8. Transfer Pricing and International Issues Flashcards
What is transfer pricing?
The prices charged for goods transferred between two divisions of the same firm.
What does transfer pricing affect?
It affects both divisions and overall firm through its impact on the divisional performance measures, firm wide profits and divisional autonomy
How does transfer pricing work?
The output of the selling division is used as input of the buying division. The price charged for the transferred goods is revenue to the selling division and costs of goods sold to the buying division.
What affects the transfer price?
Profit and profit-based measurements (ROI and EVA) of both divisions
What would be the outcome for: Revenue to A from sale/transfer of product affects profit and therefore performance =
High revenue
What would be the outcome for: Costs paid by B affect profit and therefore performance =
Low cost
What do transfer prices have an affect on?
Divisional performance measures
Managerial performance incentives
Firm-wide profits
Business unit autonomy
What is divisional performance measures?
Higher price increases profit for selling division and reduces profit for buying division and vice versa
What is managerial performance incentives?
Higher profit leads to higher bonuses etc for the managers
What is firm wide profits?
Maximising divisional profits may reduce firm-wide profits
e.g. sell component outside = lack of components for buying division
What is business unit autonomy?
If dispute occurs, senior management may intervene to set price = loss of managerial autonomy
The transfer pricing problem concerns finding a transfer pricing system that simultaneously satisfies the following three objectives?
Accurate performance evaluation.
Goal congruence
Divisional autonomy.
If external markets exist for the intermediate (transferred) product or service, then what prices are appropriate?
Market prices are the most appropriate basis for pricing the transferred good or service between responsibility centres
What does the market price provide?
The market price provides an independent valuation of the transferred product or service, and of how much each profit center has contributed to the total profit earned by the organization on the transaction, although, such competitive markets with well- defined prices seldom exist
What is the opportunity cost approach rule?
The transferred goods should be transferred internally whenever the opportunity cost (minimum price) of the selling division is less than the opportunity cost (maximum price) of the buying division.
What is the maximum transfer price?
Which is the transfer price that would leave the buying division indifferent between buying the goods from an outside party or purchasing from an internal division
What is the minimum transfer price?
Which is the transfer price that would leave the selling division indifferent between selling the goods to an outside party or transferring the goods to an internal division
Do some organisations allow negotiations for transfer pricing?
Yes some do allow supplying and receiving responsibility centres (divisions) to negotiate transfer prices between themselves:
• in the absence of market prices
• given the drawbacks of cost-based transfer pricing
What are some drawbacks of negotiating transfer prices?
Divisiveness and competition
Private information may bias outcome
Performance distorted by negotiating skills
Costly - time and resources
What are some advantages of negotiating transfer prices?
Goal congruence
Autonomy
Performance evaluation
What are the three types of cost-based transfer prices?
Full cost
Full cost plus markup
Variable cost plus fixed fee
What are some disadvantages of full cost?
Can result in dysfunctional decisions from the buying division.
Also no incentive to cut down on costs as the cost can be passed on.
(one solution is to use a standard price)
What is dual transfer pricing?
The buying division is charged the cost of the transferred product.
The selling division is credited with the cost and some profit allowance.
The difference is accounted for in a special account
What are the three main with international issues & multinational transfers?
Exchange rate
Different tax rates
Market rate is easier to justify to tax authorities
What are the ways in which different tax rates impact transfer pricing?
Multinational Companies may take advantage of country- specific corporate tax rates to maximise profitability.
Company is likely to report high costs and low revenue in the high tax jurisdiction, and low costs and high revenue in the low tax jurisdiction.
Other taxes, e.g. GST, tariffs & customs duties might be relevant
