TOPIC 7: transfer pricing

TRANSFER PRICE
 A manager’s performance should be evaluated in line with the established objectives of his center.
 Different responsibility center managers should be evaluated differently in as much as their authority, responsibility,
and accountability vary from each other.
 Performance is assessed based on reports submitted to and gathered by the manager.
 Responsibility accounting reports may either be information reports or performance reports.
 Reports submitted by a responsible center manager should segregate the controllable from the non-controllable items.
Manager’s performance should be measured for items they have control over.
 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.

TRANSFER PRICING METHOD

a. Market price – 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 – a method of setting prices when goods are sold to divisions within the same company . Cost may
either be standard or actual costs. Standard costs have the advantage of isolating variances. Actual costs give the selling
division a little incentive to control costs.
c. Negotiated 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 – is set by the management in the corporate headquarters.
e. 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 – 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.

OTHER FACTORS CONSIDERED IN TRANSFER PRICING

 Excess capacity
 Opportunity cost of the transfer
 International tax issues
 Other international issues such as foreign exchange rate fluctuations and limitations on transfer 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 from an external supplier
at P80 per piece.. The relevant production data of Marga Enterprises is as follows:

Variable Production Cost P 66

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 Enterprise (Seller) Cassie Corporation (Buyer) (HQ Company)
1. Market price of P80
Transfer price 80 Transfer price 80 Transfer 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.

Transfer price 66 Transfer price 80 Transfer 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

Transfer price 73 Transfer price 80 Transfer price 80
Less: VP Cost 66 Less: VP Cost 73 Less: VP Cost 66
Profit 7 Profit 7 Profit 14

4. Dual Pricing
Transfer price 80 Transfer price 80 Transfer 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
expense of others.