Transfer Pricing And Performance Management Flashcards
What is the key issue of transfer pricing?
Goal congruence
Organizations segment their operations in order to gain effective control. List the types of segments within a organization.
- cost centre
- Revenue centre
- Profit centre
- Investment centre
What is performance evaluation?
Subjective process of judging the quality of performance performed by managers.
What is a revenue centre?
It specializes in the sale and delivery of products or services.
How is a revenue centre evaluated?
It is evaluated on the basis of revenue generated
What is a cost centre?
It produces a product or service. The manager is responsible for costs.
How is a cost centre evaluated?
On the basis of the cost and the long term measures
What is an investment centre and how is it evaluated?
It produces, sell and invest in current and long term assets. They are held responsible for maintaining an adequate ROI. Long term performance is very important in evaluating an investment centre.
What is divisionalisation?
Dividing the organization into different divisions across various product lines. Each division would function independently as a profit or an investment centre under the control of a divisional manager.
What are some issues surrounding transfer pricing?
- The transfer price is a source of income for the transferring division. The higher the price the higher the profit generated by that division
- The transfer price is a cost for the receiving division. They will strive towards the minimization of costs therefore the lower the price paid the higher the profit
- The transfer price that is set must be consistent with the company’s objective of profit maximization
What will complicate the transfer pricing decision?
- The existence of capacity constraint on the transferring division
- The ability to acquire the product transferred on the open market
What is a transfer price?
A range of prices that ensures that company wide contribution is maximized (best interest of the company as a whole)
What are the three objectives of transfer pricing system?
- The price set must encourage goal congruence
- The transfer pricing system must facilitate measurement of performance
- The division should function autonomously
What is the fundamental of transfer pricing?
In setting transfer pricing, on,y variable costs are fixed and the transfer price set will not have an impact on the amount of fixed costs incurred. Therefore transfer price computations are based in contribution.
What is the minimum transfer price?
Price that is acceptable to the transferring division, and out of a range of acceptable prices, it is the one that would be the best for the company
What is the formula for minimum transfer price?
Minimum transfer price = variable costs -internal savings + opportunity costs
If there is no market in which the transferring department can sell its product, such a division will function as a cost centre, what would be the acceptable transfer price?
The acceptable price will be the variable costs
What is the principle for minimum price for a cost centre with no intermediates market or capacity constraint?
When the transferring division is a cost centre, the minimum acceptable price for the transferring division will be calculated as the variable cost per unit.
However, if an intermediate market exist in which the product being transferred can be sold, and there are not capacity constraints, what would be the minimum acceptable price?
The minimum acceptable acceptable price would be at least coverage of the variable cost of making the product.
The variable cost of a product transferred internally may be lower than the cost of making a product to be sold externally, why?
As a result of savings in packaging and selling cost
When there is a capacity constraint, what would be minimum acceptable price?
Whenever there are production constraints, the transfer price is set as follow:
Variable costs per unit + loss contribution expressed into unit transferred
What are some factors that could affect the maximum transfer price?
- The receiving division’s contribution per unit before acquiring the transferred
- Whether or not the required input can be acquired from the open market. The maximum acceptable price could be limited by the market price.
What is the basic principle for maximum transfer price?
- The division manager of the receiving division will be satisfied with the price quoted by another division as long as he is not generating a lower contribution than before
- The maximum acceptable transfer price is calculated as the indifference point between the position before and after selling the final product
- Whenever the buying division can acquire the same input externally for less, the maximum price calculated per the indifference formula must be limited to the market price of the input
- The maximum transfer price is calculated as the indifference point between the first and second best alternatives
What would be the contribution generated before?
- If the division sells another product on the market, then it will be the contribution generated from the sale of that product on the market
- If the division is new, then any product that it chooses to manufacture should at least yield a contribution. But the maximum point will be where the division adds no value to the company. I.e. generates zero contribution. Fixed costs will have to be covered too.
