Transfer Pricing Presentation San Beda

7/24/2019 Transfer Pricing Presentation San Beda

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1. Explain the basic issues associated with transferpricing.

2. Explain the general transfer pricing rules andunderstand the underlying basis for them.

3. Identify the behavioral issues and incentive eectsof negotiated transfer prices, costbased transferprices, and mar!etbased transfer prices.

". Explain the economic conse#uences ofmultinational transfer prices.

$. %escribe the role of transfer prices in segmentreporting.



&ransfer 'rice ( the price one subunit)department or division* charges for aproduct or service supplied to another

subunit of the same organi+ation

anagement control systems use

transfer prices to coordinate theactions of subunits and to evaluatetheir performance



&he product or service transferredbetween subunits of an organi+ation



&he transfer price creates revenuesfor the selling subunit and purchasecosts for the buying subunit

aecting each subunit-s operatingincome



&reated the same as a sale to

an outside customer

ost to thebuying unit

/evenue tothe selling

unit

&he value assigned to the goods orservices sold or rented )transferred* fromoen unit of an organi+ation to another.

Transferprice



'rice that leads both division managers,who act in their own selfinterest, to ma!ethe best decisions for the 0rm.

anagers are evaluatedon performance and bothdivision managers want to

maximi+e revenues andminimi+e costs.



'romote goal congruence a!e performance evaluation

among segments more comparable &ransform a cost center into a

pro0t center or better internal reporting



Maximum no greater than thelowest mar!et price

Minimum no less than the sum of selling segment-s incremental costs, and

the opportunity cost of the facilities used

anagers should understand how tocompute and evaluate the transfer

price



Paperhaus, Inc.

ood %ivision 'aper %ivision

&reesood for

manufacturing paper 'aper



Example 1 It costs the selling division 425 toproduce one unit of a part which, if transferred tothe buying division, re#uires additional wor!costing 4"$ and can be sold to outside customers

for 4155 per unit of the 0nished product. 6ssumethat the transfer price in #uestion is &'. &hen

7elling division-s pro0t )7* 8 &' 425.

9uying division-s pro0t )9* 8 4155 ( &' 4"$.

&otal pro0t for the 0rm 8 )&' 425* : )4155 ( &' 4"$* 8 43$.



If &' 8 425, then 7 8 45 and 9 8 43$. &he selling division gets nothing while thebuying division reaps all the pro0t.

If &' 8 4$$, then 7 8 43$ and 9 8 45. &hesituation is reversed.

If &' is somewhere between 425 and 4$$,both divisions bene0t while sharing thepro0t of 43$.



Example 2 )/evised from Example 1* It costs theselling division 4;5 to produce one unit of a partwhich, if transferred to the buying division, re#uiresadditional wor! costing 4"$ and can be sold to outside

customers for 4155 per unit of the 0nished product.6ssume that the transfer price in #uestion is &'. &hen

7elling division-s pro0t )7* 8 &' 4;5.9uying division-s pro0t )9* 8 4155 ( &' 4"$.

&otal pro0t for the 0rm 8 )&' 4;5* : )4155 ( &' 4"$* 8 4$.

hatever the transfer price is, the 0rm will suer a lossof 4$ per unit. &he internal transfer is o.



ost 'roduction %ata

Wood

Division

Paper

Division

Average units produced 100,000

Average units sold 100,000

Variable manufacturing cost per unit 20$

Variable finishing cost per unit 30$

Fixed divisional costs (unavoidable 2,000,000$ !,000,000$



Resource

FlowsWood Division )selling division*=ariable cost 8 425ixed cost 8 42,555,555

Paper Division)buying division*=ariable cost 8 435ixed cost 8 4",555,555

ar!et for paper)0nal mar!et* 'rice

8 >

ar!et for wood)intermediate mar!et* 'rice

8 >



6ssume the following data for the wood

division

"apacit# in units 100,000

elling price to outside %0$Variable cost per unit 20$

Fixed costs per unit (based on capacit# 20$



'aper %ivision is currently purchasing155,555 units from an outside supplierfor 4$5, but would li!e to purchase units

from the ood %ivision.



1. ?iven the mar!et prices and the costsin the 0rm, does 0rm pro0t increase>

2. ?iven the transfer price, theintermediate mar!et prices, and thedivisional costs, does the sellingdivision pro0t increase>

3. ?iven the transfer price, the 0nalmar!et prices, and the divisionalcosts, does the buying division pro0t

increase>



&ransferprice

8@utlaycost

:@pportunity cost ofthe resource at thepoint of transfer



6 perfect intermediate mar!et product not

dierentiated by #uality or service@ptimal transfer price is mar!etprice

&ransfer pricehigher than

mar!et

9uyingdivision will

not buy &ransfer price

lower than

mar!et

7ellingdivision will

not sell



&ransferprice

8=ariable

cost:

Aost

contributionmargin

ood %ivision hasidle capacity

ood %ivision iswor!ing at capacity

8 425

: 5

8 425

: 4"5

V" "&



&o restate the goal of each manager

Each division manager wants tomaximi+e his contribution margin.

