Professional Documents
Culture Documents
Contents
Chapter 1: Introduction ...............................................................................................................1
1.1 Early Application of Transfer Pricing ................................................................................1
1.2 Purpose of transfer pricing .................................................................................................2
1.3 Limitation of Transfer Pricing ...........................................................................................3
1.4 Relevant Concepts to Understand Transfer Pricing ............................................................4
1.5 Some Basic Issues on Transfer Pricing ..............................................................................5
1.6 A General Rule for Transfer Pricing ..................................................................................5
1.7 Factors that affect Transfer Price .......................................................................................7
1.8 Possible Methods of Transfer Pricing ................................................................................7
1.9 Internal Transfer Price Illustrated ......................................................................................8
Chapter 2: Literature review ........................................................................................................9
Chapter 3: Methods of Transfer Pricing ..................................................................................... 12
3.1 Market Based Transfer Prices .......................................................................................... 12
3.1.1 Advantage of Market Based Transfer Price ............................................................... 13
3.1.2 Limitations of Market Based Transfer Price .............................................................. 13
3.2 Cost-Based Transfer Pricing ............................................................................................ 14
3.2.1 Limitation of Cost-Based Transfer Price ................................................................... 14
3.3 Negotiated Transfer Pricing ............................................................................................. 15
3.3.1Limitations of Negotiated Transfer Pricing ................................................................ 16
3.4 Administered Transfer Pricing ......................................................................................... 17
3.5 Summary of Transfer Pricing Approaches ....................................................................... 17
3.6 Transfer Prices Based on Equity Considerations .............................................................. 17
Chapter 4: Multinational Transfer Pricing ................................................................................. 19
4.1 Illustration to understand the Tax Haven and Multinational Transfer Price ...................... 21
Chapter 5: Optimum Transfer Pricing ........................................................................................ 22
5.1 Minimum Transfer Price .................................................................................................. 22
5.2 Maximum Transfer Price ................................................................................................. 22
5.3 Idle Capacity and Transfer Price ...................................................................................... 23
5.4 No Idle Capacity and Transfer Price ................................................................................ 23
5.5 Some Idle Capacity and Transfer Price ............................................................................ 24
Chapter 6: Transfer Pricing Theory ........................................................................................... 25
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Chapter 1: Introduction
Transfer prices are the price charged by one division of a company for goods or services provided
to another division of the same company. Transfer pricing involves the policies that companies set
for these intersegment transfers, the prices for the transfers, and the administration of the transfer
pricing policy. The major focus of transfer pricing in managerial accounting is the transfer of goods
or services from one investment or profit center to another investment or profit center within a
decentralized company.
Today, many companies are giant conglomerates having multiple divisions. Simply transferring
goods or services at cost no longer serves the need of these decentralized organizations. The
divisions within the same company are evaluated based on their profit, ROI and residual income.
And transfer pricing has the ability to manipulate the figure of the evaluation measurement of
respective divisions. To the division selling goods and services, the transfer price is its revenue.
To the division buying goods and services, the transfer price is its cost. Therefore, transfer prices
have a direct bearing on segment margin. Thus a major conflict occurs between divisions when
one division sell products or services to another segment.
Consider a general case where one division of a company manufactures a component that is used
by another division of the same company to produce a final product that is sold externally to the
company. Also assume that the two divisions are treated as independent investment centers and
that measures of income are used when evaluating these divisions. Thus, price that the
manufacturing division charges the buying division for the component will affect accounting
income of each division. From a corporate perspective, how-ever, the profit in any final product is
the price that product sold externally to the firm less the cost to manufacture it. While the profit
for each divisions is charges if one division pays another divisions more or less money for a part
of final product, the profit to the overall company remains unchanged since out-of-pocket costs
are unchanged. Thus, transfer pricing involves the allocation of the overall corporate profit on a
product to each of the divisions.
pricing to evaluate unit performance. The attitude reflected the history of transfer pricing General
Motors, a company built by acquiring independent companies. The objective if evaluating unit
performance and transfer pricing was to allow these formerly independent companies to maintain
their identities and their competitive edge- to allow them to operate and to be evaluated as if they
were independent organizations.
Alfred Sloan and Donaldson Brown, the senior managers of General Motors in the 1920s
understood well the importance of transfer pricing in this role:
The question of pricing product form one division to another is of great importance.
