is JJ s assertion that the production facility is operating at least as efficiently as before the expansion correct?

IMA EDUCATIONAL Case Case Journal \\Study ima The Association of Accountants and Financial Professionals in Business ISSN 1940-204X Caribbean Brewers: Transfer Pricing, Ethics and Governance Douglas Kalesnikoff University of Saskatchewan Suresh Kalagnanam University of Saskatchewan INTRODUCTION chain of Islands, Antigua often serves as a business and transportation hub between the Windward Islands of St. It is April 2011 and you have used your newly acquired Lucia, Grenada, Dominica, and St. Vincent and the Leeward business degree to secure a management job as advisor to the Islands of St. Kitts, St. Martin, Montserrat, and Anguilla. It is chief financial officer with Caribbean Brewers Inc., located also in reasonable physical proximity to the more populated in Antigua in the Caribbean Sea. Caribbean Brewers Inc. is a islands of Puerto Rico and Dominican Republic to the north 75%-owned subsidiary of Gera International, a conglomerate and Barbados and Trinidad to the south. in the business of brewing and distributing beer. It is barely Antigua already had a successful brewery that produced a week since you started your job and you already have major Tigua beer, a popular brand in Antigua and throughout projects to deal with. the eastern Caribbean. In 2000, the Antiguan brewery had negotiated a 15-year income tax holiday with the GERA INTERNATIONAL government of Antigua on income earned from sales of Tigua beer. The combination of the central location of Antigua Gera beer has been a well-established international brand of in the eastern Caribbean, the success of the Tigua beer beer for over half a century, usually ranked among the top line, and the tax concession on Tigua beer made Antigua a three selling brands of beer in the world. Up until 2005, Gera good choice for Gera International; it purchased 75% of the International, head-quartered in Munich, Germany, brewed Antiguan brewery, Caribbean Brewers Inc., in 2005. The Gera beer for the Caribbean region at a brewery located remaining 25% of the common shares of Caribbean Brewers in Jamaica. As transportation costs continued to increase, remained held by senior management and other employees. the logistics of shipping from Jamaica, which is located in Caribbean Brewers is one of the many subsidiaries of varying the western Caribbean, to islands in the eastern Caribbean sizes under Gera International's control. became problematic. In the early 2000s, Gera International The production facilities of Caribbean Brewers were set out to find a suitable location for a plant in the eastern expanded in 2008, thereby effectively doubling the Caribbean. After due diligence investigations on a number of productive capacity. This expansion was funded through a ocations, Gera International decided on Antigua. 10-year amortized loan from Gera International at a fixed Antigua, with the population of 68,000, is the largest interest rate of 10%. All of the production of Gera beer fo the English-speaking Leeward Islands of the eastern the eastern Caribbean region was transferred to Caribbea ribbean. Antigua became Great Britain's most important Brewers after the plant expansion. The resulting produc ribbean base when Admiral Horatio Nelson sailed there figures for Caribbean Brewers are provided in Figure 1. 784. Situated in the middle of the eastern Caribbean IMA EDUCATIONAL CASE JOURNAL VOL. 5, NO. 2, ART. 1, JUNE 20126 V D delete W F R P S RECENT ISSUES that the cost allocations used in Figure 2 for production costs Upon arrival in your new position, you discover that all is not are penalizing his bonus. "Prior to the expansion, I focused rosy at Caribbean Brewers. On only your second day in the on production cost per case. Gera International now holds us office, the production manager, Jason Joseph, affectionately accountable for production cost as a percentage of sales - this known as JJ, comes into your office and shuts the door. JJ has has taken away control from the production people. I also been production manager for decades and has been heralded don't understand why the exported Gera beer bottle costs con as a master brewer, having won multiple awards for Tigua are charged to our plant," JJ exclaimed in sheer frustration. beer in the late 1990s and early 2000s. It is clear during the He also explained that Gera International has on occasion meeting that JJ is unhappy and distressed. He explains that complained about the quality of Gera beer exported to other prior to Gera International's involvement in the brewery, Caribbean countries, thereby refusing to pay Caribbean things were better; JJ previously had a 25% ownership in Brewers for some shipments. JJ is adamant that the quality Caribbean Brewers, which is now reduced to 8%. He had of the beer is consistent and desperately wants to be able always received a salary of about $100,000 as the production to