Running head: BUSINESS 1

Transfer Pricing Methods

Name

Institutional Affiliation

Date of Submission
 BUSINESS 2

Transfer Pricing Methods

Question 1

Transfer pricing refers to the process where the prices of products are set to be sold

between related authorized firms within the enterprise.

In this case, since Phipps company is permitted to use any of the transfer pricing

methods, a comparison of the technique can be made to assess the effect of methods.

If Variable -Cost transfer pricing is used, then in Division low, the full cost is CP

=$1000, the variable cost is $700, the Taxable income, therefore, will be the full cost minus the

variable cost, that is, Taxable Income=$1000-$700=$300. In this regard, the income tax rate is

30% so it will be (30/100 x $300) = $90. Applying the same method in Division High whose

selling price is $1200 and the variable cost is still $700, the Taxable income will be given by

Selling Price Minus the Variable cost, giving, Taxable income = $1200-$700 = $500, since the

income tax rate in Division high is 40%, it will then be (40/100 x $500)= $200. However, 15 %

is imposed as an import duty; in this case, therefore, the import duty is 15% of the Variable cost,

this becomes (15/100 x $700) =$105. We can then find the net tax in Division High by summing

up the income tax and the Import duty which will give us, Net Tax = $200 + 105 = $305. The

Net Tax amount will then be given by subtracting the income tax in Division Low from the Net

tax in Division High; this will give us $305-$90=$215. Therefore, by applying the full-cost

transfer pricing, Phipps will incur a Net Tax amount of $215.

On the same note, applying the full-cost transfer pricing, we can also make some

comparison, for the Division Low the cost of manufacturing is= $1000 while the Variable cost

remains to be $1000, the taxable income will then be $1000-$1000=0. On the other hand, for the

Division High the Selling price is = $1200 while the variable cost is =$1000, the Taxable income
 BUSINESS 3

is selling price subtract the variable cost, this gives $1200-$1000= $200. Furthermore, now that

the income tax rate is 40 percent, in this case it is given as (40/100 x $200) =$80. The import

duty in this regard will be given as (15/100 x $1000) = $150. The fore the tax amount in Division

High is given as $80 + $150 =$230. The tax will then be given by Net Tax= $230-0 = $230. In

this regard, therefore, comparing the two methods, it is clear that when using the full-cost

transfer pricing method, Phipps will less Net Tax ($215) than when using variable-cost transfer

pricing method ($230), there is a difference of $15 between the two methods. However, incase

Phipps company desires on making profit from each of the boards sold, the transfer price has

to be as low as possible to reduce the tax liability (Keller, 2015).

Question 2

a) In this case, we can first calculate the average cost of manufacturing by dividing the total

manufacturing cost by the quantity; this can be presented in the table, as shown below:

Quan 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
tity
Price 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15
($) 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Total 64 67 70 72 75 78 81 84 88 92 94 97 10 10 10 11
Man 5. 2. 0. 8. 7. 7. 7. 8. 0. 0. 5. 8. 12 46 81 17
ufact 00 30 20 70 80 50 80 70 20 30 00 30 .2 .7 .8 .5
uring 0 0 0 0
cost
($)
Aver 32 32 31 31 31 31 31 31 31 31 31 31 31 31 31 31
age .2 .0 .8 .6 .5 .5 .4 .4 .4 .4 .5 .5 .6 .7 .8 .9
mfg. 5 1 3 8 8 0 5 3 4 6 0 6 3 2 2 3
cost
($)
 BUSINESS 4

The Average manufacturing cost=Total Manufacturing cost/quantity of pair of boots, in

this regard, the total cost of production takes into consideration the fixed expenses as well as the

variable costs. To come up with sufficient and adequate decisions, Phipps management should

distinguish the variable costs and fixed costs that are tangled in total costs, HIGH-LOW method

may be deployed to successful do this:

details Number (Q) Total Manufacturing Cost

(TMC)
maximum 35 $1,117.50
Minimum 20 $645
Variable Cost per pair of $31.50

boots produced

[Difference in total cost/Difference in Quantity = ($1,117.50-$645.00)/ (35-20) = $31.50]

In order to find the fixed costs per week as well as the fixed costs per year, the following

calculation can be done: if 35 pair of boots were manufactured, the total cost is $1,117.50 while

the total variable cost is $1,102.50, the fixed cost per week can then be found by subtracting the

total variable cost from the total Manufacturing cost to give ($1,117.50)-($1,102.50)= $15. The

annual fixed cost will then be given by $15 x 52=$780, the number of boosts to be manufactured

will then be equal to $780/31.50= 25 boots.

b) To maximize the bonus, the manager has to choose a level of output that ensures that

the marginal cost is always equal to the marginal revenue. This is usually referred to as the Profit

Maximization rule. In this regard, therefore, the MC=MR has to be met. The marginal cost

typically refers to cost increase as a result of manufacturing one extra unit of the product.
 BUSINESS 5

Marginal Revenue, on the other hand, refers to total revenue change when the rate of sales

changes by a unit (Becker, 2015). The Profit = Total Revenue – Total Costs

c)In this case, the firm seems not to be maximizing profits; this is because there are

various conditions that the firm has to meet to be in position to maximize profits. The firm has to

specifically comply or meet the profit maximization rule which requires a firm to select an

output level that ensures that the marginal cost is the same as the marginal revenue. In the case

provided, the firm has not met this condition, and therefore it is not maximizing the profits

(Becker, 2015).

References
 BUSINESS 6

Becker, G. (2015). Profit Maximization. Wiley Encyclopedia of Management, 1-1.

doi:10.1002/9781118785317.weom080042

Keller, M. (2015). An Analysis of Adequate OECD Transfer Pricing Methods for Intangible

Property. Munich, Germany: GRIN Verlag.