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TOPIC 7 TRANSFER PRICING

Learning Objectives:
1. Define and explain the basic concept of transfer pricing and its importance to segment reporting.
2. Identify the various transfer prices and explain their importance to segment evaluation.
3. Define and explain the different Quality Measures both in the form of financial and nonfinancial
performance evaluation that are important in effective management.

TRANSFER PRICES

Transfer price is our artificial price used to record inter-divisional transactions of goods and services and
properly evaluate divisional performance in line with the objective of goal congruence.

Goal Congruence is a situation in which people in multiple levels of an organization share the same goal.
A well-thought-out organizational design causes goal congruence and results in an organization being
able to work together to accomplish a strategy. Therefore, managers should make untiring efforts to
ensure the existence of goal congruence within the organization.

Transfer pricing Methods


a. Market Price
Market based transfer prices occur where a perfectly competitive market exists for
intermediate products which makes it optimal for both decision making and performance
evaluation to set transfer prices at competitive market prices. It uses the normal market rate that
would be paid if the goods were bought on the open market.

b. Cost-based Price
Cost-based transfer pricing is a method of setting prices when goods are sold to divisions
within the same company. Cost may either be standard or actual cost. Standard cost has the
advantage of isolating variances. Actual costs give the selling division a little incentive to control
costs.

c. Negotiated Price
Negotiated Transfer price may occur when segments are free to determine the prices at
which they buy and sell internally. It is especially appropriate when market prices are subject to
rapid fluctuations.

d. Arbitrary Price
Arbitrary transfer pricing is set by the management in the corporate headquarters.

e. Dual Pricing
Dual pricing is used when the selling and buying divisions use different prices in recording
their intercompany transfers. For example, the selling division records the transfer at market
prices as if the sale is made to outside customers, while the buying division records the purchases
at variable cost of production.

f. Multinational Transfer Pricing


Multinational Transfer Pricing applies when the transacting divisions are not located in
the same country of operations. A special focus of multinational transfer pricing is the analysis of
the effects of the taxes paid by the holding company to the host countries.

Transfer pricing policy is normally set by top management. The segment’s goal is also relevant, but the
overall goal of the organization is paramount.

Other factor considered in Transfer pricing:


1. Excess capacity
2. Opportunity cost of the transfer
3. International tax issues
4. Other International issues such as foreign exchange rate fluctuations and limitations on transfers
of profits outside the host country.

When capacities are considered, transfer price may be computed as:


Transfer Price = Incremental Cost + Opportunity Cost – Savings

Sample Problem – Basic Transfer Prices


Kadenang Ginto Holdings, Inc. has two independent divisions, Marga Enterprises and Cassie
Corporation, that conduct business in the same country. Marga Enterprises produces product “Sardinas”
of which Cassie Corporation buys rom an external supplier at P80. Per piece. The relevant production
data of Marga Enterprises is as follows:

Variable Production cost P66


Allocated Factory overhead 15

Required: Determine the profit for Marga Enterprises, Cassie Corporation, and Kadenang Ginto Holdings,
Inc., if an inter-divisional transfer of goods occurred under each of the following transfer prices.
1. Market price of P80.
2. Variable production cost of P66.
3. Negotiated price of P73.
4. Dual pricing.

Kadenang Ginto Holdings, Inc.


Marga Enterprises (Seller) Cassie Corporation (Buyer) (HQ Company)
1. Market price of P80.
Trasfer price 80 Trasfer price 80 Trasfer price 80
Less: VP Cost 66 Less: VP Cost 80 Less: VP Cost 66
Profit 14 Profit 0 Profit 14
2. Variable production cost of P66.
Trasfer price 66 Trasfer price 80 Trasfer price 80
Less: VP Cost 66 Less: VP Cost 66 Less: VP Cost 66
Profit 0 Profit 14 Profit 14
3. Negotiated price of P73.
Trasfer price 73 Trasfer price 80 Trasfer price 80
Less: VP Cost 66 Less: VP Cost 73 Less: VP Cost 66
Profit 7 Profit 7 Profit 14
4. Dual pricing.
Trasfer price 80 Trasfer price 80 Trasfer price 80
Less: VP Cost 66 Less: VP Cost 66 Less: VP Cost 66
Profit 14 Profit 14 Profit 14

Quality Measurements

Product Development Time


• the period where the product is conceptualized, designed, approved, prototype, is made and is
readied for commercial production.

Manufacturing Cycle Time


• A period where the materials from suppliers are received, stocked, checked, processed, and
prepared for delivery to customers.

Partial Productivity Rate


• a measure of output (finished goods) over process input.
Balanced Scorecard
• Uses multiple measures in determining as to whether a manager is achieving objectives at the
expenses of others.

Additional readings:
• Chapter 8 Management Services, Franklin Agamata
• https://www.investopedia.com/terms/t/transfer-pricing.asp
• https://www.yourarticlelibrary.com/accounting/methods-of-transfer-pricing-4-methods/52954

For better understanding of the topic on hand, it will be beneficial to watch the following discussion
video:
• https://www.youtube.com/watch?v=W2viHN8xSHo&ab_channel=RyanRoque

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