prove the allegations of poor quality as groundless. He is manager, but had also benefited by a bonus and an annual concerned that Gera International is making false allegations dividend. Since Gera International became the majority about the quality to justify not paying for some of the shipments. "I do not understand how head office can say that shareholder, there have been no dividends. In addition, our quality is poor; I have not heard any complaints from our JJ's bonus, which is based on a combination of controlling local customers of Gera beer. I have been in the business average total production costs and quality control, has all long enough to know when quality is bad; I am able to and but been eliminated since the plant expansion. With respect usually do take corrective actions during the process itself to production costs, JJ and other production personnel are before things go out of hand." eligible for a bonus provided that total production costs do Before leaving your office, JJ explains that he is very not exceed 43% of sales. Figure 2 contains the format of frustrated and is seriously considering leaving the company the report that is used to assess production efficiency and to be the master brewer and production manager of a bonus calculations. brewery in Trinidad, a major competitor of Caribbean IJ explains that the production process for brewing beer Brewers. This would be a major loss to the company. has been fundamentally the same for decades, as outlined in Later the same day, the head accountant provides you with Appendix 1. The first two steps, i.e., milling and mash tun, a letter from the Inland Revenue Department (IRD) of Antigua account for 50% of the total production overhead costs. Tigua (equivalent to IRS in the United States of America) explaining beer has a longer and more time-intensive production process that tax auditors will be coming out next month to review the up to the stage where the wort is created; this results in the tax filings for the years ending December 31, 2008, 2009, and Tigua beer consuming 100% more overhead resources up to this 2010. You investigate and find that in order to benefit from stage compared to Gera beer. After the creation of the wort, the the tax exemption of Tigua beer, Caribbean Brewers prepares process and cost are the same regardless of the brand. profitability statements along taxable and nontaxable product The direct costs of the beer are not all that significant; lines when filing the annual tax return. This allocation between 98% of the beer is water and the cost of the raw materials the two product lines is provided in Figure 3. is only about $3 per case of 24. The costs of the bottle cap Caribbean Brewers is a tax resident of Antigua and thus and label are as much as raw materials, about $3 per case. subject to taxes of 30% of profits. As you begin preparing The cost of the bottles is $8 per case of 24; however, this for the tax audit you find out the following: is not normally treated as a cost because a deposit of $8 All export sales of Gera beer are made to Gera Caribbean, per case of 24 is collected for all returnable markets, which a wholly-owned subsidiary of Gera International, which is include all domestic markets and export of Tigua. Contrary located in Bermuda, a tax-free jurisdiction. (See Figure 4 to this normal business practice, no deposit is collected on for a chart of the transactions.) the export market for Gera beer; as a result, the cost of the bottles pertaining to Gera beer exports are expensed. For cost and logistical reasons, the exports are shipped As a result of the decline in production efficiencies, as directly to the Island where the beer will be sold in measured in Figure 2, JJ's bonus has suffered. JJ is adamant the eastern Caribbean while only the invoice is sent to that the production facility is operating as efficiently as, if not Bermuda (see Figure 4). more efficiently than, before the expansion, and is concerned IMA EDUCATIONAL CASE JOURNAL 2 VOL. 5, NO. 2, ART. 1, JUNE 2012Corporate Transaction Flow Chart Gore International Management 100% and Others 25% Gera Caribbean Caribbean Brower's Antigun Gora Export palwary Customers Other Caribbean Hlands Antigun ITA Section 23 Related Party Transactions Involving Liability to Tax Where a resident corporation carries on business with a non-resident corporation and by reason of the relationship between such corporidiots the course of business between them has been so twanged mat the business dong by the resident produces less profiles then those which could be expected to anice from that business if such relationship had not existed, Inland Revenue may determine in a reasonable fashion whether any additional profits should be deemed to be assessable income of the resident corporation. IMA EDUCATIONAL CASE JOURNAL VOL. 5. NO. 3. ART 1, JUNE 2012Allocation of Taxable and Non-taxable Streams Total Probation Conte Swan Carts 1501,090 1.484,790 121,471,713 948,000 $40 