P2 - 7. Transfer Pricing

Question 1

What would a cost centre set transfer price at?

Answer 1

Cost

Question 2

Why is it important for profit centres to have sensible transfer pricing?

Answer 2

Bonuses and other rewards are dependant on profits (revenues and costs) and poor transfer prices can lead to dysfunctional decisions

Question 3

What are the 4 objectives of transfer pricing?

Answer 3

1. Goal congruence - best decision for company
2. Autonomy - motivated
3. Performance evaluation
4. Optimum resource allocation

Question 4

What is the major conflict in transfer pricing?

Answer 4

Goal congruence vs autonomy

Question 5

What are the 3 considerations of the selling division when setting a transfer price?

Answer 5

1. Is there spare capacity
2. Can they sell more to third parties
3. Is the external market perfect or imperfect

Question 6

What are the 2 considerations of the buying division when setting a transfer price?

Answer 6

1. What can the finished goods be sold for?

2. What is the cheapest option

Question 7

What are the benefits of using market price as a transfer price?

Answer 7

1. SD make same return as if to 3rd party
2. BD pay fair price based on market conditions
3. Should ensure goal congruence
4. Can charge adjusted market price for other considerations e.g. saved postage

Question 8

What are the 2 main problems with using market price as transfer price?

Answer 8

1. 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

Question 9

What is the most common basis for transfer pricing?

Answer 9

Cost

Question 10

Is it better to use actual or standard cost as a basis for transfer prices?

Answer 10

Standard

Question 11

Why is it most appropriate to use standard cost for transfer pricing (rather than actual)?

Answer 11

1. Allows BD to plan

2. Incentivises SD to control costs

Question 12

Is it better for the SD to use full or marginal cost as a basis of transfer pricing?

Answer 12

SD prefers full cost to cover all of their costs

Question 13

Is it better for the group as a whole to use full or marginal cost as a basis of transfer pricing?

Answer 13

Marginal cost, as full cost might lead to dysfunctional decision making

Question 14

Is it fair to allow the SD to add a markup on cost for transfer pricing?

Answer 14

Yes, if it is a profit/investment centre it is fair to allow them to make a profit on their sales

Question 15

What are the 2 options to address the full cost vs marginal cost issue in transfer pricing?

Answer 15

1. Dual pricing

2. Two part tariff w/ lump sum

Question 16

What is dual pricing?

Answer 16

Credit SD with market price and debit BD with marginal cost, adjust difference centrally

Question 17

What is two part tariff pricing?

Answer 17

TP tariff set at variable cost and a lump sum fee is given by head office to SD as contribution to fixed costs

Question 18

What is a potential issue with two part tariff pricing?

Answer 18

Perceived loss of autonomy by SD

Question 19

What is the best basis for transfer pricing to ensure goal congruence?

Answer 19

Opportunity cost

Question 20

Why does providing a range of transfer pricing bases on opportunity cost increase divisional autonomy?

Answer 20

Divisions can negotiate within the range

Question 21

What is the minimum acceptable transfer price for the SD when there is spare capacity?

Answer 21

Marginal cost (op cost is zero)

Question 22

What is the minimum acceptable transfer price for the SD when there is no spare capacity?

Answer 22

Lost contribution by decision to sell to BD

Question 23

What is the maximum acceptable transfer price for the BD?

Answer 23

Lower of:
External purchase price, and
Divisional Net Revenue

Question 24

What are 2 additional issues to consider when for international transfer prices?

Answer 24

1. Impact of changing exchange rates

2. Impact on taxation liabilities

Question 25

What does double tax relief mean?

Answer 25

A company does not pay tax on the same profits twice

Question 26

What negative effects will purposefully adjusting transfer prices to leave profits in the lower taxed country have?

Answer 26

1. Demotivational (loss of autonomy)
2. Impact on bonuses
3. Tax authorities may intervene if not at arms length