30 April 2020 Mohammed Moin Uddin Reza Nadim 1

Mohammed Moin Uddin Reza Nadim

Assistant Professor
Bangladesh University of Professionals

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 Relevant Concepts Required..

Contribution
Margin, ROI,
Responsibility Opportunity
Centers (Cost Cost , Relevant
Segment & Profit) Cost etc.
Reporting

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 UNDERSTANDING TRANSFER PRICING
1. TP = Market Value
2. TP = Cost + ROI Sales 40000

DIVISION 1
Milk Butter Loss

Joint Cost 30,000

DIVISION 2
+ 4000 Pure Ghee
Cost
30000 Cost 30000
34000
Investment
40000
Sep. Cost
ROI 10%
40000
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 ? What Have Understood ?
What is Transfer Price ?
It is the internal price between one division to
other on the basis of mutual understanding.

When it is Applicable ?
When the Divisions are Individual, Independent,
Decentralized, Profit & Cost Centers etc.

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 Possible Methods….
1. TP = Total Cost + Opportunity Cost
2. TP = Cost + ROI / ROI with tax Adjustment
3. TP = Bargaining Price
4. TP = Relevant Cost Concepts
5. TP = Market Value
6. TP = Cost + Shared profit on the basis of Cost
7. TP = VC + Contribution in relation to VC
8. TP= Any other method on Mutual understanding
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 Forms of Transfer Pricing

International
Transfer Pricing Domestic Transfer
Pricing

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 ILLUSTRATION
Hello.Com has two independent Divisions that produces
Butter & Ghee respectively. Division-1 produces Butter
which it can sale to outsiders at BDT 25 each. The variable
cost per unit to Division-1 is BDT 10 and Fixed cost per
unit is BDT 5 (It has already passed the Break Even point).
The Division-2’s profit markup is 40%.

Q 1 : What is the Market Based Transfer Price ?

Q 2 : What is the Minimum Transfer Price ?
Q 3 : What is the Cost plus Transfer price ?
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 Internal Transfer Pricing

Ceiling Market Price 25 /=

Floor *Variable Cost 10 /=

Cost Plus (10 + 4) = 14/=

*VC + Mark Up

* If it passes the Break Even Point, Then Fixed Cost becomes IRRELAVENT.

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 Tax Heaven & Inter-
national Transfer Pricing

USA Pretax profit 1000k

Haven
Corp. Corp.
Tax rate= 35%
Tax= 350 k
Net Profit= 650 k
Before TP 0
Pretax profit 200k Pretax profit 800k
Tax rate 35% Tax rate 5%
After TP Tax= 70 k Tax= 40 k
Net Profit 130k Net Profit 760 k

Tax 40 k+70 k= 110 k

After TP Net Profit 130 k+760 k= 890 k
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 Multinational Transfer Pricing

Multinational For Example, An

Companies may use MNC might prefer to
TP to minimize make its profit in a
worldwide Income country where
Tax, Import Duties & maximum Corporate
Tariffs. Tax Rate is Lower.

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 Multinational Transfer Pricing

Suppose a division in a high tax rate country produces a sub

assembly for another division in a low tax rate country.

By setting the Low TP, the company can recognize most of the
profit from the production in the low tax rate country, there
by minimize taxes.

Likewise, Items Produced by division in low tax rate country and

Transferred to a division in High Tax rate country should have a
high TP to minimize Tax.

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 Multinational Transfer Pricing

Most Countries
base import
duties on the
Sometimes price paid for an Therefore, Low
Import duties item, whether TP generally
offset Income Tax bought from lead to Low
effect outside Import Duties.
companies or
transferred from
another division

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 Multinational Transfer Pricing
• Consider an item manufactured by ABC LTD (BD) with an
8% Income Tax rate and Transfer to a Division in India with
40% Income Tax Rate.

• Suppose India impose import duty equal to 20% of the price

of the item and that ABC cannot deduct this import duty for
the tax purposes.

• Full Cost= 100 , VC= 60 ; If the tax authority allows either

variable or full-cost TP, which should ABC choose ?

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 Net Saving From TP @ 100
• Income of the BD division is 40 higher, so it pays (40*
8%)= 3.20 more tax

• Income of the India Division is 40 lower, So it pays

(40*40%)=16 less tax.

• Import duty is paid by the India Division on an additional

(100-60)=40. So it pays more (40*20%)= 8 more.

