Need to observe the rights and interests of all parties in assessing Kokopellis possible avenues forward. Describe all problematic moments of the case.

Kokopelli Resort: A Case Study of Transfer Pricing in a Service Industry Context About a month ago, Stuart Tyler, President and Chief Executive Officer (CEO) was sitting with his Chief Financial Officer (CFO), Rachana Patel. Stuart had been CEO of the Kokopelli Resort for the past four years, having replaced the prior CEO who was fired after earnings before interest, taxes, depreciation, and amortization (EBITDA) had fallen nearly 50%. During his tenure, Stuart hasnt seen much growth in revenues, but EBITDA has increased 29%. The Board of Directors, wanting to get back to the record revenues and EBITDA of a decade ago, has been putting pressure onto Stuart. That led to last months meeting between Stuart and Rachana. Sitting in one of the restaurants of the 740-room hotel, Stuart said: We started out as a mid-size hotel in Scottsdale, steadily expanding to where we are today. The problem I have is that our annual income statements are an outgrowth of what we used more than 40 years ago. Back then we were a 180- room hotel. But weve expanded over the years, adding two new buildings for hotel rooms, added an event center 20 years ago and, more recently, added a golf course and spa. Our income statement treats the organization as a hotel with multiple departments. But I think of us as a multi-divisional company, and each line of business should be evaluated on its own merits. Can you put together a new income statement that better reflects the performance of our various divisions? Stuart felt that he needed to better understand how the different managers were performing. Currently, Stuart can be thought of as an investment center manager. He has eight senior managers reporting to him (see Figure 1 for the organization chart). The managers of the Hotel, Events and Food & Beverage, Golf and Spa divisions were treated as profit center managers, while his other direct reports are cost center managers. The accounting department has followed the industry practice of preparing income statement in accordance with the Uniform System of Accounts for the Lodging Industry (USALI). Income statements for the past three years are shown in Table 1. Background The Kokopelli Resort was developed in the 1970s when Scottsdale, Arizona was a small, upscale suburb of Phoenix. Scottsdale has grown into a large suburban city (population 250,000) with multiple high-end resorts, golf courses, spa centers, a thriving business center and numerous high-end retail centers. Phoenix-Mesa-Scottsdale, with a population of nearly 5 million, is the 11th-largest metropolitan area in the United States. With a large, international airport (13th busiest with 22 million passengers), Scottsdale area resorts host golf tournaments, business meetings and group events, in addition to normal business travel and tourism. For many years, hotels were simply buildings for accommodating transient guests. The food and beverage (F&B) outlets were there to feed guests. But serving the events market (corporate meetings, sales meetings, weddings, professional conferences, etc.), shifted their customer base. Many of the new customers required that the Kokopelli provide better facilities with bundled services (direct billing, bidding on the event and meeting space along with hotel rooms and banquets). Stuart felt that a new incentive compensation plan, along with a new reporting format, might be whats needed to get the performance being sought by the Kokopelli Board of Directors.

