W9 - Transfer Pricing

Question 1

Objectives of transfer pricing
5

Answer 1

Provide supplying division with a realistic revenue

Provide receiving division with a realistic cost

Give autonomy to managers

Ensure profit maximisation for the company as a whole

Used to intentionally move taxable profits to divisions in different companies

Question 2

Assessing whether division should sell at a given price:

Division A has £10 VC and £5 FC

Division B has VC of £15, FC of £10 and buys the good from Div. A at a transfer price of £20. They receive an offer to buy each unit for £30, should Division B accept?

Answer 2

This is short-term decision making, which we use CONTRIBUTION for. So, we ignore Fixed Costs ,’, variable costs are £35.

Thus, Div. B should not accept the deal as Contribution would be negative (£30-£35)

Question 3

Is this the correct decision from the COMPANY’S POV if division A has surplus capacity?

Answer 3

Ignore the transfer pricing and all FC, as the transfer pricing is irrelevant to firm’s overall profit, and FC are irrelevant

All to consider is Div.A £10 VC and Div. B £15 VC = £25

£30 is greater than this so we ACCEPT

Question 4

4 Methods of Transfer Pricing

Answer 4

Market price

Cost plus pricing:

Two-part transfer price

Dual pricing

Question 5

Two-Part Transfer Price Method
& Pros & Cons

Answer 5

Find total contribution and then allocate according to the question e.g. 20:15 split between divisions

Pros: Goal congruence

Cons: Manufacturing division can never make profit

Question 6

Dual pricing

Answer 6

Supplying & receiving divs report DIFFERENT transfer prices - Receiving div. records TP at standard VC, Supplying div. reports TP at a higher value e.g. cost-plus

Pros: Goal congruence for acceptance of transfers

Cons: Poor cost control as profits are made more easily
Can’t add the two divisions profit to get total profit, unpopular as a result