Lecture 4 - Transfer pricing Flashcards
(!) Describe transfer pricing in general
General:
- Allocate revenue among responsibility centers
- Motivational, behavioral & strategic implications
- Opportunity cost of selling to inside supplier
- Forgone benefit if no unused capacity
- Fiction of market within company
- More strategic than mathematical
- Must align w. strategy
- Profit allocation & coordination
- Should be LT
- Often when decentralized
- Dont assume asymmetric info
Implications:
- Division manager DM: Pricing, product mix, Make or buy, Investments
- Measure division manager performance
- Measure economic performance of activity
Reasons to not independent firms:
- Tax
- Capacity utilization
- Less quality test
- Low marketing costs
- Access to market segments
- Use same brand
Prices:
- Market-based prices
- Cost-based prices
- Negotiated prices
Describe the principles for divisional reporting
Measurable:
- Profit as independent as poss.
Controllable profit:
- Profit reflect controllable items of its manager & subordinates
Goal congruence:
- Not poss. to make profit at expense of other divisions or firm
(?) Describe the conventional thinking & conclusion on transfer pricing
Conventional thinking:
- Mainstream textbook
- Induce goal congruent decisions
- Measure division manager performance
- Maintain division autonomy
___________
Conventional conclusion:
Operating at capacity:
- Market based price
Imperfect competition:
- Negotiated price
- Number of transfers
No external market
- Long run MC
- ABC
- Standard
(!) Describe the transfer rule of pricing
Transfer rule:
- Add. outlay cost to point of transfer + Firms opportunity cost
Outlay cost:
- Cost identified in past, present or future
- Cash directly associated w. prod. & transfer
- Sometimes approx. VC
Opportunity costs:
- Cost of next best alternative foregone
- Max forgone firm profit if internal transfer
(!) Describe market based prices & optimal & problematic conditions for them
General:
- Independent competitive unit
- Intermediate marked = Dansk: Mellemmarked
- An opportunity cost if sold outside
- Cost + Profit markup: Mark-up by comparable units
- Often if no selling cost, carrying cost or credit risk
- Ensure divisions dont just invest in other things
- Perceived less unfairness perceived since HQ less involved
(!) Describe cost based prices
General:
- Mostly used
- Often when no external market price exist
Marginal cost:
- Optimal level of prod. & transfer level when Price = MC
- Price equal S/D
- If no market
Variable costs:
- Actual VC: Inefficiencies can be past along
- Standard VC: Norm could be manipulated
- Focus on ST DM
___________
Full cost:
- Most popular
- Use traditional standard costing
- Often capacity related unit cost
- Problematic since costs change: Standard = Less cost savings
Actual full costs
- Rarely known in advance
- Prices fluctuate
- VC + FC
Standard full cost:
- Often at full capacity
- Expected unit costs
- Try to identify changes
- Sometimes buying unit responsible for negative volumen variances: “Take or buy”
- Require trust in selling units estimates
- Bonus on corporate & individual level
___________
Activity based costing / ABC:
- Unit & batch related cost + Fixed annual fee
- Neither over- or understate capacity
- FC to other divisions ensure “responsibility accounting”
- Combine cost & profit center
Cost + Investment:
- Full-cost basis + Portion of selling units assets
- Difficult allocation
Dual sourcing:
- Dual-rate transfer price
- Combine marked-based & forced internal sourcing
- If economies of scale
- Buying unit pay cost + opportunity cost
- Selling unit receive marked price
- Risk misrepresented opportunity cost: Capacity cost used as substitute
- Require good measures
- Risk less incentive to negotiate
- Difficult to administer: Only usable for short period
- Lower incentive to deal w. external market
- Lower incentive to monitor other department
Two-step pricing:
- 1. Charge each unit the standard VC of prod.
- 2. Periodic charge for buying unit
Two set prices
- Provider unit: One prize
- Buying unit: Another prize
- HQ: Difference
Other:
- Standard FC/VC + Profit:
(!) Describe negotiated prices
General:
- When other things than just product: Eg. Timeliness, quality, flexibility
- Freedom to reject/accept price at any stage: Else dictated price
- Freedom to buy/sell outside company: Monitor sourcing decisions. Transfer pricing rule
- Require support & involvement of TM
- If no perfect competitive market
Cons:
- Conflicts
- Time consuming
- Based on negotiating skills
Pros:
- Mutual understanding: Knowledge about construct causality, tech & costs
- OBA
Necessary context:
- Committee
- Transfer pricing rule
- Settle disputes
- Monitor sourcing decisions
(?) Describe the strategical & organizational approach
.
