I.

Introduction:

In the current landscape of the global economy, multinational corporations play a crucial role,
opening up opportunities for vertical development, from sourcing raw materials to distributing
products and services globally. The vertical expansion of these enterprises poses various
challenges, including a significant issue of determining transfer pricing. In this context, setting
transfer prices not only impacts the overall profitability of Thong Nhat Company but also
presents specific challenges. Each department, from production to sales, has its own goals and
perspectives on pricing and profit. This divergence creates a management dilemma, making
decisions on transfer pricing not only a financial matter but also a strategic one. The objective of
determining transfer pricing goes beyond merely maximizing profits. It includes ensuring the fair
performance of each department and integrating them into the overall strategy of the corporation.
This requires flexibility, innovation, and risk management capabilities to ensure that every
decision on transfer pricing contributes to the global and sustainable interests of Thong Nhat
Company.

II. Definition:

Transfer pricing is a crucial aspect of organizational management, involving the determination of

the amount charged when one part of a company provides goods or services to another internal
segment. The internal price, set for transactions within the company, is distinct from the external
price, which is the amount charged to customers outside the organization for its goods or
services, reflecting market dynamics. In this context, supplying divisions plays a pivotal role as
they are responsible for producing or managing the resources used by other divisions within the
company. On the other side, receiving divisions utilize the resources provided by supplying
divisions, serving as recipients of goods or services and utilizing them to generate revenue or
enhance the value of other products or services within the company.

The relationship between the transfer price and the external selling price is displayed in the table
below:
According to Figure 1 in the topic, Thong Nhat Company consists of two main divisions: the
production division and the sales division. The production division, referred to as the "supply
division," is responsible for manufacturing the company's products. On the other hand, the sales
division deals with external sales, catering to customers outside Thong Nhat Company.
Additionally, there is an internal sale process where the production division sells its products to
the sales division for further distribution in the market. This internal transaction reflects the
coordination between the production and sales departments within the company.

III. Problems with transfer pricing that arise between Thong Nhat Company's production and
sales departments:

Thong Nhat Corporation is a multinational organization that operates at several stages of the
value chain involved in the production of bicycles. It is organized vertically. There are many
obstacles to overcome while determining transfer pricing between the production and sales
divisions of Thong Nhat Corporation.

Firstly, there is the problem of maintaining the right level of divisional autonomy. The
manufacturing division may set transfer prices higher than the market to optimize earnings. The
sales division may see decreased profitability or perhaps losses as a result of this. The sales
division could decide to set transfer prices below market value to maximize corporate profits.
Lower profitability for the production sector could result from this. For instance, to recoup its
expenses and turn a profit, the production department would wish to charge the sales division a
premium for bicycles. To remain competitive, the sales department, on the other side, would
wish to charge clients less. Conflict between the two sections could result from this.

Ensuring divisional performance is measured fairly is the second issue. Divisional success may
be impacted by transfer prices. For instance, the sales division may be undervalued if the transfer
price is high because it will result in lower profits. Bicycles can be sold for more money than the
transfer price, for instance, and the sales division will be able to make more money. The sales
division might not be able to compete with other businesses, though, if the transfer price is
excessively high.
The third challenge is ensuring corporate profits are maximized. Transfer prices can affect
corporate profits. If the transfer price is high, then corporate profits may be lower. For example,
if the production division can sell bicycles to the sales division at a lower price than it could sell
them to external customers, then corporate profits will be lower.

The aforementioned difficulties underscore the innate tensions between the production
department's profit-driven emphasis and the sales department's revenue-centric methodology.

III. Examining transfer pricing strategies:

1. Market - based transfer pricing:

The market price method sets the transfer price according to the current external selling price
between the person who wants to buy and the person who wants to sell. The market price method
is considered the optimal transfer price method and is used when the market has been well
established. The main advantage of this method is the ability to optimize transfer prices when the
market is strong. It is also easier to comply with arm's length transaction standards, helping the
unit maintain autonomy and maintain competitive prices. This is beneficial for maintaining a
balance between profits and production costs. However, the disadvantage of this method lies in
the fact that market prices may not always be available or easily determined, especially in special
industries or when market information is not transparent enough. Furthermore, rebates from
external suppliers are often not recorded, creating a gap in cost management and assessment.

For example: If Thong Nhat Company wants to apply the market price method to determine the
transfer price between the production department and the sales department, the transfer price will
be 100,000 VND/product. Specifically, if Thong Nhat Company wants to maximize profits, the
product transfer price should be higher than the market price. This will help Thong Nhat
Company gain more profits. For example, if Thong Nhat Company wants to maximize profits
with a gross profit margin of 20%, the product transfer price should be 120,000 VND/product
(100,000 VND * 1.2). On the contrary, if Thong Nhat Company wants to optimize costs, the
product transfer price should be lower than the market price. This will help Thong Nhat
Company reduce production costs. For example, if Thong Nhat Company wants to optimize
production costs with a gross profit margin of 10%, the product transfer price should be 90,000
VND/product (100,000 VND / 1.1).

2. Cost-based transfer pricing:

A method for figuring out transfer prices based on a product or service's production cost is called
the cost-based transfer pricing method. Usually, production expenses are multiplied by a profit
margin or administration expense to arrive at the transfer price. This method has the benefit of
being efficient and simple to apply, especially since production costs can be constantly and
precisely measured. Another good thing about this approach is that it is transparent. This
promotes transparency in the transfer price negotiation and review process in addition to aiding
internal management in understanding the price structure. However, the disadvantage of the cost-
based transfer pricing method is that it does not guarantee profit maximization of the entire
business. This shortcoming can result in reduced profit performance and inflexibility in the face
of market fluctuations and the business's strategic goals.
For example: Thong Nhat Company, a manufacturing enterprise, applies the cost method to
determine the transfer price between the production department and the sales department. The
production cost of each product is 50,000 VND, and the transfer price is determined to be 50,000
VND/product. Although this price may be considered fair to both departments, it does not reflect
the business's goal of optimizing profits. If Thong Nhat Company wants to maximize profits,
they can consider increasing the transfer price to, for example, 60,000 VND/product to achieve a
gross profit margin of 20%. Although this price can increase profits, it also needs to be carefully
considered to ensure competitiveness and not affect sales revenue.

