Transfer pricing Flashcards
Define “transfer price”
A transfer price is the price at which goods or services are transferred from one division to another within the same organisation
The TP chosen will have a direct impact on the performance of the divisions
What are the 5 characteristics of a good transfer price?
Goal congruence Fairness Autonomy Bookkeeping Minimise global tax liability
What is meant by “autonomy” when setting transfer prices?
The freedom of divisional managers to make decisions
The autonomy will improve managers motivation - if they are in control of the price setting
What is meant by “bookkeeping” when setting transfer prices?
The TP should make it straight forward to record the movement of goods and services between divisions
What is meant by “minimise global tax liability” when setting transfer prices?
Multinational companies can use their transfer pricing policies to move profits around the world and thereby reduce their global tax liability
What is meant by “fairness” when setting transfer prices?
The divisions must perceive the transfer price as fair since the TP will affect divisional profit and hence performance evaluation
What is meant by “goal congruence” when setting transfer prices?
Should be in the best interests of the company overall
Why should standard costs be used rather than actual costs?
If the selling division overspends, the overspend will be passed onto the buying division and impact them negatively
The adverse variance will be passed on which isn’t fair
What is meant by dual pricing?
The selling division records one price, and the buying division records another price
i.e. selling division records full cost, buying division records marginal cost
What is the consequence of dual pricing?
Period end adjustments will be required
What is “marginal cost plus lump sum” pricing?
This is another fair approach, where the selling division transfers each unit at marginal cost and a periodic lump sum is made to cover fixed costs
What are the 2 most fair transfer pricing policies?
Dual pricing
Marginal cost plus lump sum
In a perfectly competitive market, what would the transfer price be?
Transfer price = market price
A perfect market means there is only one price in the market.
There are no buying and selling costs.
What should the minimum transfer price be?
Marginal cost
This will be the very minimum that the selling division will accept
This will be preferred and considered fair price by the buying division
What should the maximum transfer price be?
Either the external market price
or the Net marginal revenue
If the selling division does not have spare capacity, how does this affect the minimum transfer price?
The minimum transfer price should include the opportunity cost, as well as the marginal cost
How should the market price be adjusted?
Since there will be no delivery and marketing costs, this should be deducted from the market price
What is the buying divisions preferred transfer price?
Marginal cost
What is the selling divisions preferred transfer price?
The full cost
They will want to recognize a profit (if they are a profit center), so they would prefer a full cost + % profit
What is the effect of taxation in international transfer pricing?
If the buying and selling divisions are based in different countries, different tax rates allows the manipulation of profit through the use of transfer pricing
What is the effect of remittance controls in international transfer pricing?
The government can impose restrictions on the transfer profits from domestic subsidiaries to foreign multinationals
Block on the remittance of dividends
i.e. it limits the payment of dividends to the parent company’s shareholders
