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Chapter 15 - Transfer Pricing

Chapter 15Transfer Pricing

Learning Objectives

1. Explain the basic issues associated ith transfer pricing.

!. Explain the general transfer pricing rules and understand the underl"ing basis for the#.

$. %dentif" the behavioral issues and incentive effects of negotiated transfer prices& cost-based transfer prices& and #ar'et-based transfer prices.

(. Explain the econo#ic conse)uences of #ultinational transfer prices.

5. *escribe the role of transfer prices in seg#ent reporting.

Chapter Outline

%. +,T % T/0E/ P/%C%02 0* +,3 % %T %4PO/T0T%%. *ETE/4%0%02 T,E OPT%4L T/0E/ P/%CE

. The setting6. *eter#ining hether a transfer price is opti#al

1. Case 17 perfect inter#ediate #ar'et for +ood

!. Case !7 0o inter#ediate #ar'et%%%. OPT%4L T/0E/ P/%CE7 2E0E/L P/%0C%PLE8 Other #ar'et conditions

%9. PPL3%02 T,E 2E0E/L P/%0C%PLE9. ,O+ TO ,ELP 402E/ C,%E9E T,E%/ 2OL +,%LE C,%E9%02

T,E O/20%:T%O0; 2OL9%. TOP 402E4E0T %0TE/9E0T%O0 %0 T/0E/ P/%C%029%%. CE0T/LL3 ET6L%,E* T/0E/ P/%C%02 POL%C%E

. Establishing a #ar'et price polic"6. Establishing a cost-basis polic"C. lternative cost #easures

1. ull absorption cost-based transfers!. Cost-plus transfers$. tandard costs or actual costs

*. /e#ed"ing #otivational proble#s of transfer pricing policies< *ual transfer prices

9%%%. 0E2OT%T%02 T,E T/0E/ P/%CE%=. %4PE/ECT 4/>ET

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distribution in an" #anner. This docu#ent #a" not be copied& scanned& duplicated& forarded& distributed& or posted on a ebsite& inhole or part.

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=. 2LO6L P/CT%CE=%. 4BLT%0T%O0L T/0E/ P/%C%02=%%. E24E0T /EPO/T%02=%%%. B44/3

=%9. PPE0*%=7 CE 1 PE/ECT %0TE/4E*%TE 4/>ET DBL%T3*%E/E0CE

>e" Concepts

LO 15-1 Explain the basic issues associated with transfer pricing.

8 *ecentraliAation in the fir# is often beneficial because it loers infor#ation costs associatedith atte#pting to #a'e decisions centrall" and because the organiAation benefits fro# using

#anagers; local 'noledge.

< /ecall that decentraliAation is the delegation of decision-#a'ing authorit" tosubordinates.

< long ith the benefits of decentraliAation co#e the costs of d"sfunctional decision#a'ing that occur hen local #anagers& #a'ing decisions based on local interests& #a'echoices that are subopti#al for the organiAation as a hole.

< co##on d"sfunctional behavior arises hen business units divisionsF ithin theorganiAation bu" goods and services fro# one another and hen each is treated as a

profit center i.e.& hen each unit #anager is evaluated on reported unit profitF.

< The accounting s"ste#s in the to divisions record the transaction as if it ere anordinar" sale purchaseF to fro#F an external custo#er supplierF.

< Transfer priceis the value assigned to the goods or services sold or rented transferredFfro# one unit of an organiAation to another. Transfer price is the price at hich thetransaction beteen the divisions is recorded.

< 6ecause the exchange ta'es place ithin the organiAation& the fir# has considerablediscretion in setting the transfer price.

< Transfer prices are idel" used for decision #a'ing& product costing& and perfor#anceevaluation. %t is i#portant to consider alternative transfer pricing #ethods and theiradvantages and disadvantages.

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< 6ecause the #anagers of both the selling division and bu"ing division are evaluated ondivision profit& the" consider the effect of all sales& not just sales to custo#ers outside theco#pan"& on their division& not co#pan" profit.

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< The definition of the transfer price can affect corporate profitabilit".

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LO 15-2 Explain the general transfer pricing rules and understand the

underlying basis for them.

8 The transfer price is a device to #otivate #anagers to act in the best interests of the co#pan".

< >eeping separate accounting records and using transfer prices to record exchangesa#ong divisions allo fir#s to delegate decisions to local #anagers hile holding the#responsible for divisional perfor#ance.

< There #a" be an intermediate marketfor the 'ind of outputs delivered b" the sellingdivision. The bu"ing division #a" also purchase these ite#s fro# the inter#ediate#ar'et& but it sells its products in the final #ar'et& as shon in Exhibit 15.!.

elling *ivision2oods or services

6u"ing *ivision inal 4ar'et

Transfer price

%nter#ediate4ar'et

< There is a si#ple test& an application of the differential profitabilit" anal"sis discussed

in Chapter (& to deter#ine hether the calculated transfer price is opti#al.

1F 2iven the #ar'et prices and the costs in the fir#& does the transfer increase fir#profit

!F 2iven the transfer price& the inter#ediate #ar'et prices& and the divisional costs& doesthe transfer increase the selling division profit

$F 2iven the transfer price& the final #ar'et prices& and the divisional costs& does thetransfer increase the bu"ing division profit

< %f the anser to the first )uestion is K"es& the ansers to )uestions ! and $ #ust also beK"es or the transfer price is not opti#al. %f the anser to the first )uestion is Kno& theanser to either )uestion ! or $ or bothF #ust be Kno or the transfer price is not

opti#al.

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Exa#ple ! /evised fro# Exa#ple 1F7 %t costs the selling division JM@ to produce oneunit of a co#ponent hich& if transferred to the bu"ing division& re)uires additionalor' costing J(5 and can be sold to outside custo#ers for J1@@ per unit of the finished

product. ssu#e that the transfer price in )uestion is TP. Then

elling division;s profit F H TP - [email protected]"ing division;s profit 6F H J1@@ TP - J(5.Total profit for the fir# H TP - JM@F I J1@@ TP - J(5F H -J5.

+hatever the transfer price is& the fir# ill suffer a loss of J5 per unit. The internaltransfer is better called off since the anser to the first )uestion above is Kno.

< %n deter#ining the opti#al transfer price& the i#portant issue is the nature of the

inter#ediate #ar'et here the goods are being transferred. To cases are considered7

1F perfect inter#ediate #ar'et& and!F 0o inter#ediate #ar'et.

8 #ar'et is perfect if bu"ers can bu" and sellers can sell an" )uantit" ithout affecting theprice.

< The product being sold in a perfect #ar'et is not differentiated b" )ualit"& service& orother characteristics.

< The parties in a perfect #ar'et are Kprice ta'ers.

< The opti#al transfer price in a perfect inter#ediate #ar'et is the inter#ediateF #ar'etprice.

< t an" price loer than the inter#ediate #ar'et price& the selling division ill suppl"no output to the bu"ing division. t an" higher price& the bu"ing division ill notpurchase an" output fro# the selling division.

< 2iven the opti#al transfer price& the to division #anagers acting independentl" ill#a'e the transfer that the corporate staff ould set if it had all the infor#ation that thedivision #anagers have.

< +ith an efficient transfer pricing s"ste# li'e this& hen external #ar'ets bothinter#ediate and finalF change& there is no need to change the transfer price polic".

8 %f there is no inter#ediate #ar'et for the goods being transferred& or the co#pan" has decidedthat it ill not allo the divisions to bu" or sell the ite#s externall"& then the onl" outlet for the

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selling division is the bu"ing division& and the onl" source of suppl" for the bu"ing division isthe selling division.

< t an" transfer price belo the variable cost in the selling division& no transfers illta'e place because the selling division ill lose #one" on each unit sold.

< t an" transfer price above the final #ar'et price less the otherF variable cost of thebu"ing division& no transfers ill ta'e place.

< To be the opti#al transfer price in general& it cannot depend on the current externalprice.

< %n this case& the onl" price that ill or'& for all possible external #ar'et prices& is thevariable cost of the selling division& assu#ing it is not operating at capacit".

< The fixed costs of the selling division ill be incurred i.e.& unavoidableF regardless of

hether the transfer is #ade& and is irrelevant for the decision.

Exa#ple $ /evised fro# Exa#ple 1F7 %t costs the selling division J!@ variable costonl"F to produce one unit of a co#ponent hich& if transferred to the bu"ing division&re)uires additional or' costing J(5 and can be sold to outside custo#ers for J1@@ perunit of the finished product. There is no inter#ediate #ar'et for the co#ponent in)uestion.

