P2 - 7. Transfer Pricing Flashcards
What would a cost centre set transfer price at?
Cost
Why is it important for profit centres to have sensible transfer pricing?
Bonuses and other rewards are dependant on profits (revenues and costs) and poor transfer prices can lead to dysfunctional decisions
What are the 4 objectives of transfer pricing?
- Goal congruence - best decision for company
- Autonomy - motivated
- Performance evaluation
- Optimum resource allocation
What is the major conflict in transfer pricing?
Goal congruence vs autonomy
What are the 3 considerations of the selling division when setting a transfer price?
- Is there spare capacity
- Can they sell more to third parties
- Is the external market perfect or imperfect
What are the 2 considerations of the buying division when setting a transfer price?
- What can the finished goods be sold for?
2. What is the cheapest option
What are the benefits of using market price as a transfer price?
- SD make same return as if to 3rd party
- BD pay fair price based on market conditions
- Should ensure goal congruence
- Can charge adjusted market price for other considerations e.g. saved postage
What are the 2 main problems with using market price as transfer price?
- Can’t use if there is no external market
2. If SD is at full capacity and makes other more profitable products, won’t want to sell to BD
What is the most common basis for transfer pricing?
Cost
Is it better to use actual or standard cost as a basis for transfer prices?
Standard
Why is it most appropriate to use standard cost for transfer pricing (rather than actual)?
- Allows BD to plan
2. Incentivises SD to control costs
Is it better for the SD to use full or marginal cost as a basis of transfer pricing?
SD prefers full cost to cover all of their costs
Is it better for the group as a whole to use full or marginal cost as a basis of transfer pricing?
Marginal cost, as full cost might lead to dysfunctional decision making
Is it fair to allow the SD to add a markup on cost for transfer pricing?
Yes, if it is a profit/investment centre it is fair to allow them to make a profit on their sales
What are the 2 options to address the full cost vs marginal cost issue in transfer pricing?
- Dual pricing
2. Two part tariff w/ lump sum
What is dual pricing?
Credit SD with market price and debit BD with marginal cost, adjust difference centrally
What is two part tariff pricing?
TP tariff set at variable cost and a lump sum fee is given by head office to SD as contribution to fixed costs
What is a potential issue with two part tariff pricing?
Perceived loss of autonomy by SD
What is the best basis for transfer pricing to ensure goal congruence?
Opportunity cost
Why does providing a range of transfer pricing bases on opportunity cost increase divisional autonomy?
Divisions can negotiate within the range
What is the minimum acceptable transfer price for the SD when there is spare capacity?
Marginal cost (op cost is zero)
What is the minimum acceptable transfer price for the SD when there is no spare capacity?
Lost contribution by decision to sell to BD
What is the maximum acceptable transfer price for the BD?
Lower of:
External purchase price, and
Divisional Net Revenue
What are 2 additional issues to consider when for international transfer prices?
- Impact of changing exchange rates
2. Impact on taxation liabilities
What does double tax relief mean?
A company does not pay tax on the same profits twice
What negative effects will purposefully adjusting transfer prices to leave profits in the lower taxed country have?
- Demotivational (loss of autonomy)
- Impact on bonuses
- Tax authorities may intervene if not at arms length
