Wk 7 Transfer price

Question 1

Define transfer price

Answer 1

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 and control within an organisation

Question 2

Discuss the ideal transfer price - opportunity costs. Define fixed costs vs variable costs

Answer 2

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.

Question 3

List the 5 alternative methods of transfer prices

Answer 3

COST BASED - Based on an element of cost of goods. eg Variable, fixed, depending on ext demand.
Pros - seller regains some fixed costs if forced to sell int
Cons - Encourages outsourcing, can pass on fixed costs

DUAL RATE - seller charges market, buying dept pays variable.
Pros - motivates both managers behaviour
Cons - Over states profit at sub unit level.

MARKET BASED - requires perfect competition, based on perception of market value
Pros - maintains sellers profitability
Cons - Hides underlying costs.

ACTIVITY BASED - purchaser charged for unit/batch costs + fee/% fixed costs
Pros - seller regains proportion fixed costs, takes accurate order
Cons - commits buyer

NEGOTIATED COSTS - agreement between buyer and seller
Pros - fairer way to determine price between the two
Cons - relies on negotiation skills of managers, takes time, can result in sub optimal decisions

Question 4

Discuss congruence problems regarding transfer price & management conflict.

Answer 4

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.

Question 5

List the strategic issues associated with transfer pricing

OCWISH

Answer 5

Outsourcing vs internal supply
Competition between cost centres
Which price method
I/national tax considerations
Support service & corporate cost shring
Higher transfer prices encourage outsourcing

Question 6

Define outsourcing & why outsource

RAIL

Answer 6

finding outside vendors for products / services

Why outsource?
• Costs
• Affects degree of vertical specialisation
• Influences resource allocation
• Lowers investment in value chain and so, exposure to risk

Question 7

When would you consider outsourcing?

Answer 7

• Rapid tech change
• Dynamic market with frequent new products
• Seasonal markets
• Cyclical markets
• Inconsistent workloads
• Cost cutting
• Policy

Question 8

What are the risks of outsourcing?

QACC

Answer 8

Loss of:
•	Quality
•	Access to suppliers
•	Competence
•	Control

Question 9

What would be the minimum acceptable transfer price from the POV of the selling division?

Answer 9

Variable costs plus contribution margin lost by selling internally.
Note: margin dependant on demand