Unless a true competitive situation is preserved, as to prices, there is no basis upon which the
performance of the divisions can be measured. No division is required absolutely to purchase
product from another division. In their interrelation they are encouraged to deal just as they would
with outsiders. The independent purchaser buying products from any of our divisions is assured
that prices to it are exactly in line with prices charged our own car divisions. Where there are no
substantial sales outside, such as would establish a competitive basis, the buying division
determines the competitive picture- at times partial requirements are actually purchased from
outside sources so as to perfect competitive situation.
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with its focus on autonomy of divisional managers, is desirable, then divisional managers
must be free to make their own decisions.
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Segment
Reporting
Responsibility
Centers (Cost &
Profit)
Contribution
Margin, ROI,
Opportunity
Cost , Relevant
Cost etc.
a. The company must be decentralized in nature. It means that the whole company is divided
into several divisions. Each division is responsible to report on their performance
individually which is known as segment reporting. This reporting is valid under the concept
of Responsibility accounting.
b. Divisions are individual in nature and independent.
c. Divisions are responsible for both cost and revenue individually. Thus the divisions must
be profit centers.
d. The senior managers will evaluate each division individually on the basis of divisional
contribution margin, ROI or residual income.
e. Corporate profit will be distributed to the divisions and transfer pricing will be treated as
the base for that.
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opportunity cost for internal transfer is the contribution margin the division could have received
from the external sale.
To understand how this general rule works, an example can be illustrated. Consider two
hypothetical divisions. X division (the selling division) is considering transferring the fabric
required for a polo shirt to the Y division (the buying division).
Y Division
X Division
Outlay cost = Tk 6
Opportunity Cost= Tk 4
=TK 10 + TK 12 = TK 22
Final Selling price= TK
25
Suppose the X divisions TK 4 opportunity cost arises because it can get TK 10 for the fabric on
the market. Thus, the contribution margin from selling on the market is TK 10 6 = TK 4. At any
transfer price less than TK 10, the division is better off selling the fabric on the market rather than
transferring it. Thus the minimum transfer price it would accept is TK 6 + (TK 10 TK 6) = TK
10.
Decision by Division
manager
Less than TK 10 Do not transfer- buying
division rejects transfer
because buying internally will
reduce profits?
Greater than TK 10 If value to buying division is
greater than TK 10: transfer
at TK 10.
If value to buying division is
less than TK 10: Buying
division rejects transfer.
Now consider how much the item is worth to the Division Y. For the fabric to be profitable to the
Y division, it must be able to sell the final product for more than the transfer price plus the other
costs it must incur to finish and sell the product. Because it can sell the Polo Shirt for TK 25 and
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its other costs are TK 12, it would be willing to pay up to TK 25 TK 12 = TK 13 for it. But it
would not pay more to the X division than it would have to pay to the outsider for the equivalent
fabric. Thus the largest transfer price acceptable to the Y division is the lesser of i) TK 13 and ii)
the cost charged by an outside supplier.
If it passes the Break Even Point, Then Fixed Cost becomes irrelevant.
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independent of the level of operations in other centers (technological independence) and that
additional external sales by a center do not reduce external demand for the other centers products
(demand independence), Hirshleifer demonstrates that the optimal transfer price is the marginal
cost of producing the intermediate good or service. More generally, the center that produces the
intermediate product should provide a schedule of marginal cost associated with different output
levels so that the center that produces the end product can choose the optimal joint level of output.
The only circumstance under which this optimal price equals the market price for the intermediate
product is when the external market for the product is perfectly competitive. Marginal cost transfer
prices provide the center that produces the end product with the information necessary to produce
at the level that is optimal for the firm as a wholethe level that equates the marginal cost of
production with marginal revenue.
Eccles interviewed 144 managers in 13 firms from the chemicals, electronics, heavy machinery,
and machinery components industries to determine how transfer prices are implemented and
managed in practice. Eccles (1985 and 1991) and Eccles and White (1988) discuss the three most
common transfer pricing policies observed in the survey: mandated full-cost transfers, mandated
market-based transfers, and exchange autonomy in which prices range between full cost and
market. In addition to observing diversity in policies across firms, the authors observed multiple
policies even within firms corresponding to different product strategies and environments. This
divergence between theory and practicein particular, a lack of marginal cost pricing and frequent
use of full-cost transfersled to a new theory to explain transfer pricing practices.
