Presented by:

Md. Nazmul Islam, ACMA

Assistant Professor
Department of Accounting & Information
Systems
Faculty of Business Studies
Jagannath University, Dhaka, Bangladesh.

Chapter
Transfer Pricing
Transfer Pricing
L.O. 1 Explain the basic issues associated with transfer pricing.
Transfer price:
The value assigned to the goods or services sold or rented
(transferred) from one unit of an organization to another.

Treatment is the same as a sale to an outside customer.
Revenue to the selling unit
Cost to the buying unit


15 - 2
The Setting
L.O. 2 Explain the general transfer pricing rules and
understand the underlying basis for them.
Padre Papers
Wood Division Paper Division
Trees Paper
Wood for
making paper
15 - 3
The Setting
LO2
Padre Papers
Cost and Production Data
Average units produced
Average units sold
Variable manufacturing cost per unit
Variable finishing cost per unit
Fixed divisional cost (unavoidable)
100,000

$ 20

$2,000,000

100,000

$ 30
$4,000,000
Wood Paper
15 - 4
The Setting
LO2
Wood Division
(selling division)
Variable cost = $20
Fixed cost = $2,000,000
Paper Division
(buying division)
Variable wood cost = ?
Variable finishing cost = $30
Fixed cost = $4,000,000
Wood
Transfer
price
Market for paper
(final market
Price = ?
Market for wood
(intermediate market
Price = ?
Padre Papers Resources Flow
15 - 5
Padre Papers Example
LO2
Assume the following data for the wood division:
Capacity in units
Selling price to outside
Variable price per unit
Fixed price per unit (based on capacity)
100,000
$ 60
$ 20
$ 20
15 - 6
Padre Papers Example
LO2
The Paper Division is currently purchasing 100,000
units from an outside supplier for $50, but would
like to purchase units from the Wood Division.
15 - 7
Padre Papers Example
LO2
Transfer
price
Variable
cost (VC)
Lost contribution
margin (CM)
= +
If the Wood Division
has idle capacity:
Transfer
price
$20 $0 = +
If the Wood Division
is working at capacity:
Transfer
price
$20 $40 = +
15 - 8
Optimal Transfer Price
LO2
There is no intermediate market.
In this case, the only outlet for the Wood Division
is the Paper Division and the only source of
supply for the Paper Division is the Wood Division.
The optimal transfer price is the outlay cost for
producing the goods (generally the variable costs).




15 - 9
Perfect Intermediate
Marked-Quality Differences
LO2
Variable manufacturing cost (Wood Division) per unit
Variable finishing cost (Paper Division) per unit
Other data:
Final market (paper) price
Intermediate market (grade A wood) price
Intermediate market (grade B wood) price
$ 20
$ 30

$120
$ 60
$ 50
15 - 10
Quality Difference Example
LO2
Sales:
$ 50 100,000 (transfer)
$120 100,000 (transfer)
Variable costs:
$ 20 100,000
$ 50 100,000 (transfer)
$ 30 100,000 (processing)
Fixed costs
Operating profit
Total company operating profit

$5,000,000


$2,000,000


$2,000,000
$1,000,000



$12,000,000


$ 5,000,000
3,000,000
4,000,000
$ -0-

Wood Paper









$1,000,000
Grade B wood: $50 internal transfer price
15 - 11
Quality Difference Example
LO2
Sales:
$ 60 100,000 (transfer)
$120 100,000 (transfer)
Variable costs:
$ 20 100,000
$ 60 100,000 (transfer)
$ 30 100,000 (processing)
Fixed costs
Operating profit
Total company operating profit

$6,000,000


$2,000,000


$2,000,000
$2,000,000



$12,000,000


$ 6,000,000
3,000,000
4,000,000
$ (1,000,000)

Wood Paper









$1,000,000
Grade A wood: $60 internal transfer price
15 - 12
Managers Goals versus Firms Goals
L.O. 3 Identify the behavioral issues and incentive effects
of negotiated transfer prices, cost-based transfer
prices, and market-based transfer prices.
Transfer price higher than market:
Buying division will not buy
Transfer price lower than market:
Selling division will not sell
15 - 13
Centrally Established
Transfer Price Policies
LO3
Market price-based:
Sets the transfer price at the market price or
at a small discount from the market price

Cost-based:
Outlay cost to selling division plus forgone
contribution to company projects
Negotiated transfer:
The managers of the buying and selling
divisions agree on a price.


15 - 14
Multinational Transfer Pricing
L.O. 4 Explain the economic consequences
of multinational transfer prices.
International (or interstate) transfer pricing
can affect tax liabilities, royalties, and other
payments due to different laws in different
countries or states.
Company incentive:
Increase profit in low-tax country
Decrease profit in high-tax country
15 - 15
Segment Reporting
L.O. 5 Describe the role of transfer prices in segment reporting.
The FASB requires companies to report certain
information about segments in order to provide
a measure of performance for those segments
that are significant to the company as a whole.
15 - 16
End of Chapter 15
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