875,000 Production Costs 147 210 370 Sales Coats 2.844,300 1/440,500 Ad ammoration Corts i prirancy 2807,000 3217,050 1,752 843 Net profit $27.479.055 Total Non taxable Tigan Taxable - Gora 2.565,000 984/000 1:401/090 $48 300,060 180300030 Production Coats $71,045 687 Salma Casts 5,614.500 2,747.400 2087-100 Administrative Costs 5.270,500 2,554,600 2.065,900 2 832 080 1,434.745 1.417 256 Net profit $28 795,200 $20 417,868 $ 8317.512 Notes: Sales price of Gora Exported bear is $25 while all others are $50 Total production costs allocated on the basis of volume ( of cases). Sales and Administrative and Intorent experiso allseated on the basis of sales dollarsProduction Costs as a Percentage of Sales 4 0 100 $4 471 010 10400 1 521 1830 17% 1,559/200 7 454 500 108% 118% 11 MOOD 10300 000 14.15 Thatal Production Costs 578 835,400 147 21050 $55,907/400 Note: For simplicity Ily assumed thatalen units are equal to producing wnia IMA EDUCATIONAL CASE JOURNAL VOL 5, NO. 2, ART. I, JUNE 2012A Chen the wording in Firun $ witch used in the bauchain of plaid pantry innucom, to what mount b Cardigan 5. What are the rikical implications of the majming who alcaponed Tiru beer. Contrary to the mental Ponies procdice, modepoint in invoked to Cera Gera Caribbean in nim invoices the other Islands in the the burden ABOUT IMA You quickly research the Antigua Income Tax Act (ITA With a workdecide movement of more than tooto poofcuban and come across a genered tax anti-avoidance section fics Figure 5k. unpowering booming and finsince profesibenals in drive business performance BMA provides a thy name foran for THE CHALLENGES AHEAD (OR THE ROAD AHEAD) profesionals to advance thew careen through Certificd profewionul education, networking and shegary of the You ponder everything that you have heard from JU. You highest ethical and professional wandand. Fox moore also reflect upon your new responsibilities, particularly with information sheall LALA, please whit www.iminckorg respect to new elaborate planning and budgeting processes that you will be spearheading, You have been told that these processes are extremely critical and will bring Gen Canbbean in line with the other segments in terms of using standard procedures for resource allocation, performance measurement, evaluation, and row and "had corporate group standard approach the right way to go. or should each subsidiary have some flexibility?" you wonder There is a board of director meeting scheduled for next week. Frederik Versiam, a long-time executive of Gera International, has been parachuted in as the CEQ and chairman of the board of Canbbean Brewers. The other members of the board of directors of Caribbean Brewers ard Grandview Goerdler and Delores Garstad from the head office, who fly in for the quarterly meetings from Munich; Edward Woods, a local politician; and Byron Jackson, a local businessman in Antigua with a 21 ownership interest in Caribbean Brewers. You receive an agenda for the board meeting and note that you are required to prepare a report that answers the following questions. " 1. To what extent, if any, are the costs of production rising? 2. Is JJ's assertion that the production facility is operating at least as efficiently as before the expansion correct? 3. Is the current performance measurement system for production personnel appropriate? If so, why? If not, what would you recommend for an alternative performance measurement system? IMA EDUCATIONAL CASE JOURNAL VOL. J. NO. 2, ART. 1, JUNE 2012The Nine-Stop Process of Beer Making 1. Milling - Ben brewing begins with polished barley gains called malt, which are passed throughin milling machine to crack the dried Intrends and grind them into a conne powder 1. Mash tun - The milled probe in dropped into the much ton with warm water of a certain temp nature, depending on the Drew recipe, the pain and water are moved together to create a mash .a thick. wwest lypaid called wart 3. Lautering - The wort is Shin drabed off Ina waged called a bitter tum (German for "pariSession tack") where the lanik are wood like a g int shove or Itor bad for Sharing out the "spent" grain. 4. Beirving - The wort is boiled and spiced with hope for up to 90 minutes in a huge bottle, or wort copper 5. Fermenting - After it is cooked, the wort is then banstered Ba fermentation tank where the sugars one maybalked into alcohol and acarbon dincity, and the resulting mature is then called young beer. & Conditioning - The beer is cooled to around freezing point, which encourages setding of the yeast and causes proteins to thicken; the 7. Fillering - In this slings the fitring removes aaccus youat, protein, and other indolubles, as well as stabilizes the flavor so that the beer becomes bright and clout Pasteurizing - The beer is pasteurized to kill off any of the remaining youst and another microorganisms, 4. Packaging - The frished beer is then mechanically filled inte bottles or ings. IMA EDUCATIONAL CASE JOURNAL VOL. 5, NO. 2, ART. 1, JUNE 2012