Transfer pricing in divisionalized companies.ppt

8/9/2019 Transfer pricing in divisionalized companies.ppt

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Unit 3 – Transferpricing indivisionalizedcompanies Advanced Cost and Management

Accounting


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Purposes of transfer pricing

To provide information that motivates divisionalmanagers to make good economic decisions.

To provide information that is useful for evaluatingthe managerial and economic performance of thedivisions.

To intentionally move profits between divisions or

locations.

To ensure that divisional autonomy is notundermined.


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Alternative transfer pricingmethods Market-based

Marginal cost

Full cost

Cost-plus a mark-up

Negotiated transfer prices


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Market-based transfer prices

here there is a perfectly competitive marketfor the intermediate product! the currentmarket price is the most suitable basis for

setting the transfer prices.

T" #s will motivate sound decisions and form

a suitable basis for performance evaluation


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Marginal cost transfer prices

$conomic theory indicates T" based on theMC of producing the intermediate product atthe optimum output level for the company as

a whole will encourage total organi%ationaloptimality.

Adopting a short-run perspective to deriveMC results in MC & 'C and the assumptionthat MC is constant per unit throughout therelevant output range.


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Marginal cost transfer prices

Marginal Cost is not widely used(

"rovides poor information for performanceevaluation

MC may not be constant over entire range ofoutput

Measuring MC beyond short-term is difficult

Managers re)ect short-term perspective


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Full cost transfer prices

idely used because managers re*uire anestimate of long-run marginal cost fordecision-making.

Traditional costing systems tend to providepoor estimates of long run MC.

+oes not enable supplying division to reporta profit on goods transferred.


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ost-plus a mark-up transferprices Attempts to meet the performance evaluation

purpose of transfer pricing ,profit allocated tothe supplying division

esults in non-optimal decisions because T"e/ceeds short-run or long-run MC.

$normous mark-ups can result whengoods0services are transferred betweenseveral divisions.


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!egotiated transfer prices

Most appropriate where there are marketimperfections for the intermediate productand managers have e*ual bargaining power.

To be effective managers must understandhow to use cost and revenue information.

Claimed behavioural advantages.


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!egotiated transfer prices

1imitations( Can lead to sub-optimal decisions Time - consuming +ivisional profitability may be strongly

influenced by the bargaining skills andpowers of the divisional managers.

2nappropriate in certain circumstances ,e.g.no market for the intermediate product or animperfect market e/ists.


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Marginal cost plusopportunit" cost 3ften cited as a general rule that will lead to

optimal decisions for the company as awhole.

here there is no intermediate market theapplication of the rule leads to T" & 'C

,assuming 'C & MC


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Marginal cost plusopportunit" cost here there is a perfect market for the

intermediate product the application of therule leads to T" & M",e.g. market price & 456 and 'C & 47

T" & 87'C 9 8:7 opportunity cost & 456

ule tends to be a restatement of thegeneral principles previously established andit is also difficult to apply in more comple/situations.


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$llustration


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$llustration


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$llustration


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%iscussion

8=7 T" does not motivate optimum outputlevel for the company as a whole.

To ensure overall company optimality the T"must be set at MC of the intermediateproduct ,i.e. 'C of 8:: per unit or 8::!666 perbatch of :!666 units.

At 8:: T" receiving division will choose toe/pand output to 7!666 units.


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%iscussion

Consider a full cost T" without a mark-up,85= if the denominator level to compute unitfi/ed costs is 7!666 units

The receiving division manager will choose toproduce >!666 units

Negotiation ? if there is no e/ternal marketthe supplying division manager has littlebargaining power


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&esolving transfer pricingcon#ictsTwo approaches advocated(

Adopt a dual rate T" system

Transfer at MC plus a lump sum fee


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%ual rate TP s"stem

@ses two transfer prices ;upplying division may receive full cost plus

a mark-up so that it makes a profit on inter-

divisional transfers ,e.g. 3slo T" 85=. eceiving division charged at MC of

transfers thus motivating managers tooperate at the optimum output level for the

company as a whole. "rofit on inter-group trading removed by an

accounting ad)ustment.


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%ual rate TP s"stem

Not widely used because(

@se of two T" #s causes confusion

;een as artificial

+ivisions protected from competition

eported inter-divisional profits can bemisleading


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Marginal cost plus a lumpsum fee 2ntended to motivate receiving division to

e*uate MC of transfers with its net marginalrevenue to determine optimum company

profit ma/imi%ing output level.

$nables supplying division to cover its fi/ed

costs and earn a profit on inter-divisionaltransfers through the fi/ed fee charged forthe period.


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Marginal cost plus a lumpsum fee Motivates receiving division to consider full

cost of providing intermediateproducts0services ,T" & 8:: MC plus 8B6!666

lump sum plus a profit contribution in thee/ample.


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%omestic TP conclusions orrecommendations Competitive market for the intermediate

product @se market prices.

No market for the intermediate product or animperfect market Transfer at MC plus alump sum or negotiation may be appropriatein certain circumstances.

@se standard costs for cost-based T" #s


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$nternational transfer pricing

here divisions are located in differentcountries ta/ation implications becomeimportant and T" has the potential to ensure

that most of the profits on inter-divisionaltransfers are allocated to the low ta/ationcountry.


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'(ample

;upplying division in country A ,Ta/ rate & 57D

eceiving division in country < ,Ta/ rate & >6D

+iscussion(

Motivation is to use highest possible T" so receivingdivision will have high costs and low profits whereassupplying division will have high revenues and highprofits.


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'(ample

Ta/ation authorities in most countries arewise to companies using T" to manipulateprofits and seek to apply 3$C+ guidelines

based on arm #s length pricing principles.

T" can also have an impact on import duties

and dividend repatriations.


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)eller*s Minimum Price

Transfer "rice & outlay cost 9 opportunitycost

3utlay cost ? relevant cost to supplycommodity to the buying division.

3pportunity cost ? any sacrifice the seller willhave to make to supply commodities to thebuying division.


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1ecture Euestion 5


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+u"er*s Ma(imum Price

T" & ;" ? 'C@ e/cluding transferred item ?relevant FC@ but not higher than marketprice.


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1ecture Euestion =


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&eference

Management and Cost Accounting 7e by Colin+rury 2;>I67BB5

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Transfer pricing in divisionalized companies.ppt