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CPA Charles W. Inc. CPA.. CMA Jon A. Rooney.. . Booker. CIA Cynthia J.D. CPA McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies. Ph.A..D. All rights reserved. Ph. D. Caldwell.D.Transfer Pricing Chapter 15 PowerPoint Authors: Susan Coomer Galbreath.B. Ph..

Because the exchange takes place within the organization.LO 15-1 Transfer Pricing LO 15-1 Explain the basic issues associated with transfer pricing Transfer Price The value or amount recorded in a firm’s accounting re when one business unit sells (transfers) a good or serv another business unit. the firm has considerable discretion in setting this transfer price. 15-3 . however. The accounting records in the t (responsibility centers) treat this transaction in exactly same way as a sale to an outside customer.

LO 15-1 Transfer Pricing Because the managers of both the selling division and the buying division are evaluated on division profit. not company. to make decisions that are in the firm’s best interest. The optimal transfer price is the price that leads both division managers. on their division. they consider the effect of all sales. both internal and external. 15-4 . each acting in his or her own self-interest. profit. not company profit.

and the divisional costs. does firm profit increase? • Given the transfer price. the final market prices.LO 15-2 Determination of Optimal Transfer Price • Given the market prices and the costs in the firm. does the selling division profit increase? • Given the transfer price. and the divisional costs. the intermediate market prices. does the buying division profit increase? 15-5 .

LO 15-2 Optimal Transfer Price Transfer Outlay Opportunity cost of the + = price cost resource at the point of transfer 15-6 .

15-7 .LO 15-2 Optimal Transfer Price To restate the goal of each manager: • Each division manager wants to maximize his contribution margin. • Each manager is indifferent about the transfer price if it has no impact on their contribution margin.

• In this case. 15-8 . the company has decided that it will not allow the divisions to buy or sell wood on the outside market. • The optimal transfer price is the outlay cost for producing the goods (generally the variable costs). the only outlet for the Wood Division is the Paper Division and the only source of supply for the Paper Division is the Wood Division.LO 15-2 Optimal Transfer Price: No Intermediate Market Suppose that no intermediate market for wood exists or that. for whatever reason.

• Transfer price higher than market: Buying division will not buy • Transfer price lower than market: Selling division will not sell 15-9 . cost-based transfer prices.LO 15-3 Managers’ Goals versus Firms’ Goals LO 15-3 Identify the behavioral issues and incentive effects of negotiated transfer prices. and market-based transfer prices.

LO 15-3 Centrally Established Transfer Price Policies Market Price-Based Sets the transfer price at the market price or at a small discount from the market price Cost-Based Outlay cost to selling division plus forgone contribution to company projects Negotiated Transfer Managers of the buying and selling divisions agree on a price 15-10 .

complex. standard standard costs costs are are generally generally used used as as aa basis basis for for transfer transfer pricing pricing in in cost-based cost-based systems. divisions. costs. Consequently. price. Cost-Plus Transfers Cost-Plus Transfers We We also also find find companies companies using using cost-plus cost-plus transfer transfer pricing pricing based based on on either either variable variable costs costs or or full full absorption absorption costs. manufacturing manufacturing firms firms sometimes sometimes use use full full absorption absorption cost cost as as the the transfer transfer price. this this is is not not always always the the case. transfer. cost. available. division. Standard Standard Costs Costs or or Actual Actual Costs Costs If If actual actual costs costs are are used used as as the the basis basis for for the the transfer. To To promote promote responsibility responsibility in in the the selling selling division division and and to to isolate isolate variances variances within within divisions. 15-11 .LO 15-3 Alternative Cost Measures Full Full Absorption Absorption Cost-Based Cost-Based Transfers Transfers Although Although the the transfer transfer pricing pricing rule—differential rule—differential outlay outlay cost cost to to the the selling selling division division plus plus the the opportunity opportunity cost cost of of making making the the internal internal transfer transfer to to the the company—assumes company—assumes that that the the company company has has aa reliable reliable estimate estimate of of differential differential or or variable variable cost. any any variances variances or or inefficiencies inefficiencies in in the the selling selling division division are are passed passed to to the the buying buying division. case. systems. Consequently. These These methods methods generally generally apply apply aa normal normal markup markup to to costs costs as as aa surrogate surrogate for for market market prices prices when when intermediate intermediate market market prices prices are are not not available. The The problem problem of of isolating isolating the the variances variances that that have have been been transferred transferred to to the the subsequent subsequent buying buying divisions divisions becomes becomes extremely extremely complex.

LO 15-3 Motivational Problems of Transfer Pricing A A supplier supplier whose whose transfers transfers are are almost almost all all internal internal is is usually usually organized organized as as aa cost cost center. operations. measures. Hence. center. costs. In In companies companies in in which which such such aa supplier supplier is is aa profit profit center. revenues. The The center center manager manager is is normally normally held held responsible responsible for for costs. 15-12 . Hence. the the artificial artificial nature nature of of the the transfer transfer price price should should be be considered considered when when evaluating evaluating the the results results of of that that center’s center’s operations. not not revenues. center. the the transfer transfer price price does does not not affect affect the the manager’s manager’s performance performance measures.

15-13 . and the selling division could be credited for cost plus some profit allowance. That is. The difference could be accounted for in a specialized centralized account. however cost is determined. the buyer could be charged the cost of the unit.LO 15-3 Dual Transfer Prices A dual transfer pricing system could be installed to provide the selling division with a profit but to charge the buying division only for costs.

LO 15-4 Multinational Transfer Pricing LO 15-4 Explain the economic consequences of multinational transfer prices. Because tax rates vary among countries. companies have incentives to set transfer prices that will increase revenues (and profits) in low-tax countries and increase costs (thereby reducing profits) in high-tax countries. 15-14 . transfer prices can affect tax liabilities. royalties. In international (or interstate) transactions. and other payments because of different laws in different countries (or states or provinces).

This reporting requirement is intended to provide a measure of performance for those segments that are significant to the company as a whole.LO 15-5 Segment Reporting LO 15-5 Describe the role of transfer prices in segment reportin The Financial Accounting Standards Board (FASB) requires companies engaged in different lines of business to report certain information about segments that meet the FASB’s technical requirements. 15-15 .

• Certain specialized items. • Capital expenditures. • Depreciation and amortization. 15-16 . from both internal and external customers. • Identifiable segment assets. • Interest revenue and expense. • Segment operating profit or loss.LO 15-5 Segment Reporting The following are the principal items that must be disclosed about each segment: • Segment revenue.

End of Chapter 15 15-17 .