Eccles (1985) and Eccles and White (1988) emphasize that a firms transfer prices must be tailored
to support the firms strategy and policies. Further, prices must be flexible enough to adapt to
changes in these. Eccles and White link the three popular transfer pricing practices to two strategic
questions that any firm with an internal market must address. The first is whether the profit centers
are part of a strategy of vertical integration; that is, are internal transfers mandated or are
purchasing and selling centers allowed to make choices among potential internal and external
exchange partners that maximize their individual outcomes. If the firm has a strategy of vertical
integration, the second question is whether the firm is pursuing a strategy of vertical integration to
lower the costs of intermediate products. If so, Eccles survey indicates that the firm will
implement full-cost transfer prices.4 Otherwise, the firm will use market-based prices that
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facilitate comparisons of internal profit centers to external competitors. Eccles (1985) argues that
transfer prices based on variable costs are rarely seen in practice because they hinder measurement
and evaluation of profit center contributions to the company.
Kaplan and Atkinson (1989) also acknowledge the tension between the transfer pricing goals of
promoting economic decisions and enhancing performance evaluation and tie their
recommendations for optimal transfer pricing policies to firm strategies and environments. The
authors first three recommendations are quite similar to those discussed above. First, if a
competitive market exists for the intermediate product, Kaplan and Atkinson recommend that the
transfer price for the item should be set equal to the market price (less transaction costs that are
avoided with internal transfers). At the other extreme, if no external market exists for the
intermediate product, the transfer price that leads to the optimal level of internal transactions is the
marginal cost of production. The authors also advocate that the purchasing center should pay a
fixed fee to the selling center for the privilege of transacting with it at marginal cost. This fixed
fee would cover the selling centers fixed costs. By assigning fixed costs in proportion to the
percentage of capacity devoted to the internal purchaser, this two-part pricing scheme leads to
efficient resource allocation while allowing the selling division to recover its costs and forcing the
purchasing center to recognize the full cost of obtaining products from the selling center.5 When
an imperfectly competitive market exists for the intermediate product, Kaplan and Atkinson
recommend that the managers of the purchasing and selling centers negotiate the price and terms
of the transfer. This policys success requires freedom to buy and sell externally, occasional
transactions with external suppliers and buyers, and support from high-level management.
Kaplan and Atkinsons recommendations diverge from those of Eccles (1985 and 1991) and Eccles
and White (1988) with respect to full cost prices. While Kaplan and Atkinson note that such prices
are often used in practice, they find no justification for them. The authors argue that full-cost prices
distort economic decision making by transforming the fixed costs of the selling center into variable
costs for the purchasing center. These prices provide poor incentives for the selling center because
they do not reward efficiency or penalize inefficiency. Full-cost prices also do not contribute to
evaluating the performance of centers. And finally, inclusion of firm costs, such as G&A, that are
allocated across centers may make the firms end product less competitive (e.g., if the prices of
intermediate products include a proportional markup for profit).
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the possibility of an uncollected account receivable with an internal sale, selling division may
agree to a price that is less than the market price.
From the companys point of view, the market price is the opportunity cost when a selling division
is at full capacity. Sales at less than market price result in lost business that would have served if
transfers occur at market.
If there is a competitive market for the intermediate product or service being transferred internally,
using the market price will generally lead to goal congruence. Because the market price is equal
to the variable cost plus opportunity cost.
Transfer Price = Variable Cost + Opportunity Cost
= Variable Cost + (Market Price - Variable Cost)
= Variable Cost Variable Cost + Market Price
= Market Price
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divisions of the company may be evaluated as a revenue center. In this case there is dependence
between the divisions, and it would be best if they were evaluated together as a single unit.
Finally, there are some market-based transfer prices that can lead to suboptimal decision.
$5.00
$5.50
$8.00
$8.80
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Cost based transfer prices do not provide incentives to control costs. If the actual costs of
one division are simply passed on to the next, there is little incentive for anyone to work to
reduce it. This problem can be overcome by using standard costs rather than actual cost
transfer prices.
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The following Figure exhibits the overall considerations of negotiated transfer price.
