7. Transfer Pricing

Question 1

What is a transfer price?

Answer 1

The price at which two division agree to transfer goods

Question 2

What is the simplest way of dealing with transfer pricing between cost centres?

Answer 2

Transfer at cost (no profit making targets)

Question 3

What are the 3 objectives of a successful transfer pricing system?

Answer 3

1. Goal Congruence
2. Autonomy
3. Fair Performance Evaluation

Question 4

What should a good transfer pricing system result in?

Answer 4

Optimum allocation of resources and motivation for divisional managers

Question 5

What is the biggest conflict classically found in transfer pricing situations?

Answer 5

Goal congruence and autonomy

Question 6

What is a perfect vs imperfect market?

Answer 6

Every item sells for the same vs to sell more, the price must be dropped

Question 7

What are the 3 advantages of using a market price approach to transfer pricing?

Answer 7

1. SD receives same return as through 3rd parties
2. RD pays fair price based on market conditions
3. Helps ensure goal congruence

Question 8

What is the adjusted market price sometimes used in transfer pricing?

Answer 8

The market price less an adjustment to reflect savings on admin and distribution

Question 9

What are the 2 main issues of using a market price approach to transfer pricing?

Answer 9

1. There may be no external market (e.g. intermediary)

2. If SD is at full capacity, there may be other more profitable products it could sell to 3rd parties

Question 10

What are the 2 advantages of using a standard cost approach to transfer pricing?

Answer 10

1. SD has incentive to control their actual costs

2. RD knows in advance how much the items will cost

Question 11

What is the main advantage of using a full cost approach to transfer pricing?

Answer 11

SD will cover all of their costs and so will want the transfer to happen

Question 12

What is the main disadvantage of using a full cost approach to transfer pricing?

Answer 12

There is danger of dysfunctional decision making, as the SD may charge more than a 3rd party and thus encourage the RD to buy externally, leaving the group worse off overall

Question 13

What is the main advantage of using a marginal cost approach to transfer pricing?

Answer 13

RD always makes the optimum guying decision from the groups perspective

Question 14

What is the main disadvantage of using a marginal cost approach to transfer pricing?

Answer 14

SD does not earn any contribution towards its fixed costs and profitability, which is demotivational

Question 15

In which situation is it particularly likely that dysfunctional decision making will occur?

Answer 15

If SD charges at full cost + markup

Question 16

What are the two most common solutions for the dilemma of goal incongruence in transfer pricing?

Answer 16

1. Dual pricing

2. Two part tariff

Question 17

What is dual pricing?

Answer 17

Credit SD with market price and Debit RD with the marginal cost

Question 18

What is the two part tariff approach?

Answer 18

Transfer price is set at marginal cost and each period a lump sum fixed fee is given to the SD by head office

Question 19

What is the main disadvantage of using a two part tariff approach to transfer pricing?

Answer 19

SD is treated like a glorified cost centre and may perceive loss of autonomy

Question 20

What method should be used if asked to suggest the best transfer price to ensure goal congruent decisions?

Answer 20

Opportunity costing

Question 21

What is the range created when looking at the opportunity costing approach to transfer pricing?

Answer 21

Between the minimum SD would accept for the transfer and the maximum RD would be prepared to pay

Question 22

What is the minimum acceptable price for the SD if there is spare capacity?

Answer 22

Marginal Cost

Question 23

What is the minimum acceptable price for the SD if there is no spare capacity?

Answer 23

Marginal Cost + lost contribution

Question 24

What is the maximum acceptable price for the RD?

Answer 24

The lower of external purchase price and divisional net revenue

Question 25

What are the 2 most important considerations when setting transfer prices in an international environment?

Answer 25

1. Impact of changing exchange rates

2. Impact of taxation liabilities

Question 26

What is the unethical behavior that might be driven by difference in tax rates in international transfer pricing?

Answer 26

Moving profits made to countries with lower tax rates

Question 27

What is an arms length transaction?

Answer 27

The price expected to be paid in a fair market transaction