Chapter 15: Transfer Pricing

Transfer PricingChapter 15Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinTransfer PricingL.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 unit15 - *The SettingL.O. 2 Explain the general transfer pricing rules and understand the underlying basis for them.Padre PapersWood DivisionPaper DivisionTreesPaperWood formaking paper15 - *The SettingLO2Padre PapersCost and Production DataAverage units producedAverage units soldVariable manufacturing cost per unitVariable finishing cost per unitFixed divisional cost (unavoidable) 100,000$ 20$2,000,000 100,000$ 30$4,000,000WoodPaper15 - *The SettingLO2Wood Division(selling division)Variable cost = $20Fixed cost = $2,000,000Paper Division(buying division)Variable wood cost = ?Variable finishing cost = $30Fixed cost = $4,000,000WoodTransferpriceMarket for paper(final marketPrice = ?Market for wood(intermediate marketPrice = ?Padre Papers – Resources Flow15 - *Padre Papers ExampleLO2 Assume the following data for the wood division:Capacity in unitsSelling price to outsideVariable price per unitFixed price per unit (based on capacity) 100,000$ 60$ 20$ 2015 - *Padre Papers ExampleLO2 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 - *Padre Papers ExampleLO2TransferpriceVariablecost (VC)Lost contributionmargin (CM)=+If the Wood Divisionhas idle capacity:Transferprice$20$0=+If the Wood Divisionis working at capacity:Transferprice$20$40=+15 - *Optimal Transfer PriceLO2 There is no intermediate market. In this case, the only outlet for the Wood Division is the Paper Division and the only source of supply for the Paper Division is the Wood Division. The optimal transfer price is the outlay cost for producing the goods (generally the variable costs).15 - *Perfect IntermediateMarked-Quality DifferencesLO2Variable manufacturing cost (Wood Division) per unitVariable finishing cost (Paper Division) per unitOther data: Final market (paper) price Intermediate market (grade A wood) price Intermediate market (grade B wood) price$ 20$ 30$120$ 60$ 5015 - *Quality Difference ExampleLO2Sales:$ 50 × 100,000 (transfer)$120 × 100,000 (transfer)Variable costs:$ 20 × 100,000$ 50 × 100,000 (transfer)$ 30 × 100,000 (processing)Fixed costsOperating profitTotal 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-WoodPaper$1,000,000 Grade B wood: $50 internal transfer price15 - *Quality Difference ExampleLO2Sales:$ 60 × 100,000 (transfer)$120 × 100,000 (transfer)Variable costs:$ 20 × 100,000$ 60 × 100,000 (transfer)$ 30 × 100,000 (processing)Fixed costsOperating profitTotal 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)WoodPaper$1,000,000 Grade A wood: $60 internal transfer price15 - *Managers’ Goals versus Firms’ GoalsL.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 sell15 - *Centrally EstablishedTransfer Price PoliciesLO3 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 - *Multinational Transfer PricingL.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 country15 - *Segment ReportingL.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 - *End of Chapter 15Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin