Transfer Pricing

Question 1

What is Transfer Pricing?

Answer 1

Transfer Pricing is required within organisation when the different subsidiaries enter into financial transactions with one another

Question 2

Why do we need Transfer pricing?

Answer 2

• source of documentation for organisation that is trading on intracompany basis
• documentation allows the goods to be recorded in the accounts of both the selling & buying subsidiary
• Required for customs purposes- need correct paperwork bringing goods across borders
• Inter-company sales must be properly accounted for in FS

Question 3

The goals of Transfer Pricing

Answer 3

1. Goal congruence - negotiate in best interest of company
2. Fairness - divisions must perceive TP to be fair hence performance evaluation
3. Autonomy - system of TP maintains autonomy of divisional managers, improving motivation.
4. Bookkeeping - TP chosen should make it straight forward to record the movement of g&s between divisions

Question 4

The impacts of Transfer Pricing

Answer 4

• Performance evaluation - ROI & RI will be changed
• Performance-related pay - remuneration for employees based on new profits
• Make/abandon/buy-in decisions
• Motivation - TP must be profitable for both divisions
• Taxation & profit remittance - operating in different countries - tax on profits

Question 5

Transfer pricing ‘rules’ : no external market for the product & alternative use

Answer 5

TP = Variable cost

or

TP= VC + additional amount to cover FOH

Question 6

Transfer pricing ‘rules’ : no external market for the product & alternative use with lost contribution

Answer 6

TP = VC + any lost contribution

Question 7

Transfer pricing ‘rules’ : external market for the product

Answer 7

• supply = demand : TP = Market Price (potential adjustment for cost savings)
• supply > demand : TP = VC (minimum)(potential adjustment for cost savings)
• supply < demand : VC + lost contribution

Question 8

Data required for design of TP system

Answer 8

• Marginal/ Variable costs and incremental FC for various capacity levels (both divisions)
• External market prices if appropriate
• External brought-in prices from suppliers outside the group
• Opportunity cost from switching products
• Data on capacity position & resource requirements
• Demand situation
• Contribution

Question 9

Disadvantages of a divisionalised structure

Answer 9

• Duplication of central & divisional functions
• Dysfunctional decision making. Eg. personal interests are prioritised
• Loss of central control & Loss of goal congruence