The selling division;s fixed cost is not a factor because it is unavoidable therefore not

differentialF. The selling division ill not accept a transfer price belo J!@& thevariable cost per unit.

2iven the final #ar'et price of J1@@ and the additional cost of J(5 to #a'e theco#ponent salable& the bu"ing division ill not pa" #ore than J55 for the part.

%f the final #ar'et price drops to JM5 H selling division;s variable cost of J!@ I bu"ingdivision;s additional cost of J(5F or loer& no internal transfer should ta'e place as thefir# ill suffer a loss.

+ith a final #ar'et price of JM5 or #ore& the internal transfer benefits the fir#. Theopti#al transfer price should be set at the variable cost of the selling division to ensurestead" exchanges beteen the to divisions.

8 The transfer price that is opti#al represents the value of the goods being transferred to thebu"ing division at the transfer point.

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< general principle on setting the transfer price that leads #anagers to #a'e decisionsin the fir#;s best interests is7

Transferprice H Outla"costa I Opportunit" cost of the resourceat the point of transfer.b

a The incre#ental cost to produce the good being transferred and bring it to the point oftransfer.

b The opportunit" cost of choosing to transfer internall" and not sell it on the outsideinter#ediateF #ar'et.

< %n the case of a perfect inter#ediate #ar'et& the value to the bu"ing division is e)ual tohat it can be sold for in the inter#ediate #ar'et i.e.& inter#ediate #ar'et priceF.

< %f there is no inter#ediate #ar'et& there is no opportunit" cost and the onl" cost is thevariable& or outla" cost. The transfer price should be set accordingl".

< %f the selling division is operating at capacit" and there is a #ar'et for the goods beingtransferred& the #ar'et price of the goods should be used.

< %f the selling division is operating at capacit" and there is no inter#ediate #ar'et& thenthe opportunit" cost depends on the cost of adding capacit".

< %f the inter#ediate #ar'et is i#perfect& the opti#al transfer price is still the outla" costplus the opportunit" cost. ,oever& in this case the opportunit" cost is less than thecurrent inter#ediate #ar'et price less the outla" cost.

8 The general principle can be easil" applied ith the folloing to general rules henestablishing a transfer price.

1F %f an inter#ediate #ar'et exists& the opti#al transfer price is the #ar'et price.

!F %f no inter#ediate #ar'et exists& the opti#al transfer price should be the outla" costfor producing the goods generall"& the variable costsF.

< This transfer price ensures that if the #anagers #a'e the correct decision for theirdivisions& the result transfer or no transferF ill also be the correct decision for the fir#.

HHHHHHHHHHHHHHHHHHHHHH

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*e#onstration Proble# 1

#anufacturing co#pan" has to divisions7 4otor and Pu#p. The 4otor *ivision produces aninter#ediate good& #otors& that can be used as an input for the Pu#p *ivision. The 4otor

*ivision also sells the #otors in the open #ar'et. The Pu#p *ivision secures the #otors fro#either the 4otor *ivision or an outside supplier and asse#bles the parts together to #a'e aterpu#ps hich are sold to the consu#ers. The Pu#p *ivision needs an average of 1@&@@@ #otorsever" "ear. The folloing infor#ation is available.

otor

!i"ision

#ump

!i"ision

elling price J!@ elling price J@9ariable cost 1! 9ariable cost other than the #otorF $@

Contribution #argin J9ariable cost of the #otorpurchased fro# an outside supplierF 1

Contribution #argin J$1

/e)uired7*iscuss the possible transfer prices under each of the folloing independent situations.1. The 4otor *ivision sells all it can produce @&@@@ #otorsF to the outside custo#ers.!. The 4otor *ivision can produce @&@@@ #otors but sells onl" M5&@@@ #otors to the

outsider custo#ers.$. The Pu#p *ivision re)uires a custo#iAed version of the #otors that onl" the 4otor

*ivision can suppl". The variable cost for the 4otor *ivision ould be J!! per #otor.The 4otor *ivision is running at capacit".