3. Dual-rate pricing:

Dual-rate pricing is a combination of different methods, which involves recording transfer

pricing in different amounts for the buying and selling departments. Under the dual pricing
method, the sales department records sales at market price and the purchasing department
records purchases at the sales department's variable cost. Dual-rate pricing method brings
benefits to both sellers and buyers. The seller can profit from the transaction, while the buyer
minimizes the cost of the purchase. Furthermore, this approach encourages internal transfers, as
profits are shared across departments, creating incentives for internal collaboration. Using this
strategy has the drawback of potentially complicating accounting records, particularly when
comprehensive tracking and recording of transactional information is required. Account
administration, finance, and accounting may be complicated by the requirement to withdraw the
transfer at the original price, which may result in an account hold (pending) until the transaction
is zero.

For example: Applying the dual pricing method between the production department and the sales
department for new products of Thong Nhat Company, the transfer price for the sales department
is 100,000 VND/product, while the transfer price for the sales department is 100,000
VND/product, while the transfer price assigned to the production department is 50,000
VND/product. The result of this method is that the production department will have a profit of
100,000 VND/product (market price) minus variable costs of 50,000 VND/product, which is
50,000 VND/product. In contrast, the sales department will reduce costs by 50,000
VND/product, creating conditions for both departments to benefit during the internal transfer
process.

IV. Addressing the Thong Nhat Company's transfer price issue:

Thong Nhat Company had significant difficulties when determining transfer pricing. The
production department seeks to maximize profits, while the sales department wants to maximize
revenue. This creates a situation of competing interests between the two departments. A further
difficulty in estimating production costs is the complexity of products with a wide range of
manufacturing costs, which creates problems in figuring out transfer prices and sustaining
profits. More risk is involved in determining prices and bringing products to market because, in
particular, new products do not yet have a standard market price.
In the context of Thong Nhat Company's transfer pricing, the market price method stands out as
the most suitable choice. Choosing this method not only ensures that both departments,
production and sales, are profitable but also fully reflects the strategic goal of the business,
which is profit optimization. The market price method focuses on the price at which the product
can be sold in the market, and setting the transfer price at this price helps ensure that businesses
can sell the product at the highest price. The explanation for this choice is obvious. The market
price method not only meets the goal of profit optimization but also simultaneously ensures fair
profits for both departments. The production department profits from the difference between the
market price and the cost of production, while the sales department profits from the difference
between the market price and the transfer price. This helps create balance and encourage
cooperation between internal departments of the business. Thong Nhat Company can realize the
transfer pricing method by applying the market price of the product. This process is simple and
effective by referencing the prices of similar products on the market. For example, if the market
price of Thong Nhat Company's product is 100,000 VND/product, the transfer price between the
production department and the sales department will also be 100,000 VND/product.

V. Summary:

In the context of corporate governance, transfer pricing is a significant problem that requires
creative and efficient solutions. To improve transfer pricing performance, businesses need to set
clear policies and procedures that will facilitate the management and execution of this process
effectively and transparently. A key strategy is to routinely assess transfer pricing's efficacy. This
calls for ongoing observation and assessment of the outcomes to make the necessary corrections.
Businesses can do this by gradually modifying their transfer pricing approach to maximize
earnings while maintaining internal departmental balance. This not only makes the transfer
pricing process easier for businesses to handle, but it also develops an automated system that is
adaptable and quick to change in the market and consumer needs. All things considered,
resolving issues and enhancing the effectiveness of the transfer pricing process depend on
developing and maintaining solid procedures and efficient review.

VI. References:

1. Transfer Price: What It Is, How It’s Used, and Examples. (2022, April 28). Investopedia.
https://www.investopedia.com/terms/t/transferprice.asp

2. Transfer Pricing: What It Is and How It Works, With Examples. (2023, May 28). Investopedia.
https://www.investopedia.com/terms/t/transfer-pricing.asp

3. Gandhi, R., Rai, M., Kumar, R., & Kumar, N. (2022, March 22). Know about Market-Based
Transfer Pricing - Enterslice. Enterslice. https://enterslice.com/learning/market-based-transfer-
pricing/

4. BSc, CEPF®, T. T. (n.d.). Dual Pricing | Definition, Importance, Types, How to Set Up One.
Finance Strategists. https://www.financestrategists.com/financial-advisor/dual-pricing/
5. Group, V. (n.d.). The Cost Plus Transfer Pricing Method (With Examples). The Cost Plus
Transfer Pricing Method (With Examples). https://www.valentiam.com/newsandinsights/cost-
plus-method

6. Group, V. (n.d.). 5 Challenges Of Transfer Pricing To Consider | Valentiam. 5 Challenges of

Transfer Pricing to Consider | Valentiam.
https://www.valentiam.com/newsandinsights/challenges-transfer-pricing

7. The Problems of Transfer Pricing. (1998, July 1). Journal of Accountancy.

https://www.journalofaccountancy.com/issues/1998/jul/carter.html

8. Loss making MNCs in Vietnam and transfer pricing implication. (2021, October 1). Grant
Thornton Vietnam | Audit | Tax | Advisory | Business Process Solutions.
https://www.grantthornton.com.vn/press/press-release-2020/vietnamtransfer-pricing-challenges-
for-mnes/