Transfer Pricing

CA Final: Paper 5: Advanced Management Accounting: Chapter 7

CA. ROHIT CHORARIA B.Com, FCA

 Learning Objectives
2

Basic Concepts in Transfer Pricing

Methods of Transfer Pricing

 Definition
3

Transfer price is the price which one

division of an organisation charges for a
product or service supplied to another
division of the same organisation.
 Concept
4

Several divisions in an organisation

Performance of each division measured in terms of profit

Manager of the division responsible for its performance/ profits

When goods are transferred, income of the supplying division is the

cost of the receiving division

Thus Transfer price fixed will affect the profitability of both divisions
 Objectives
5

Optimise
Maximum
Emphasis on allocation of
Utilisation of
Profits financial
plant capacity
resources
 Methods of Transfer Pricing
6

Pricing at Cost or variants of cost method

Actual
Standard Cost Full Cost Full Cost + Markup
Manufacturing Cost

Pricing at Market Price

Pricing at bargained or negotiated price

7 I. Pricing at Cost
Various Methods
 Actual Manufacturing Cost
8

Goods or services are transferred at their actual cost of

production

Useful for those units where the responsibility of profit

performance is centralised

Difficult to measure the performance of each profit

centre
 Standard Cost
9

Transfers of goods and services are made at their standard cost

Any difference between actual and standard cost viz., variances are
usually absorbed by the supplying unit. Occasionally, variances are
transferred to the user unit

This will result in the inventory being carried at identical standard cost by
both the supplying and receiving units

Here also the profit performance responsibility is centralised and thus it

cannot be measured for individual units involved
 Full Cost Pricing
10

Full cost means cost of production plus expenses like selling

and distribution, administration, research and development
cost etc

In this method, the supplying unit is not allowed to make any

profit on transfers to other units. But it is free to earn profit
on outside sale

One good thing about this method is that the supplying unit is
allowed to recover the full cost of the goods/services
transferred
 Full Cost + Markup Pricing
11

Supplying unit transfers goods and services at full cost plus some mark-up

The markup added to full cost is either expressed as a percentage of full cost or of
capital employed

Selling expenses here are recovered by the supplying unit without incurring them,
especially when the goods/services are transferred internally

Due to this defect the use of full cost plus method is not appreciated by the internal
receiving units

To overcome this defect either the use of standard cost plus or actual cost plus are
preferred

Use of either of the preceding method facilitates the task of measuring profit
performance and efficiency of the units involved
12 II. Pricing at Market Price
An Introduction.
 Objective
13

In a competitive market
goods/services cannot
Transfer prices of
be transferred to its
goods/services
users at a higher price.
transferred to other
Such a competitive
units/divisions are
market provides an
based on market prices
incentive to efficient
production

Since market prices will,

Competitive market
by and large be
prices provide reliable
determined by demand
measures of divisional
and supply in the long
income because these
run, it is claimed that
prices are established
profits which results
independently rather
under this method, will
than by individuals who
provide a good indicator
have an interest in the
of the overall efficiency
results
of the various units
 Market Pricing - Limitations
14

Difficulty in determining the elements of

selling and distribution expenses such as
commission, discounts, advertisement and
Difficulty in obtaining market prices sales promotion etc., so that necessary
adjustment may be made in the market
price to provide benefit of these expenses,
to the profit centre, receiving the goods.
15 Illustration 1
 Problem Statement
16

 A Ltd. manufactures a product using a series of mixing operations.

 The finished product is packaged in the company-made glass bottles and
packed in attractive cartons.
 The company is divided into two independent divisions
1. one for the manufacture of the end-product
2. one for the manufacture of glass bottles.
 1 can buy all the bottles from 2.
 Division 2 obtained quotations from the outside manufacturers for empty
bottles. The summary is given below along with A’s production cost.