(?) Conclude on the mainstream & strategy
Procedure:
- Main purposes = strategy
- Construct most suitable system
- Analyze dysfunctions
- Constrains
Communications:
- Subsidiary management
- Top-management
Pragmatic effects:
- Observe decisions & problem
- Holistic view: Problem
- Question org. structure
(?) Describe transfer prices & international companies
- Taxation: Tax rates, & regulations
- Tariffs
- Competition
- Funds accumulation
- Inflation
- Country risk
- Limits for fund transfer
- Import quota
- Ethics
- Joint venture
- Performance evaluation
- Economic evaluation
- Decision making
Describe the arms-length pricing OECD
General:
- Parties to a transaction is independent & equal
___________
Methods for arm’s-length price setting:
General:
- OECD TP guidelines
Traditional metods:
Comparable uncontrolled price method:
- TP = Price paid in comparable uncontrolled sales +/- adjustments
Resale price method:
- TP = Applicable resale price - appropriate markup+/-adjustments
Cost plus method:
- TP = Costs + appropriate markup+/- adjustments
Else:
- Comparability
- Avoid double taxation
- OECD generally don’t allow adjustments if within arm’s length range
- Proof of appropriate adjustment rely on tax authority
(?) Describe some implications of transfer pricing tax compliance
- Extensive & detailed documentation
- Increased centralization & structuring of activities
- Increased use of universal applied benchmarks
- Less participation by LLM in setting standards & targets
- Changes in performance evaluation & rewards
- More non-financial performance indicators
- Less flexibility and adaption
- Disadvantages for motivation, effectiveness & commercial entrepreneurship
(!) Describe the difference between competitive, cooperative & collaborative organizations
Competitive organization:
General:
- If highly diversified
- Often decentralized DM
- Much bottom up
- Sometimes maximize obj. at others expense
- More counterproductive toward insiders > Outsiders
- Risk if individual units performance is rewarded
Solutions:
- Market based pricing
- Dual sourcing
__________
Cooperative organization:
- Low autonomy at SBU: TM more involved
- Often based on historical budgets
- Evaluation criteria differ btw. units
- Bonus, salary & promotion based on corporate performance
- Top down
- Unit may sacrifice itself for firm
- Eg. Many cost centers & one revenue center
Solutions:
- Actual full cost
- Standard full cost
- Cost plus investment:
__________
Collaborative organization:
- Vertical integration
- Independent diversified business
- Combination of competitive & cooperative
- Often matrix structure
- Balance unit & company objectives: Shift by condition
- Iterative: Bottom-up + Top-down
- Perceived fairness depend on trust in TM
- Often quantitative: Difficult finding benchmark
- Often if more diversification or emphasis on individual unit performance
- Conflict warn TM to reexamine strategy
(!) Describe the pros & cons so as common transfer prices problems
Pros:
- Goal congruence
- Poss. synergy effects
- Ensure quality standard
- Keep confidential info in house
- Enable evaluation as independent firm
- Better align centers
Cons:
- Risk conflict
- Complicated
- Not always satisfying both control & fairness aspect
- Risk hidden costs: Eg. Unreasonable delivery demands
__________
Performance problems:
- Change transfer price if hard to meet obj.
- Eg. If seek to increase bottom line
Interpersonal disputes:
- Easier than name-calling
Power imbalance:
- Poss. correction of felt imbalance w. transfer price
Demand fluctuation:
- Happy if agreement when FC < MP when market fluctuate
Product pricing:
- Risk of not reducing enough or being too aggressive w. price
- Risk potential market share
Describe transfer pricing of functional departments services
Allocation principles:
- Volume charge
- Capacity charge: Cost eliminated if one withdraw
- Usage charge:
____________
Consumptions cont. by buying division:
Required to buy:
- Maintenance of equipment, training, it- services etc.
- VC: May induce high consumption
- Market price: Forces to buy outside
- Full cost / full cost plus profit margin
Not required to buy
- Training & it-services
- Justify themselves
- VC: May induce high consumption
- Market price: Motivate to outside buy
___________
Consumptions cont. by functional dep.
Division required to buy:
- Internal auditing
- Cost based
- Paying for services
- Increases division attention to costs of services
- Profit more realistic
