Week 7 - transfer pricing Flashcards
Define transfer price
Transfer price - the price used to record revenue and cost when goods or services are transferred between responsibility centres in an entity
Facilitiates cost determination & control within an organisation
Discuss the ideal transfer price - opportunity costs. Define fixed costs vs variable costs
The perfect transfer price would be the opportunity cost of transferring goods and services internally.
External demand and available capacity determine the price in this case.
Rarely used as they vary over time.
Fixed costs = constant costs that are independent of output. eg rent, buildings, machinery, etc.
Variable costs = vary with output. Generally variable costs increase at a constant rate relative to labor and capital. Variable costs may include wages, utilities, materials used in production, etc.
List the 5 alternative methods of transfer prices
COST BASED - Based on an element of cost of good. Variable, fixed, etc.
Cons - Encourages outsourcing
DUAL RATE - selling dept charges market, buying dept pays variable.
Cons - Over states profit at sub unit.
MARKET BASED - requires perfect competition, based on perception of market value
Cons - Hides underlying costs.
ACTIVITY BASED - purchaser charged for unit/batch costs + fee
Pros - predicts internal demand accurately
NEGOTIATED COSTS - agreement between buyer and seller
Cons - relies on negotiation skills of managers, takes time.
Outline issues associated with transfer pricing.
International income taxes - compliance issues to prevent tax fraud.
Transfer prices for support services - shared services prices as goods are.
Best transfer pricing method
Corporate costs - actitiy centres should not be responsible for costs that are not their own yet corporate costs often shed.
Discuss congruence problems regarding transfer price & management conflict.
Where remuneration is tied to sub unit performance, managers can prioritise the units performance over the organisations, leads to sub optimal decisions.
Consider capacity v demand v best interest of unit or org.
List the strategic issues associated with transfer pricing
OCWISH
Outsourcing vs internal supply Competition between cost centres Which price method I/national tax considerations Support service cost shring Higher transfer prices encourage outsourcing
Define outsourcing
finding outside vendors for products / services
- Reduces costs
- Lowers investment in value chain and so, exposure to risk
- Influences resource allocation
- Affects degree of vertical specialisation
Why would you consider outsourcing?
- Rapid tech change
- Dynamic market with frequent new products
- Seasonal markets
- Cyclical markets
- Inconsistent workloads
What are the risks of outsourcing?
Loss of: • Competence • Quality • Control • Access to suppliers