No. of empty bottles Total Purchase Value A Ltd’s Production Cost

8,00,000 Rs. 14,00,000 Rs.10,40,000

12,00,000 Rs. 20,00,000 Rs.14,40,000

 Problem Statement
17

The production cost and sales value of the end product marketed by the product
manufacturing division are as under:
Volume (Bottles of end Total cost of end product (excluding Sales value (Packed in
product) cost of empty bottles) bottles)

8,00,000 64,80,000 91,20,000

12,00,000 96,80,000 1,27,80,000

There has been considerable discussion at the corporate level as to the use
of proper price for transfer of empty bottles from the bottle manufacturing
division to product manufacturing division. This interest is heightened
because a significant portion of the Divisional General Manager ’s salary is in
incentive bonus based on profit centre results.
 Problem Statement
18

 As the corporate management accountant responsible for defining

the proper transfer prices for the supply of empty bottles by the
bottle manufacturing division to the product manufacturing division,
you are required to show for the two levels of volumes of 8,00,000
and 12,00,000 bottles, the profitability by using
 market price and
 shared profit relative to the costs involved basis for the determination of
transfer prices.
 The profitability position should be furnished separately for the two
divisions and the company as a whole under each method.
 Discuss also the effect of these methods on the profitability of the
two divisions.
 Solution
19

Statement of profitability of two divisions at two different levels of output using different transfer prices
No. of bottles 8,00,000 12,00,000
Rs. Rs.
Sales value packed item (A) 91,20,000 1,27,80,000
Less: Costs
Product Manufacturing Divn 64,80,000 96,80,000
Bottle Manufacturing Divn 10,40,000 14,40,000
Total Costs (B) 75,20,000 1,11,20,000
Profit : (A) –(B) 16,00,000 16,60,000
Pro-rated Profit
Share of Bottle Mfring
16,00,000 x 10.40L/ 75.2L 2,21,276
16,60,000 x 14.4L/111.2L 2,14, 964
Balance for Product Mfring 13,78,724 14,45,036
Total 16,00,000 16,60,000
 Solution - Transfer price of bottles
20

Costs 10,40,000 14,40,000

Profit as computed above 2,21,276 2,14,964
Total Price 12,61,276 16,54,964
Transfer price per bottle Rs. 1.577 Rs. 1.379

From the above computations, it is observed that shared profit relative to the
cost involved is Rs.2,21,276 (Re. 0.2766 per bottle) at 8,00,000 production
level and Rs. 2,14,964 (Re. 0.179 per bottle) at 12,00,000 production level.
The profit of Product Mfg. Division is Rs.13,78,724 (Rs.1.723per bottle) at
8,00,000 production level and Rs. 14,45,036 (Rs. 1.2042 per bottle) at
12,00,000 production level.
 Solution - Profitability based on
market price
21

No. of bottles 8,00,000 12,00,000

Bottle Mfg Divn Rs. Rs.
Market Price 14,00,000 20,00,000
Less: Cost 10,40,000 14,40,000
Profit (i) 3,60,000 5,60,000
Product Mfg Divn
Sales 91,20,000 1,27,80,000
Less: Bottle cost 14,00,000 20,00,000
Product Cost 64,80,000 96,80,000
Profit (ii) 12,40,000 11,00,000
Total profit: (i) + (ii) 16,00,000 16,60,000
 Comments
22

Profit based on cost (Rs. Lakhs) Profit based on market price (Rs. Lakhs)

Production Level Bottle Mfg Product Mfg Bottle Mfg Product Mfg

8,00,000 bottles 2.21 13.79 3.60 12.40

12,00,000 bottles 2.15 14.45 5.60 11.00

Comments:
•Market price method gives better profitability to Bottle Mfg. at both production levels.
•Market price method gives lower profitability to Product Mfg as compared to Bottle Mfg.
•Under Cost-based method, there is a better profit at lower level of production in Bottle
Mfg. Division. However in Product Mfg. Division 12,00,000 production level gives a higher
profit. But in Market price method, the position is reverse.
23 III. Pricing at Bargained Price
 Methodology
24

Under this method each decentralised unit is considered as an independent unit

and such units decide the transfer price by negotiations or bargaining

Divisional managers have full freedom to purchase their requirement from

outside if the prices quoted by the outside party is lower

A system of negotiated prices develops business like attitude amongst

divisions of the company

To avoid any reduction in overall profits of the company, top management may
impose restriction on the external purchase/sale of goods
 Intra-Company Transfer
25

In order to have an effective system of intra-company

transfer pricing the following points should be kept in view:

Prices of all transfers in and out of a profit centre

should be determined by negotiation between the
buyer and the seller

Negotiations should have access to full data on

alternative sources and markets and to public and
private information about market prices

Buyers and sellers should be completely free to deal

outside the company
26 Illustration 2
 Problem Statement
27

B Ltd. is has several production shops. Each shop charges other shops
for material supplied and services rendered.