Each manager is indierent

about the transfer price if theresulting contribution margin is+ero.



?rade 9 wood 4$5 internal transfer

price

Wood Paper

ales

'0$ x 100,000 (transfer ',000,000$

120$ x 100,000 (transfer 12,000,000$

Variable costs

20$ x 100,000 2,000,000$

'0$ x 100,000 (transfer ',000,000$

30$ x 100,000 (processing 3,000,000$

Fixed costs 2,000,000$ !,000,000$perating profit 1,000,000$ $ )0)

*otal compan# operating profit 1,000,000$



?rade 6 wood 4;5 internal transfer

price



&ransfer price higherthan mar!et

9uyingdivision will

not buy

&ransfer price lowerthan mar!et

7ellingdivision will

not sell



&he minimum transfer price in manysituations should be

B Incremental cost is the additional cost ofproducing and transferring the product orservice

B Opportunity cost is the maximumcontribution margin forgone by the sellingsubunit if the product or service istransferred internally



If an intermediate mar!et exists, theoptimal transfer price is the mar!etprice.

If no intermediate mar!et exists, theoptimal transfer price should be the

cost outlay )or incremental cost* forthe producing the goods )i.e.,generally, the variable costs*



ostbased prices

ar!etbased prices

Cegotiated prices



&he managers of the buying and sellingdivisions agree on a price.

Cegotiated

transfer

@utlay cost to selling division plus forgonecontribution to company proDects

ostbased

7ets the transfer price at the mar!et priceor at a small discount from the mar!etprice

ar!et pricebased



%e0nition of costB variable cost vs. absorption cost

B actual vs. standard

7tandard cost is superior to actualcostB actual costs vary according to season

B actual costs vary according to production

volumeB variances are attributed to selling division

B standard costs are stable measures ofproduction costs



Market-ased Transfer PricesMarket-ased Transfer Prices

+ 'otential problems when the mar!etdetermines transfer price

( Co exact counterpart in the external

mar!et( Ignores internal cost savings

( ar!et price varies+ current depressed price v.s. longrun mar!et price

( %ierent prices, discounts, and creditterms for dierent buyers



!e"otiated Transfer Prices!e"otiated Transfer Prices

+ 9elow mar!et purchase price

+ 6bove the incremental and

opportunity costs of the selling unit+ If negotiation fails

( managers can purchase on the

mar!et( arbitration by top management



Dual Pricin"Dual Pricin"

+ 7eller transfers at mar!et or negotiatedprice

+ 9uyer records transfer at costbased

amount+ Eliminates need to arti0cially divide pro0ts

+ 'rovides relevant information for decisionma!ing and performance evaluation

+ 'romotes goal congruency

+ Eases tension between segments



&ransfer 'ricing 7ystem &ransfer 'ricing 7ystem+ 'ermits evaluation of segment

performance

+ 6llows for rational ac#uisition ofgoods and services betweencorporate divisions

+ Is exible to respond to changes

+ Encourages and rewards goalcongruence



#ervice Transfer Prices#ervice Transfer Prices

B $llocate service costs using direct, step, oralgebraic method, or

B #ell service costs using transfer price

B &ransfer price useful when distinct,measurable bene0ts are provided

B &ransfer price useful when services providedhave a speci0c causeandeect

relationshipB &ransfer price depends on

( cost and volume of service

( comparable substitutes



Market-%ased common, standardi+edservices that are highcost, high volume

!e"otiated transfer price customi+ed services that are highcost,high volume

&ost-%ased or dual lowcost, lowvolume



6dvantages Encourage involvement between

service departments and their users

'romote cost consciousness andelimination of waste

'rovide information for performance

evaluations controllable servicedepartment cost



7ervice &ransfer 'rices7ervice &ransfer 'rices

%isadvantages

B %isagreement among unit managersabout transfer price

B Implementation re#uires additional costsand employee time

B %oes not wor! e#ually well for allsegments

B ay cause dysfunctional behavior orcause some services to be under oroverutili+ed

B omplex tax regulations



Transfer Pricin" inTransfer Pricin" in

Multinational #ettin"sMultinational #ettin"s

%ierences in

B &ax systems

B ustoms dutiesB reight and insurance costs

B ImportFexport regulations

B oreignexchange controls



Internal O%'ectives 9etter goal

congruence

9etter performanceevaluations ore motivated

managers

9etter cashmanagement

(xternalO%'ectives

Aess taxes and

taris Aess foreignexchange ris!s

9etter competitive

positions 9etter relationswith government

Transfer Pricing Presentation San Beda

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