7. Transfer Pricing Flashcards
What is a transfer price?
The price at which two division agree to transfer goods
What is the simplest way of dealing with transfer pricing between cost centres?
Transfer at cost (no profit making targets)
What are the 3 objectives of a successful transfer pricing system?
- Goal Congruence
- Autonomy
- Fair Performance Evaluation
What should a good transfer pricing system result in?
Optimum allocation of resources and motivation for divisional managers
What is the biggest conflict classically found in transfer pricing situations?
Goal congruence and autonomy
What is a perfect vs imperfect market?
Every item sells for the same vs to sell more, the price must be dropped
What are the 3 advantages of using a market price approach to transfer pricing?
- SD receives same return as through 3rd parties
- RD pays fair price based on market conditions
- Helps ensure goal congruence
What is the adjusted market price sometimes used in transfer pricing?
The market price less an adjustment to reflect savings on admin and distribution
What are the 2 main issues of using a market price approach to transfer pricing?
- 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
What are the 2 advantages of using a standard cost approach to transfer pricing?
- SD has incentive to control their actual costs
2. RD knows in advance how much the items will cost
What is the main advantage of using a full cost approach to transfer pricing?
SD will cover all of their costs and so will want the transfer to happen
What is the main disadvantage of using a full cost approach to transfer pricing?
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
What is the main advantage of using a marginal cost approach to transfer pricing?
RD always makes the optimum guying decision from the groups perspective
What is the main disadvantage of using a marginal cost approach to transfer pricing?
SD does not earn any contribution towards its fixed costs and profitability, which is demotivational
In which situation is it particularly likely that dysfunctional decision making will occur?
If SD charges at full cost + markup
What are the two most common solutions for the dilemma of goal incongruence in transfer pricing?
- Dual pricing
2. Two part tariff
What is dual pricing?
Credit SD with market price and Debit RD with the marginal cost
What is the two part tariff approach?
Transfer price is set at marginal cost and each period a lump sum fixed fee is given to the SD by head office
What is the main disadvantage of using a two part tariff approach to transfer pricing?
SD is treated like a glorified cost centre and may perceive loss of autonomy
What method should be used if asked to suggest the best transfer price to ensure goal congruent decisions?
Opportunity costing
What is the range created when looking at the opportunity costing approach to transfer pricing?
Between the minimum SD would accept for the transfer and the maximum RD would be prepared to pay
What is the minimum acceptable price for the SD if there is spare capacity?
Marginal Cost
What is the minimum acceptable price for the SD if there is no spare capacity?
Marginal Cost + lost contribution
What is the maximum acceptable price for the RD?
The lower of external purchase price and divisional net revenue
What are the 2 most important considerations when setting transfer prices in an international environment?
- Impact of changing exchange rates
2. Impact of taxation liabilities
What is the unethical behavior that might be driven by difference in tax rates in international transfer pricing?
Moving profits made to countries with lower tax rates
What is an arms length transaction?
The price expected to be paid in a fair market transaction