(. The Pu#p *ivision re)uires a custo#iAed version of the #otors that onl" the 4otor

*ivision can suppl". The variable cost for the 4otor *ivision ould be J!! per #otor.The 4otor *ivision has the excess capacit" to handle the Pu#p *ivision;s de#and.

olution71. ince the 4otor *ivision is operating at capacit"& the onl" transfer price that is

acceptable is the inter#ediate #ar'et price of J!@& hich is the su# of the outla" costJ1!F and the opportunit" cost at the point of transfer J& the contribution #argin lostdue to internal transferF. The Pu#p *ivision& on the other hand& gets its #otors fro# anoutsider supplier for J1 per unit and is not li'el" to give up the source. There ill be notransfers beteen the 4otor *ivision and the Pu#p *ivision.

!. ince the 4otor *ivision has excess capacit"& it ill accept a price that at least covers thevariable cost of J1! per #otor. There is no opportunit" cost in this situation. The Pu#p*ivision currentl" pa"s J1 per #otor fro# an outsider supplier. o a transfer pricebeteen J1! and J1 ill benefit both divisions.

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$. ince the 4otor *ivision is operating at capacit"& it ill not accept an" price less thanJ$@& hich is the su# of the outla" cost J!!F and the opportunit" cost at the point oftransfer J& the contribution #argin lost due to internal transferF. The Pu#p *ivisionill have to pa" at least J$@ each as this is the onl" source for the custo#iAed #otors.

(. ince the 4otor *ivision has excess capacit"& it ill accept a price that at least covers thevariable cost of J!! per #otor. There is no opportunit" cost in this situation. The Pu#p*ivision #a" even pa" a nor#al #ar'up just to secure these pu#ps.


LO 15-$ %dentify the beha"ioral issues and incenti"e effects of negotiated

transfer prices& cost-based transfer prices& and mar'et-based

transfer prices.

8 conflict can occur beteen a co#pan";s interests and the divisional #anager;s interestshen transfer price-based perfor#ance #easures are used.

< The general transfer pricing rules are eas" to state but difficult to appl" in practice.

< There are three general approaches to this t"pe of proble# in a decentraliAedorganiAation7

1F *irect intervention b" top #anage#ent&

!F Centrall" established transfer price policies& and$F 0egotiated transfer prices.

8 %f the transfer is an extraordinaril" large order& or if internal transfers are rare& directintervention could be the best solution to the proble#.

< The disadvantages of direct intervention are that

1F top #anage#ent #a" beco#e sa#ped ith pricing disputes& and!F individual division #anagers ill lose the flexibilit" and other advantages of

autono#ous decision #a'ing& the benefits fro# decentraliAation.

< s long as transfer pricing proble#s are infre)uent& the benefits of direct interventioncould outeigh the costs.

8 transfer pricing polic" should allo divisional autono#" "et encourage #anagers to pursuecorporate goals consistent ith their division goals. The polic" should also consider the



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perfor#ance evaluation s"ste# used and the i#pact that alternative transfer prices ill have on#anagerial perfor#ance evaluation.

< Corporate #anagers have to econo#ic bases on hich to establish transfer pricepolicies7 #ar'et prices and cost.

< ar'et price-based transfer pricingis a transfer pricing polic" that sets the transferprice at the #ar'et price or at a s#all discount fro# the #ar'et price.

< To general guidelines for #ar'et price-based transfer pricing are7

1F The transfer price is usuall" set at a discount fro# the cost to ac)uire the ite# on theopen #ar'et.

!F The selling division #a" elect to transfer or to continue to sell to the outside.

< Externall" based #ar'et prices are generall" considered the best basis for transferpricing hen a co#petitive #ar'et exists for the product and hen #ar'et prices arereadil" available.

< Bsuall"& there are differences beteen products produced internall" and those that canbe purchased fro# outsiders& such as costs& )ualit"& or product characteristics.

< n advantage of #ar'et prices is that both the bu"ing and selling divisions areindifferent as to trading ith each other or ith outsiders& as long as the selling divisionis not operating at capacit".

< +hen such advantages exist& it is in the co#pan";s interest to create incentives forinternal transfer.

< cost-based transfer pricing polic" should adhere to the folloing rule7

Transfer at the differential outla" cost to the selling division t"picall" variable costsFplus the foregone contribution to the co#pan" of #a'ing the internal transfers J@ if theseller has idle capacit"G selling price #inus the variable costs if the seller is operating atcapacit"F.

8 The transfer pricing rule can be i#ple#ented as follos7

1F seller operating belo capacit" should transfer at the differential cost of productionvariable costF.

!F seller operating at capacit" should transfer at the #ar'et price.