Kokopelli Resort: A Case Study of Transfer Pricing 2 The Complaint Late last week Rachana distributed her proposed Divisional Income Statement. See Table 2. This statement summarized and reorganized what was on the current statement. She listed five separate areas of responsibility: Hotel, Events, Golf, Spa and Other. The first four were the profit centers, but the last category was a collection of items that Rachana wasnt sure about. She felt that shed need more input from Stuart and the other members of the senior executive team to refine the new income statement. Today, in the monthly executive team meeting, Melanie expressed some concerns over the new format. She spoke up: Stuart, I think this new approach is a good idea. But I think we need to make some improvements. I dont think this statement accurately reflects my contribution to the organization. Last year I booked more than 40 major events, with an average attendance of 300 persons, staying an average of 5 nights. These numbers suggest that my hard work brought in more than 60,000 room-nights. The marketing, sales, negotiations and successful executions have made us a leader in the events business in the Valley of the Sun. Mark gets all of the credit for those room rentals but and I hate to say this he hasnt done anything to capture that incremental business. Now if you look at Marks business, he rented about 169,000 rooms last year. If he didnt have the customers I brought, his revenues would have dropped more than $13.4 million. But since his marginal costs are low, most of that would have fallen to his bottom line. His gross margin and EBITDA would have dropped about $10 million. Stuart recognized right away that Melanie had a valid point. He needs to recognize and award her for doing a good job for working hard and making the right decisions. It was clear that the proposed income statement, while an improvement, wasnt quite there yet. Stuart had taken a management accounting course and had heard of transfer pricing. While the examples hed seen were all in a manufacturing setting, he didnt see why Mark couldnt sell rooms to Melanie. But was he wrong? Stuart asked Rachana to evaluate this further and come to the executive committee next month with a revised income statement that will incorporate a transfer price that the two managers (Mark and Melanie) could agree upon. Stuart also had two other concerns. Recently, the executive committee had thought about closing the golf course and spa. The land around the hotel is valuable and the Board of Directors asked Stuart to look into selling the land to a local developer who would turn the land into a shopping center. The Executive Committee did a study and found that most golf patrons were attending events. Apparently, the golf course was a major selling point for events and Melanie feared that her event events business would drop 20-40% if the golf course were to go away. For this reason, the Board decided to keep the golf course. But Stuart wondered if Bob Nasr, GM of the golf course should remain as a profit center reporting to him. Stuarts second concern was whether the spa should be closed. It has not done well and last year the division lost more than $100,000. Neither Mark nor Melanie felt that closing the spa would have an effect on the performance of their profit centers. Stuart, Rachana, Mark, Melanie, and Kokopellis other employees hold unique perspectives and interests, although they all share the common goal of ensuring the achievement of its mission, over the long-term. You will need to observe the rights and interests of all parties in assessing Kokopellis possible avenues forward.

Kokopelli Resort: A Case Study of Transfer Pricing 3 Figure 1. Organization Chart

Kokopelli Resort: A Case Study of Transfer Pricing 4 Table 1. Income Statements Panel A: Revenues 2019 2018 2017 Room Nights Available 269,272 269,068 221,796 Room Rentals 169,467 184,747 160,741 Transient Revenue $ 14,321,446 $ 12,708,218 $ 10,433,763 Group Revenue 21,598,944 22,340,493 19,438,393 Rooms Other 1,944,550 1,652,437 2,917,357 Total Rooms 37,864,940 36,701,148 32,789,513 Outlets 10,078,543 9,828,486 9,865,115 In-room Dining 790,987 885,872 957,647 Banquet/Catering 20,686,606 20,088,864 21,702,607 Mini Bar and Other 451,317 450,419 522,204 Meeting Room Rental 478,228 409,588 306,037 Other 1,123,051 1,366,164 1,404,299 Audio/Visual Rentals 4,389,131 4,325,106 4,074,827 Service Charges 2,430,491 2,425,543 6,338,279 Total Food & Beverage 40,428,354 39,780,042 45,171,015 Golf - Retail (Merchandise) 1,643,452 1,514,476 1,591,175 Golf - Other 178,572 178,302 186,227 Spa - Treatments 1,539,723 1,835,534 1,955,865 Spa - Retail 169,678 192,736 230,233 Spa - Other 183,100 153,572 100,454 Garage/Parking 647,526 529,893 667,948 Telecom 704,558 677,019 718,223 Laundry 0 63,485 77,198 Other 403,033 399,671 2,000,592 Total Other Operated Departments 5,469,642 5,544,688 7,527,915 Rentals & Other Income 1,916,199 1,190,850 2,528,751 Cancellation Penalties 0 397,234 314,476 TOTAL REVENUES $ 85,679,135 $ 83,613,962 $ 88,331,670