In order to have an effective and efficient system of intra company transfer pricing, the following
issues should be kept in mind.
Problems
Market Based
Cost Based
Negotiated
Administered
savings from the total cost of $14 million if each manager were to build a separate warehouse. The
issue is how the manager should split the cost of the warehouse.
One alternative, sometimes called the relative cost method, is for each manager to bear a share of
warehouse cost that is proportional to that managers alternative opportunity. The cost allocation
may be:
Manager As Share = $11,000,000 * $3,000,000/$14,000,000 = $2,357,143
Manager Bs Share = $11,000,000 * $6,000,000/$14,000,000 = $4,714,286
Manager Cs Share = $11,000,000 * $5,000,000/$14,000,000 = $3,928,571
This process is fair in the sense of being symmetrical. All parties are treated equally, and each
allocation reflects what each individual faces. Another approach, which reflects the equity criterion
of ability to pay, is to base the allocation of cost on the profits that each manager derives from
using warehouse. Still another approach, which reflects the equity criterion of equal division, is to
assign each manager a one third share of the warehouse cost.
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For example, a company may choose a low transfer price for parts shipped to a foreign subsidiary
to reduce custom duty payments or to help the subsidiary to compete in foreign markets by keeping
the subsidiarys costs low. On the other hand, it may choose to charge a higher transfer price to
draw profits out of a country that has high income tax rates to a country that has lower tax rates or
out of a country that has stringent control on foreign remittances.
Transfer pricing is a major concern for multinational companies as highlighted by the fact that
approximately 80% of Fortune 1000 firms select transfer pricing policies keeping financial, legal
and other operational considerations in mind. In addition, intra-firm trade accounts for about 55%
of the trade between Japan and EU, and 80% of the trade between US and Japan.
Tax authorities are aware of the incentives to set transfer prices to minimize taxes and import
duties. Therefore, U.S. Internal Revenue Service (IRS) pays close attention to taxes paid by
multinational companies within their boundaries. At the heart of the issue are the transfer prices
that companies use to transfer products from one country to another. For example, in 2004, the
IRS fined U.K. based pharmaceutical manufacturer GlaxoSmithKline $5.5 billion in back taxes
and interest, stemming from a transfer pricing dispute regarding profits from 1989 through 1996.
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$
($4.80)
16.00
(8.00)
$3.20
The net savings from transferring at $100 instead of $60 is $3.20 per unit. Companies may also
use transfer pricing to avoid financial restrictions imposed by some governments. For example, a
country might restrict the amount of dividends paid to foreign owners. It may be easier for a
company to get cash from a foreign divisions as payment for items transferred than as cash
dividends.
In summary, transfer pricing is more complex in multinational company than it is in a domestic
company. Multinational companies try to achieve more objectives through transfer-pricing
policies, and some of the objectives can conflict with one another.
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This is true, however, if the selling division has sufficient capacity to produce the entire order and
would not have to give up some of its regular sales. In cases where capacity constraints force the
division to either transfer an item internally or sell it externally- that is, it cannot produce enough
to do both, then the selling division would expect to be compensated for the contribution margin
on those lost sales. In general, if the transfer has no effect on fixed costs, then from the selling
divisions standpoint, the transfer price must cover both the variable cost of producing the
transferred units and any opportunity costs from lost sales.
From the firms standpoint, transfer is desirable if (1) the total cost of producing the good (by both
divisions) is less than the price it can receive for the good in the outside market and (2) it does not
pay more to produce the good internally than it would have to pay to buy it in the marketplace.
The only transfer price that would achieve both these objectives for the firm is the formula
suggested below:
Minimum Transfer Price =Sellers variable cost +opportunity cost.
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market for $30 and the variable costs of selling and buying division are $10 and $6 respectively,
then the buying division can pay up to $24 ($30 - $6). Anything more would put him at a loss.
In cases where the buying division has an outside supplier available, the choice of maximum
transfer price is simple. Buy from an inside supplier only if the price is less than the price offered
by the outside supplier. This may lead to suboptimal decision from the firms standpoint. For
example, if a good can be sold in the market for $30 and the variable costs of selling and buying
division are $10 and $6 respectively, then per unit profit for the company is $14. However, if the
transfer price is set at $12 and an outside supplier is willing to provide it for $11, the buying
division would buy it from outside, even though the company could have spent only $10 in
producing it internally. So, the highest transfer price in this case is $11, the alternative maximum
price from an outside source.