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< The general rule is opti#al for the co#pan"& but it does not benefit the selling divisionfor an internal transfer in the belo-capacit" case.

< +hen a #easure of differential or variable cost& or #ar'et price is not available&

co#panies usuall" use full absorption costs as the transfer price.

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< This s"ste# ould preserve the cost data for subse)uent bu"er divisions and ouldencourage internal transfers b" providing a profit on such transfers for the sellingdivisions.

Exa#ple ( /evised fro# Exa#ple 1F7 %t costs the selling division J!@ to produce oneunit of a co#ponent hich& if transferred to the bu"ing division& re)uires additionalor' costing J(5 and can be sold to outside custo#ers for J1@@ per unit of the finishedproduct.

To encourage internal transfers& the co#pan" decides to i#ple#ent a dual transferpricing s"ste# in hich the bu"ing division is charged for the J!@ cost hile theselling division is credited ith a J$ profit alloance. On a per-unit basis&

elling division;s profit F H J!@ I J$F - J!@ H J$.

6u"ing division;s profit 6F H J1@@ - J!@ - J(5 H J$5.Total profit for the fir# H J1@@ - J!@ - J(5 H J$5 Q J$ I J$5.

The su# of the to divisions; profits J$F is not e)ual to the fir#;s total profit J$5F.The journal entries recorded b" the to divisions tell the stor".

)elling di"ision*

R/ 6u"ing division !@%nterco#pan" sales in excess of assigned costs $ %nterco#pan" sales !$

%nterco#pan" cost of goods sold !@ inished goods !@

+uying di"ision*

%nventor" !@ RP elling division !@

< *isadvantages of dual price s"ste# are7

1F %t reduces the value of the transfer price as a signal to division #anagers of the valueof the inter#ediate goods to the fir#& and

!F %t also tends to re#ove so#e of the perfor#ance evaluation value because both#anagers benefit and the difference in the central account is ignored.

8 ,egotiated transfer pricingis a s"ste# that arrives at the transfer prices through negotiationbeteen #anagers of bu"ing and selling divisions.

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< The #anagers involved in negotiation should act in #uch the sa#e a" as the #anagersof independent fir#s.

< The negotiated prices are generall" beteen the #ar'et price at the upper li#it andso#e #easure of cost at the loer li#it.

< The #ajor advantage to negotiated transfer pricing is that it preserves the autono#" ofthe division #anagers.

< To disadvantages of negotiated transfer pricing are7

1F great deal of #anage#ent effort #a" be consu#ed in the negotiating process& and

!F The final price and its i#plications for perfor#ance #easure#ent could depend #ore

on the #anager;s abilit" to negotiate than on hat is best for the co#pan".


*e#onstration Proble# !/evised fro# *e#onstration Proble# 1F

#anufacturing co#pan" has to divisions7 4otor and Pu#p. The 4otor *ivision produces aninter#ediate good& #otors& that can be used as an input for the Pu#p *ivision. The Pu#p*ivision asse#bles the parts together to #a'e ater pu#ps hich are sold to the consu#ers. ThePu#p *ivision needs an average of 1@&@@@ #otors ever" "ear. The folloing infor#ation is

available.

otor

!i"ision

#ump

!i"ision

elling price J@9ariable #anufacturing cost 1! $@Transferred-in cost 9ariable overhead ! 15ixed overhead $

/e)uired7Calculate divisional operating inco#e and total operating inco#e given the folloingindependent transfer pricing policies.1. 4ar'et-based transfer price of J!@ per #otor.!. Cost-based transfer price at 1@5S of the full absorption cost per #otor.$. 0egotiated transfer price of J1.5 per #otor.



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$.

otor

!i"ision

#ump

!i"ision

/evenues J15&5@@ J@@&@@@Costs7 9ariable #anufacturing cost 1!@&@@@ $@@&@@@ Transferred-in cost 15&5@@ 9ariable overhead !@&@@@ 15@&@@@ ixed overhead $@&@@@ @&@@@

*ivisional operating inco#e J15&5@@ JN(&5@@

Total operating inco#e J@&@@@

(.

otor!i"ision

#ump!i"ision

/evenues J1N&5@@ J@@&@@@Costs7 9ariable #anufacturing cost 1!@&@@@ $@@&@@@ Transferred-in cost 1!@&@@@ 9ariable overhead !@&@@@ 15@&@@@ ixed overhead $@&@@@ @&@@@

*ivisional operating inco#e J&5@@ J1(@&@@@

Total operating inco#e J@&@@@a

a %ntraco#pan" sales in excess of assigned cost H J1N&5@@ - J1!@&@@@ H J5&5@@. J&5@@ I J1(@&@@@ J5&5@@ H J@&@@@.


