Transfer Pricing

Question 1

What is transfer pricing?

Answer 1

Price at which goods or services are transferred between different units of the same company.

Question 2

What are the main purposes of transfer pricing?

Answer 2

• Ensure optimal resource allocation
• Motivate divisional managers for economic decisions
• Evaluate managerial and economic performance
• Intentionally move profits between divisions
• Maintain divisional autonomy

Question 3

How can transfer prices influence divisional profits?

Answer 3

Transfer prices act as revenue for the supplying division and cost for the receiving division.

Question 4

What are the limits within which transfer pricing should fall?

Answer 4

• Minimum: sum of supplying division’s marginal cost and opportunity cost
• Maximum: lowest market price for external purchase minus internal cost savings

Question 5

What are some alternative transfer pricing methods?

Answer 5

• Market-based transfer prices
• Marginal/variable cost transfer prices
• Full cost transfer price
• Negotiated prices (including dual-rate and marginal cost plus fixed lump-sum fee)

Question 6

When is a market-based price used for transfer pricing?

Answer 6

When buying/selling divisions can buy/sell externally and the market price is known.

Question 7

What are the advantages of market-based transfer prices?

Answer 7

• Motivates selling division to improve efficiency
• Allows buying division to evaluate as any other supplier
• Quality of service and dependability can maximize profit

Question 8

What are the disadvantages of market-based transfer prices?

Answer 8

• Requires a perfectly competitive market
• External market for the intermediate product may not exist
• Market price may be temporary

Question 9

What should transfer prices be when there is no external market?

Answer 9

• Greater than or equal to variable cost in supplying division
• Less than or equal to selling price minus variable cost in receiving division

Question 10

What are cost-based approaches to transfer pricing?

Answer 10

Approaches that base transfer prices on costs due to the absence of a suitable market price.

Question 11

What are the advantages of cost-based transfer pricing?

Answer 11

• Covers all costs of the selling division
• Full cost plus mark-up may equate to market price

Question 12

What are the disadvantages of cost-based transfer pricing?

Answer 12

• Managers may make sub-optimal decisions
• Performance may be distorted
• Autonomy of divisional managers may be threatened

Question 13

What is marginal or variable cost-based transfer pricing?

Answer 13

Transfer pricing that charges the variable cost incurred by the selling division to the receiving division.

Question 14

What are the advantages of marginal cost-based transfer pricing?

Answer 14

• Ideal for selling divisions with excess capacity
• Useful when no external market exists

Question 15

What are the disadvantages of marginal cost-based transfer pricing?

Answer 15

• Difficult to compute
• May not cover fixed costs
• Poor information for performance evaluation

Question 16

What are negotiated transfer prices?

Answer 16

Prices determined through negotiation between the buying and selling divisions, especially in the presence of market imperfections.

Question 17

What are the conditions for effective negotiated transfer pricing?

Answer 17

• Equal bargaining power between managers
• Understanding of cost and revenue information

Question 18

What issues arise with dual-rate transfer prices?

Answer 18

• Causes confusion
• Reduces effective competition
• Can lead to double counting of internal profits

Question 19

What is marginal cost plus a fixed lump-sum fee in transfer pricing?

Answer 19

A method where transfers are priced at short-run variable cost plus a fixed fee for the privilege of obtaining those transfers.

Question 20

What are the key issues in international transfer pricing?

Answer 20

• Low taxation rates in different countries
• Profit allocation to low tax divisions
• Manipulation of taxable profits
• Ethical problems for companies

Question 21

What is a potential example of income shifting in international transfer pricing?

Answer 21

Google shifting UK income to Netherlands/Ireland/Bermuda.

Question 22

True or False: The current system of international transfer pricing is considered effective.

Answer 22

False