Maximum transfer price would, once again, depend on the availability of an outside price. If the
buying division can buy similar product from an outside vendor for $15, then it would be unwilling
to pay more than $15 as the transfer price.
Thus combining the requirements of both the selling and the buying division, the acceptable range
of transfer price would be between $10 and $15.
other administrative costs and would prefer to produce a part internally than buy it from outside.
Other reasons for firms to prefer an internal transaction may be quality control, timely delivery
and security of proprietary information. So if the selling division is selling its entire capacity
production to outside market, it would have to divert some product away from its regular customers
to be able to fill an order from the buying division.
In such cases, the minimum transfer price would be unit variable cost plus the unit contribution
margin from lost sales. To continue the example above, suppose that the selling division is selling
its entire capacity of 1000 units to outside market at $15 per unit and receives an order of 200 units
to be supplied to the internal division. So the minimum price, that the selling division is willing
to consider as transfer price, is its unit variable cost ($10) plus the unit contribution margin on lost
sales ($5 = $15 - $10).
The maximum transfer price, as before, would be equal to the cost of buying it from an outside
supplier. Thus, if the outside vendor is ready to supply the good at $18 as in the example above,
the transfer price would be set between a range of $15 and $18.
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The economic theory will be discussed under two market conditions namely,
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Y (Selling
Division)
Supply
Decision of Divisions
1000
1500
1800
1500
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no
External
marginal
price
Market
Exists
determination
follows,
this
intersection
is
marginal revenue for the total firm. This is referred to as the Net Marginal Revenue in production
(NMR) and is calculated as the marginal revenue from the firm minus the marginal costs of
distribution.
Where Competitive External Market Exists
If the production division is able to sell the
transfer good in a competitive market (as
well as internally), then again both must
operate where their marginal costs equal
their
marginal
maximization.
revenue,
Because
for
the
profit
external
forces (their
horizontal summation of points A and B (and likewise for all other points on the Net Marginal
Revenue curve (NMRa)). The total optimum quantity (Q) is the sum of Qf plus Qt.
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of accounting records for corporate reporting. However, managers may not like a system that
reflects different values for the two divisions.
Say, Division A incurs variable cost TK 5 to start the product and Division B incurs TK 3 to
complete the product which is sold at TK 20. Then, the transfer price charged to division B from
division A is TK 5. The price received by division A is TK 17. Different price is recorded in
different account.
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(f) The cumulative guarantees provided by one enterprise in favor of the other enterprise exceeds
10% of the book value of total borrowings of that other enterprise
(g) More than half of the board of directors or members of the governing board of one enterprise
are appointed by the other enterprise
(h) Any executive director or executive members of the governing board of one enterprise is
appointed by or is in common with the other enterprise
(i) Same person or persons appoint more than half of the board of directors or members in both
enterprises
(j) Same person or persons appoint any executive director or executive members in both enterprises
(k) One enterprise has the practical ability to control the decision of the other enterprise
(l) The two enterprises are bounded by such relationship of mutual interest as may be prescribed
International Transaction Section 107(A)(5)
Transfer pricing provisions are applicable to the following types of international transactions
between associated enterprises, at least one of them being a nonresident:
Purchase, sale or lease of tangible or intangible property
Provision of services
Lending or borrowing money
A mutual agreement or arrangement for cost allocation or apportionment in connection
with a benefit, service or facility provided or to be provided
Any other transaction having a bearing on the profits, income, losses, assets, financial
position or economic value of such enterprises
If an enterprise enters into a transaction with a third party, where there is a prior agreement between
the third party and the associated enterprise, or if the terms of the relevant transaction are
determined in substance between the third party and the associated enterprise, then such
transactions shall be deemed to be an international transaction.
Enterprise means a person or a venture of any nature and also includes a permanent establishment
of such person or venture.
