Lecture 8

Question 1

Transfer pricing

Answer 1

• A transfer price is the price one subunit charges for a product or service supplied to another subunit of the same oraganisation
• The transfer price creates revenues for the selling subunit and purchase costs for the buying subunit, affecting each subunit’s operating profit

Question 2

Intermediate products

Answer 2

• Intermediate products are the products transferred between subunits of an organisation
• Intermediate products can either be
  
  • processed further by the receiving subunit
  • or resold to an external customer

Question 3

What is the rationale for transfer prices?

Answer 3

The rationale for transfer prices is that subunit managers, when evaluating decisions, need only focus on how their actions wille affect subunit performance without evaluating their impact on company-wide performance

Question 4

Transfer-pricing methods

Answer 4

• There are three general methods for determining transfer prices

1. Market-based transfer price
2. Cost-based transfer price
3. Negotiated transfer price

• Different transfer-pricing methods produce different operating profits for individual subunits
• In determing transfer prices, management may choose to use the price of a similar product or service publicly listed (market-basted transfer price)
• Management may choose a transfer price based on the costs of producing the product (cost-based transfer price)
• In some cases , the subunits of a company are free to negotiate the transfer price between themselves and then to decide whether to buy and sell internally or deal with outside parties (negotiated transfer prices)
  
  • Arise from the outcome of a bargaining process between selling and buying divisions

Question 5

Dual pricing

Answer 5

• There is seldom a single cost-based transfer price that simultaneously meets the criteria of goal congruence, management effort, subunit performance evaluation and subunit autonomy.
• Dual pricing is using two separate transfer-pricing methods to price each interdivision transaction

Question 6

Comparison of methods

Answer 6

Question 7

Minimum transfer price =

Incremental costs per unit incuured up to the point of transfer + oppurtunity costs per unit to the selling division

Question 8

Multinational transfer pricing

Answer 8

• Transfer prices can reduce profit tax payments by recognising more profit in low tax rate countires and less profit in high tax rate countries
• Tax regualtions of different countries restrict the transfer prices that companies can choose