A: The application of transfer prices can have a significant impact on division performance appraisal. By accurately allocating costs and revenues between divisions, transfer prices can help to ensure that each division is evaluated fairly and that the company's overall performance is accurately reflected.

Q: What are the benefits of using transfer prices in division performance appraisal?

A: The benefits of using transfer prices in division performance appraisal include:

Improved accuracy: Transfer prices can help to ensure that each division is evaluated fairly and that the company's overall performance is accurately reflected.
Increased objectivity: Transfer prices can help to reduce the subjectivity of division performance appraisal by providing a clear and objective basis for evaluating division performance.
Better decision-making: Transfer prices can help to provide a clear and objective basis for making decisions about division performance and resource allocation.

Q: What are the challenges of implementing transfer prices in division performance appraisal?

A: The challenges of implementing transfer prices in division performance appraisal include:

Complexity: Determining transfer prices can be a complex task, particularly in companies with multiple divisions and products.
Subjectivity: Transfer prices can be subject to interpretation and may be influenced by personal biases and opinions.
Resistance to change: Implementing transfer prices may require significant changes to existing processes and procedures, which can be resisted by some employees.

Q: How can companies overcome the challenges of implementing transfer prices in division performance appraisal?

A: Companies can overcome the challenges of implementing transfer prices in division performance appraisal by:

Developing clear policies and procedures: Companies should develop clear policies and procedures for determining transfer prices and allocating costs and revenues between divisions.
Providing training and support: Companies should provide training and support to employees to help them understand the transfer price process and how to apply it in practice.
Monitoring and evaluating performance: Companies should regularly monitor and evaluate the performance of each division to ensure that transfer prices are being applied accurately and consistently.

Q: What are the future directions for research on transfer prices and division performance appraisal?

A: Future research on transfer prices and division performance appraisal should focus on:

Developing more sophisticated transfer price models: Researchers should develop more sophisticated transfer price models that take into account the complexities of real-world business environments.
Investigating the impact of transfer prices on division performance: Researchers should investigate the impact of transfer prices on division performance and explore ways to improve the accuracy and objectivity of division performance appraisal.
Developing new methods for determining transfer prices: Researchers should develop new methods for determining transfer prices that are more accurate, objective, and efficient than existing methods.