Kokopelli Resort: A Case Study of Transfer Pricing 5 TABLE 1. Income Statements Panel B: Expenses 2019 2018 2017 Salaries & Wages $ 3,541,610 $ 3,480,816 $ 3,660,587 Payroll Taxes & Benefits 1,259,271 1,143,510 1,195,865 All Other Room Expense 3,668,882 3,513,834 3,877,131 Total Rooms 8,469,763 8,138,160 8,733,583 Cost of Food Sales 4,540,544 4,580,571 4,863,727 Cost of Beverage Sales 1,347,852 1,325,367 1,455,987 Salaries & Wages 6,937,536 7,036,709 10,792,574 Payroll Taxes & Benefits 3,328,114 3,110,256 3,145,694 All Other F & B Expenses 4,632,571 4,565,746 4,413,615 Total Food & Beverage 20,786,617 20,618,649 24,671,597 Total Golf Expenses 0 0 0 Spa - Salaries & Wages 786,091 880,689 948,878 Spa - Payroll Taxes & Benefits 260,238 283,128 293,925 Spa - Cost of Sales (Merchandise) 94,829 105,133 143,394 Spa - Other Expenses 204,844 247,468 207,174 Parking Expenses 146,208 135,641 128,252 Telecom Expenses 561,434 534,173 508,505 Other - Salaries & Wages 708,389 705,587 862,984 Other - Payroll Tax & Benefits 229,514 211,696 249,951 Other Operated Expenses 868,529 807,852 2,423,010 Total Other Operated Departments 3,860,076 3,911,367 5,766,073 Salaries & Wages 1,956,249 1,828,520 1,678,268 Payroll Taxes & Benefits 554,574 539,585 398,974 Credit Card Commissions 1,985,307 1,860,225 1,985,754 All Other Expenses 2,089,387 2,247,169 2,649,651 Total Administrative & General 6,585,517 6,475,499 6,712,647 Salaries & Wages 2,082,623 2,025,570 2,008,992 Payroll Taxes & Benefits 596,115 544,091 544,001 All Other Marketing Expense 4,313,660 4,320,109 4,771,378 Total Marketing Expense 6,992,398 6,889,770 7,324,371 Electricity 1,877,944 1,940,195 1,905,014 Gas 477,041 481,624 421,909 Water & Sewer 950,407 985,344 990,814 Total Utility Expense 3,305,392 3,407,163 3,317,737 Payroll & Related Expense 2,196,120 2,045,615 1,958,639 Maintenance Other Expenses 2,619,250 2,547,973 2,467,765 Total Maintenance Expense 4,815,370 4,593,588 4,426,404 Management Fees 2,570,374 2,508,419 2,649,950 Land/Building 15,552 10,260 0 Property Tax Expenses 2,666,332 2,970,839 2,949,938 Insurance Expense 965,347 1,303,397 1,198,350 Other Fixed Charges 2,426,274 5,968,575 3,684,189 Total Fixed Cost Expenses 8,643,879 12,761,490 10,482,427 TOTAL EXPENSES 63,459,012 66,795,686 71,434,839 EBITDA (NET OP. INCOME) $ 22,220,123 $ 16,818,276 $ 16,896,831

Kokopelli Resort: A Case Study of Transfer Pricing 6 Table 2. Proposed Divisional Income Statement (in millions of $) Hotel Events/F&B Golf Spa Other Total Revenue $ 37.865 $ 40.428 $ 1.822 $ 1.893 $ 3.671 $ 85.679 Expense 8.470 20.787 0 1.346 2.514 33.116 Gross Margin 29.395 19.642 1.822 0.546 1.157 52.563 Allocated Costs Administration 2.910 3.107 0.140 0.145 0.282 6.586 Marketing 3.090 3.299 0.149 0.154 0.300 6.992 Utilities 1.461 1.560 0.070 0.073 0.142 3.305 Maintenance 2.128 2.272 0.102 0.106 0.206 4.815 Management Fee 1.136 1.213 0.055 0.057 0.110 2.570 Other Fixed Costs 2.684 2.866 0.129 0.134 0.260 6.074 Total Allocation 13.410 14.317 0.645 0.670 1.300 30.343 EBITDA $ 15.986 $ 5.325 $ 1.177 $ (0.124) $ (0.143) $ 22.220