8 4anage#ent tends to settle for a transfer pricing s"ste# that see#s to or' reasonabl" ellhen both the costs and benefits of the s"ste# are considered.

< %n Exhibit 15.5& surve" data shoed that nearl" 5@ percent of the B.. co#panies used acost-based transfer pricing s"ste#& $$ percent used a #ar'et price-based s"ste#& and !!percent used a negotiated s"ste#.

< 0o transfer pricing polic" applied in practice is li'el" to do#inate all others.

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LO 15- Explain the economic conseuences of multinational transfer

prices.

8 %n international or interstateF transactions& transfer prices #a" affect tax liabilities& ro"alties&and other pa"#ents because of different las in different countries or states or provincesF.

< 4anage#ent control considerations suggest that the transfer price reflect the value ofthe goods or services being transferred.

< Co#panies have incentives to set transfer prices that ill increase revenues and profitsFin lo-tax countries and increase costs thereb" reducing profitsF in high-tax countries.

< %nternational taxing authorities loo' closel" at transfer prices hen exa#ining thereturns of co#panies engaged in related-part" transactions that cross national boundaries.

< Co#panies #ust have ade)uate support to justif" the use of the transfer price that the"have chosen.


*e#onstration Proble# $/evised fro# *e#onstration Proble# !F

#anufacturing co#pan" has to divisions7 4otor and Pu#p. The 4otor *ivision is located ina lo tax countr" Tax rate H !5SF and produces an inter#ediate good& #otors& that can be used

as an input for the Pu#p *ivision. The Pu#p *ivision is located in a high tax countr" Tax rateH (@SF and asse#bles the parts together to #a'e ater pu#ps hich are sold to the outsidecusto#ers. The Pu#p *ivision needs an average of 1@&@@@ #otors ever" "ear. The folloinginfor#ation is available.

otor

!i"ision

#ump

!i"ision

elling price J@9ariable #anufacturing cost 1! $@Transferred-in cost 9ariable overhead ! 15

ixed overhead $

/e)uired7Calculate divisional operating inco#e and total operating inco#e and discuss taxi#plications& given the folloing independent transfer pricing policies.1. 4ar'et-based transfer price of J!@ per #otor.



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!. Cost-based transfer price at 1@5S of the full absorption cost per #otor.$. 0egotiated transfer price of J1.5 per #otor.

olution7

ar'et-basedtransfer price

/ 02

(ost-basedtransfer price

/ 01.35

,egotiatedtransfer price

/ 013.5

otor !i"ision

/evenues $200,000 $178,500 $185,500Costs7 9ariable #anufacturing cost 1!@&@@@ 1!@&@@@ 1!@&@@@ 9ariable overhead !@&@@@ !@&@@@ !@&@@@ ixed overhead $@&@@@ $@&@@@ $@&@@@*ivisional inco#e before tax J$@&@@@ J&5@@ J15&5@@

%nco#e tax !5SF N&5@@ !&1!5 $&N5

*ivisional inco#e J!!&5@@ JM&$N5 J11&M!5

ar'et-based

transfer price

/ 02

(ost-based

transfer price

/ 01.35

,egotiated

transfer price

/ 013.5

#ump !i"ision

/evenues J@@&@@@ J@@&@@@ J@@&@@@Costs7 9ariable #anufacturing cost $@@&@@@ $@@&@@@ $@@&@@@ Transferred-in cost 200,000 178,500 185,500

9ariable overhead 15@&@@@ 15@&@@@ 15@&@@@ ixed overhead @&@@@ @&@@@ @&@@@

*ivisional inco#e before tax JM@&@@@ J1&5@@ JN(&5@@%nco#e tax (@SF !(&@@@ $!&M@@ !&@@

*ivisional inco#e J$M&@@@ J(&@@ J((&N@@

Total inco#e J5&5@@ J55&!N5 J5M&$!5

%f the selling division is located in a lo-tax countr" relative to the bu"ing divisionF& the#anage#ent has the incentive to set the transfer price high to increase revenue of the sellingdivision hile reducing the tax burden of the bu"ing division.