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Profile of each associate enterprise including tax registration numbers and financial
statements of any
associated enterprise operating in Bangladesh
Business description
The nature and terms (including prices) of international transactions
Description of functions performed, risks assumed and assets employed
Record of any financial estimates
Record of uncontrolled transaction with third parties and a comparability evaluation
Description of methods considered
Reasons for rejection of alternative methods
Details of transfer pricing adjustments
Any other information or data relating to the associated enterprise which may be relevant
for determination of the arms length price
As per Rule 73, the abovementioned information and documents shall be kept and maintained for
a period of eight years from the end of the relevant assessment year.
The above documentation requirements shall not be applicable in case of an assessee where the
aggregate value of international transactions entered into during an income year, as recorded in the
books of accounts does not exceed Taka 30,000,000 (approx. US$ 390,000).
Statement of international transactions Section 107(EE)
The Finance Act, 2014 has inserted a new section 107EE by virtue of which every person who has
entered into an international transaction shall furnish, along with the return of income, a statement
of international transactions in the form and manner as prescribed under Rule 75A.
Accountants report Section 107(F)
Under Section 107F, every person who has entered into an international transaction or transactions
the aggregate value of which exceeds Taka 30,000,000 (approx. US$ 390,000) during an income
year shall furnish, on or before the specified date, in the form and manner as prescribed under Rule
75, a report from a Chartered Accountant.
Transfer pricing penalties Section 107(G), 107(H), 107(I)
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For failure to keep, maintain or furnish any information or documents or records as required by
Section 107E, the tax officer may impose a penalty on the taxpayer not exceeding 1% of the value
of each international transaction. Such penalty shall be levied without prejudice to the provisions
of chapter XV of the Ordinance, which deals with imposition of penalties.
For a failure to comply with the notice or requisition under section 107D of the ordinance by the
Deputy Commissioner of Taxes, the tax officer may impose a penalty on the taxpayer not
exceeding 1% of the value of each international transaction. For a failure to furnish a report from
a Chartered Accountant as required by section 107F of the Ordinance, the tax officer may impose
a penalty on the taxpayer of an amount not exceeding Taka 300,000 (approx. US$ 3,900).
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Buying Division is more powerful in negotiation here despite market prices are more reasonable
TP.
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$40
20
12
42
$114
The Electrical Division has been selling 250,000 batteries per year to outside buyers for $136 each.
Capacity is 350,000 batteries/year. The Assembly Division has been buying batteries from outside
suppliers for $130 each.
Should the Electrical Division manager accept the offer? Will an internal transfer be of any benefit to the
company?
Solution 1:
ED manager should accept.
There is surplus capacity. So the relevant costs to the ED is the VC = $72 / battery.
The increased CM to the ED would be 90,000*($104 72) = $2.88 M
The company would be better off with an internal transfer. Currently paying $130 for batteries that could
be made internally for incremental cost of $72. The company would save 90,000 * (130 72) = $5.22 M
per year!
The TP range = maximum of $130 to low of $72
What if there is no excess capacity?? (Maximum = $130, but minimum= $136)
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Problem 2:
Minimum transfer price = incremental (outlay) costs/unit to point of transfer + opportunity
cost/unit to the supply division.
The SF Manufacturing Co. has two divisions in Iowa, the Supply Division and the BUY Division.
Currently, the BUY Division buys a part (3,000 units) from Supply for $12.00 per unit. Supply
wants to increase the price to BUY to $15.00. The controller of BUY claims that she cannot afford
to go that high, as it will decrease the divisions profit to near zero. BUY can purchase the part
from an outside supplier for $14.00. The cost figures for Supply are:
Direct Materials
Direct Labor
Variable Overhead
Fixed Overhead
$3.25
4.75
0.60
1.20
A. If Supply ceases to produce the parts for BUY, it will be able to avoid one-third of the fixed MOH.
Supply has no alternative uses for its facilities. Should BUY continue to get the units from Supply
or start to purchase the units from the outside supplier? (From the standpoint of SF as a whole).
What is the minimum & maximum transfer price if BUY and SUPPLY negotiate?
MAX. TP = $14.00 / unit (most BUY is willing to pay, market price)
MIN. TP = $8.60 + (1/3 * 1.20) = $9.00
MAX > MIN so transfer internally would happen and be in the best interests of SF!
