Chapter 10 - Transfer Pricing Flashcards
Why is a transfer price important?
Allows profit sharing between entities
Affects decisions from divisional managers
What are the objectives of tranfer pricing?
Goal Congruence
Performance Measurement
Maintaining Divisional Autonomy
Minimising the global tax liability
recording the movement of goods and services
a fair allocation of profits between divisions
What are the three bases for setting a transfer price?
Market based
Cost based (preferably standard cost vs actual cost)
Negotiated prices
Which two types of markets are there and what are the implications for the transfer price?
Perfect intermediate market:
suppliers are able to sell all their output at the prevailing market price. No restrictions on demand, no one supplier domination. Only limitation is capacity.
Imperfect intermediate market:
A market when the selling division is unable to sell all its output externally at the same market price (e.g. in a monopoly or oligopoly market). Issue how to identify suitable transfer price: demand curve.
Describe the demand curve and related formula’s for price, total revenue and maximised profit
Total market demand varies with the sales price. Relationship between demand and price is linear.
Demand curve formula: P = A + BQ
Total Revenue = P x Q
Marginal Revenue = A + 2BQ
Maximise profit = MR = MC
What is the general rule for decision making?
That all goods and services should be transferred at opportunity cost.
Describe optimum transfer price when there is a competitive market for an intermediate product
One price
No buying or selling costs
market able to absorb entire output
Optimum TP = Market Price + any small adjustment.
Describe the optimum transfer price when selling division has a surplus capacity but limit to amount which can be sold externally.
Optimum TP = Marginal Cost
What is the problem and three possible solutions for the Marginal cost transfer price?
It can be considered “unfair”.
Three solutions:
2 part tariff
marginal cost plus charge for fixed cost. Downside: not motivational for selling manager, not fair and time consuming negotiation process.
Cost plus pricing
standard cost plus mark up.
Dual pricing
one price recorded for supplyling division and different price is recorded by buying division. Diff in HQ books.
Desribe optimum transfer price when production is constraint and division has no surplus capacity.
Optimum TP = Marginal Cost + Shadow Price
How can transferpricing be used to minimise the group’s total tax liability?
Reduce profit in high tax countries
Increase profit in low tax countries
Can move currency risks as well.
How do governments respond to potential tax avoidance?
Transfer price needs to be at arm’s lenght. Otherwise risk of double taxation.
What are the characteristics of a tax-haven?
Low tax rate on profits
Low witholding tax on dividend paid to foreign holding companies
tax treaties with other countries
no exchange controls
a stable economy
good communications with rest of the world
well developed legal framework
What types of lowering tax exist?
Evasion and avoidance. Latter is legal, first is not.