On the other hand& if the selling division is located in a high-tax countr" relative to thebu"ing divisionF& then the #anage#ent ill loer the transfer price to reduce the tax burdenin the selling division hile increasing the profit of the bu"ing division.




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Exa#ple 5 /evised fro# Exa#ple 1F7 %t costs the selling division J!@ to produce oneunit of a co#ponent hich& if transferred to the bu"ing division& re)uires additionalor' costing J(5 and can be sold to outside custo#ers for J1@@ per unit of the finished

product.

The co#ponent in )uestion has to grades& grade % betterF and grade %%. ssu#e thateither grade is suitable for the bu"ing division and that there are perfect #ar'ets for theto different grades. The inter#ediate #ar'et price for grade % is J5@ and theinter#ediate #ar'et price for grade %% is J(@ per unit. The selling division specialiAes ingrade % co#ponents.

%f the division #anagers are alloed to choose here to bu" and sell the co#ponents&the selling division ill sell its outputs on the inter#ediate grade %F #ar'et for J5@&and the bu"ing division ill bu" its co#ponents needed on the inter#ediate grade %%F

#ar'et for J(@. 0o transfers ill be #ade since the opti#al transfer price in this case isJ5@& and the co#pan" benefits fro# the #anagers; independent decisions.

4atching

. Cost-plus transfer pricing

6. *ual transfer pricingC. 4ar'et price-based transfer pricing*. 0egotiated transfer pricingE. Transfer price

UUUUU 1. The value assigned to the goods or services sold or rented transferredF fro# one unitof an organiAation to another.

UUUUU !. s"ste# that arrives at the transfer prices through negotiation beteen #anagers ofbu"ing and selling divisions.

UUUUU $. transfer pricing s"ste# that charges the bu"ing division ith costs onl" and creditsthe selling division ith cost plus so#e profit alloance.

UUUUU (. transfer pricing polic" that sets the transfer price at the #ar'et price or at a s#alldiscount fro# the #ar'et price.

15-!1? !@1( b" 4c2ra-,ill Education. This is proprietar" #aterial solel" for authoriAed instructor use. 0ot authoriAed for sale or


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UUUUU 5. transfer pricing polic" based on a #easure of cost full costing or variable costing&actual or standard costF plus an alloance for profit.

nsers

1. E

!. *

$. 6

(. C

5.

4ultiple Choice

1. Transfer pricea. %s the value assigned to the goods or services sold fro# one unit of anorganiAation to another.b. /epresents a cost to the selling division.c. +ill affect the co#pan";s total profits.d. %s the sa#e as the #ar'et price.

!. #ar'et is perfect if a. The bu"ers can bu" at an" )uantit" ithout affecting the price.b. The sellers can sell at an" )uantit" ithout affecting the price.c. The parties in the #ar'et are price ta'ers.

d. ll of the above.

$. +hich of the folloing state#ents is incorrecta. %f an inter#ediate #ar'et exists& the opti#al transfer price is the #ar'et price.b. %f no inter#ediate #ar'et exists& the opti#al transfer price should be the outla" cost for

producing the goods.

15-!!? !@1( b" 4c2ra-,ill Education. This is proprietar" #aterial solel" for authoriAed instructor use. 0ot authoriAed for sale or


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nsers

1. a LO1

!. d LO!

$. c LO!

(. d LO$

5. d LO!

J1 - JM H J1!.

M. d LO!

N. b LO!

J15 - J! - J5 H J.

. b LO!

The 4otor *ivision losses the contribution #argin of J per unit hile the Pu#p *ivisiongains JN per unit fro# internal transfer H J1 - J1!F. The net loss is J1 per unit.

. a LO!

+ith excess capacit"& the 4otor *ivision does not suffer fro# an" contribution #argin losthile the Pu#p *ivision benefits fro# internal transfer b" JN. The net result is a gain of JNper unit.

1@. d LO5

11. d LO$

1!. c LO$

15-!5? !@1( b" 4c2ra-,ill Education. This is proprietar" #aterial solel" for authoriAed instructor use. 0ot authoriAed for sale or

distribution in an" #anner. This docu#ent #a" not be copied& scanned& duplicated& forarded& distributed& or posted on a ebsite& inhole or part

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IMChap015

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