• Net saving from transferring at 100 instead of 60 is

(16 -3.2- 8) = 4.8

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 Approaches to Transfer Pricing

Market Based Transfer Pricing

Cost-Based Transfer Pricing

Negotiated Transfer Pricing

Administered Transfer Pricing

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 Market Based Transfer Price
Market price refers to the price that a selling division can
get for its product in the external market or the price at
which a buying division can purchase the product in the
market.
If external markets (Highly Competitive) exist, market
based transfer price is more appropriate basis for TP.
The conditions of a highly competitive market imply that
the producing division can sell as much as it wishes to
outsiders and the purchasing division can acquire as
much as it wishes from outsiders without affecting the
price.

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 Continued………..
✓ From the company’s view, the market price is the
opportunity cost when a selling division is at full
capacity.
✓ Market Price allows each division to be evaluated
on a stand alone basis. The managers are
interested to treat their divisions as independent
companies and to buy from what ever source
seems the best under current market conditions.

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 Cost-Based Transfer Pricing
When the transferred goods or services do not
have a well defined market, some common
alternatives TP are variable cost, variable cost
plus mark-up, full cost, full cost plus mark-up.

Although cost approach to setting TP is simple to

apply, it has some major defects.

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 Continued………
✓The use of cost- particularly full cost- as a TP
can lead to bad decisions and sub
optimization.
✓The selling division will never show a profit on
any internal transfer if cost is used in TP.
✓Cost based TP does not provide incentives to
control cost.

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 Negotiated Transfer Price
Negotiated transfer price results from discussions
between the selling and buying divisions.
The purchasing division may:
1. Accept the deal
2. Bargain to obtain a lower price or better
conditions
3. Obtain outside bids and negotiate with external
suppliers
4. Reject the bid and either purchase outside or
not purchase at all

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 Continued………
The Conditions under which a negotiated TP will be
successful include:
1. Some form of outside market for the
intermediate product.
2. Sharing of all market information among
negotiators.
3. Freedom to buy or sell outside.
4. Support and occasional involvement of top
management.

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 Administered Transfer Price
A manager who applies some policies, for
example, market price less 10% or full cost plus
5%.
Organizations often use administered TP when a
particular transaction occurs frequently.

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 Problem Statement
Division A is a Profit Center. It produces -
SL Product External Demand Max
1. X 800
2. Y 500
3. Z 300
Product Y can be transferred to Division B but the maximum quantity
of units that might be required to transfer is 300 Units of Y.
Instead of receiving Product Y from Division A, Division B could buy the
product Y from external market at the rate of 45 BDT.
What should be the transfer price be for each of 300 units of Y if the
total hours available for division A is 3800 or 5600.

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 Problem Statement
• The Following Information is Available
X Y Z
Selling Price Per Unit 48 46 40
Variable Cost Per Unit 33 24 28
Hours Required for Per Unit 3 4 2

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 Statement Showing CM/U, CM/H &
Rank
X Y Z
External Selling Price/Unit 48 46 40
Variable Cost/Unit (33) (24) (28)
Contribution Margin/Unit 15 22 12
Hours Per Unit Required 3 4 2
Contribution Margin Per Hour 5 5.5 6
RANK 3 2 1

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 Statement Showing Production Plan
for Maximum Profit
Hours Available Product Unit * Hours/Unit = TOTAL Balance
3800 Z 300 * 2 = 600 (3800-600)

Y 500 * 4 = 2000 (3200-2000)

X 400 * 3 = 1200 (1200-1200)

Manufacturing Cost of 300 Unit of Y = 300 * 24 = 7200

+ Opportunity Cost of Leaving X of 400 Units = 400 * 15 = 6000
13,200 / 300 Units of Y
= 44 / Unit of Y T.P.

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 Check…
• What would happen if 1800 hours were
required for Y to transfer in Division B instead
of 1200 Hours ???

Manufacturing Cost of Y = 7200

+ Opportunity Cost X + Y = (400*15 + 150*22)

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 Check Again…
• If Say, after meeting the external Demand, still
500 hours is left to Division A. what will
happen ??

Hour Required for Transfer 1200

- Hours Available in A (500)
= 700 hours/ 3 will
be required to cut from X to meet the transfer.

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 If 5600 hours
Hours Available Product Unit * Hours/Unit = TOTAL Balance

5600 Z 300 * 2 = 600 (5600-600)

Y 500 * 4 = 2000 (5000-2000)

X 800 * 3 = 2400 (3000-2400)

Manufacturing Cost of 300 Unit of Y = 300 * 24 = 7200

+ Opportunity Cost of Leaving X of 200Units = 200 * 15 = 3000
10,200 / 300 Units of Y
= 34 / Unit of Y T.P.

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