Now, assume that Supply could use the facilities currently used to produce the 3,000 units for
BUY to make 5,000 units of a different product. The new product will sell for $16.00 and has the
following costs:
Direct Materials
Direct Labor
Variable Overhead
$3.00
4.30
5.40
B. What is the minimum & maximum transfer price if BUY and SUPPLY negotiate?
Supply VC = $8.60 + lost CM
Lost CM = $16 12.70 = $3.30 / unit of new product = $16,500 total lost CM
OR $16,500 / 3,000 units transferred to BUY = $5.50/unit made for BUY
MAX. TP = $14.00
MIN. TP = $8.60 + $5.50 = $14.10
C. What should be done from the companys point of view? Why?
SF is better off for SUPPLY to make new product and BUY to get part from outside.
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Problem 3:
Division A is a Profit Center. It produces SL
Product
1.
800
2.
500
3.
300
Product Y can be transferred to Division B but the maximum quantity of units that might be
required to transfer is 300 Units of Y.
Instead of receiving Product Y from Division A, Division B could buy the product Y from external
market at the rate of 45 BDT.
What should be the transfer price be for each of 300 units of Y if the total hours available for
division A is 3800 or 5600?
The Following Information is AvailableX
48
46
40
33
24
28
Solution 3:
Statement Showing CM/U, CM/H & Rank
48
46
40
(33)
(24)
(28)
15
22
12
5.5
1
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Product
3800
Unit * Hours/Unit
= TOTAL
Balance
300 * 2
= 600
(3800-600)
500 * 4
= 2000
(3200-2000)
400 * 3
= 1200
(1200-1200)
What would happen if 1800 hours were required for Y to transfer in Division B
instead of 1200 Hours?
Manufacturing Cost of Y = 7200
+ Opportunity Cost X + Y = (400*15 + 150*22)
If Say, after meeting the external Demand, still 500 hours is left to Division A. what
will happen?
Hour Required for Transfer. 1200
- Hours Available in A. (500)
= 700 hours/ 3 will be required to cut from X to meet the transfer.
If 5600 hours
Statement Showing Production Plan for Maximum Profit
Hours
Available
5600
Product
Unit * Hours/Unit
= TOTAL
Balance
300 * 2
= 600
(5600-600)
500 * 4
= 2000
(5000-2000)
800 * 3
= 2400
(3000-2400)
Problem 4:
Hello.Com has two independent Divisions that produce Butter & Ghee respectively. Division-1
produces Butter which it can sale to outsiders at BDT 25 each. The variable cost per unit to
Division-1 is BDT 10 and fixed cost per unit is BDT 5 (It has already passed the Break Even point).
The Division-2s profit markup is 40%.
Q 1: What is the Market Based Transfer Price?
Q 2: What is the Minimum Transfer Price?
Q 3: What is the Cost plus Transfer price?
Solution 4:
Market based Transfer Price = 25 (Market Price)
Minimum Transfer Price = 10 (Variable Cost)
Cost Plus Transfer Price = 10 + 4 = 14
Income of the BD division is 40 higher, so it pays (40* 8%) = 3.20 more tax
Income of the India Division is 40 lower. So, it pays (40*40%) =16 less tax.
Import duty is paid by the India Division on an additional (100-60) = 40. So it pays more
(40*20%) = 8 more.
Net saving from transferring at 100 instead of 60 is (16 -3.2- 8) = 4.8
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Conclusions
While transfer pricing has been the subject of much theoretical argument over the years, both
general economic and accounting theory seem too limited by assumptions or too narrow in scope
to guide operating managers. What can be gleaned from theory is that company should incorporate
opportunity costs in transfer prices. At full capacity, the opportunity cost is based on market prices.
When excess capacity exists, opportunity costs are related to incremental variable and fixed costs
and/or some measure of capacity.
In practice, it seems that more companies use market based transfer prices than cost based ones.
Within the companies using cost-based prices, full costs seem to prevail counter to what theory
predicts. Negotiation and dual prices are options that many companies employ.
Transfer prices cannot be viewed in a vacuum. Life-cycle issues are important. In addition, since
transfer prices are part of the concept of decentralization and segment/managerial evaluation, all
aspects of transfer pricing have behavioral consequences.
It is not easy to prescribe the best transfer pricing have behavioral consequences. As with segment
evaluation, many factors need to be considered. However, if companies make sure that transfer
pricing is consistent with overall strategic planning, there is together likelihood that there will be
success.
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