B Limited is having a welding shop and painting shop. The welding shop
welds annually 75,000 purchased items with other 1,50,000 shop made
parts into 12,000 assemblies.

The assemblies are having variable cost of Rs. 9.50 each and are sold in
market at Rs. 12 per assembly.

Out of the total production, 80% is diverted to painting shop at same price
ruling in the market.
 Problem Statement
28

Welding shop incurs a fixed cost of Rs. 25,000 per annum while the
painting shop is having fixed cost of Rs. 30,000. Its cost of painting
including transfer price from welding shop comes to Rs. 20 per unit.

The painting shop sells all units transferred to it by welding shop at

Rs. 25 per assembly.

You are required to:

• Find out profit of individual cost centres and overall profitability of the concern.
• Recommend course of action if painting shop wishes to purchase its full requirement
at market price which is Rs. 10 per assembly either from open market or from
welding shop at market price of Rs. 10 per assembly.
 Solution: (a) Present profitability of
individual shops and overall profitability
29

Particulars Welding Shop Painting Shop

Qty (Unit) Rate (Rs.) Value (Rs.) Qty (Unit) Rate (Rs.) Value (Rs.)

Sale in open market 2,400 12.00 28,800 9,600 25.00 2,40,000

Transfer to painting 9,600 12.00 1,15,200

shop
Total Sales (A) 12,000 1,44,000 9,600 2,40,000

Less: Variable Cost (B) 1,14,000 9,600 x 20 1,92,000

12,000 x 9.50
Contribution (A) – (B) 30,000 48,000

Less: Fixed Cost 25,000 30,000

Profit/(Loss) 5,000 18,000

Overall profit for the company: Rs. 5,000 + Rs. 18,000 = Rs. 23,000

29
 (b) (i) When painting shop purchases all its
requirements from open market at a price of
Rs.10 per unit
30

Particulars Welding Shop Painting Shop

Qty Rate (Rs.) Value (Rs.) Qty (Unit) Rate (Rs.) Value (Rs.)
(Unit)
Sale in open 2,400 12.00 28,800 9,600 25.00 2,40,000
market
Less: Variable 2,400 9.5 22,800 9,600 18.00 1,72,800
Cost

Contribution 6,000 67,200

Less: Fixed Cost 25,000 30,000

Profit/(Loss) (19,000) 37,200

Overall profit for the company:Rs. 37,200 – Rs. 19,000 = Rs. 18,200

30
 (b) (ii) When all the requirements of painting
shop is met by transfer from welding shop at
a transfer price of Rs. 10 per unit
31

Particulars Welding Shop Painting Shop

Qty (Unit) Rate (Rs.) Value (Rs.) Qty (Unit) Rate (Rs.) Value (Rs.)
Sale in open market 2,400 12.00 28,800 9,600 25.00 2,40,000
Transfer to painting 9,600 10.00 96,000
shop
Total Sales (A) 12,000 1,24,800 9,600 2,40,000
Less: Variable Cost (B) 1,14,000 9,600 x 18 1,72,800
12,000 x 9.50
Contribution (A) – (B) 10,800 67,200
Less: Fixed Cost 25,000 30,000
Profit/(Loss) (14,200) 37,200

Overall profit of the company = Rs. 37,200 – Rs. 14,200 = Rs. 23,000

31
 Summary of the Alternatives
32

Welding Shop Painting Shop Total

Rs. Rs.

Profit/ (Loss) under (b) (i) (19,000) 37,200 18,200

Profit/ (Loss) under (b) (ii) (14,200) 37,200 23,000

33 Illustration 3
 Problem Statement
34

 Division A is a profit centre which produces three products

X, Y and Z. Each product has an external market.

Products X Y Z

Rs. Rs. Rs.

External mkt price p.u. 48 46 40

Variable cost of prodn in Divn A 33 24 28

Labour hrs reqd p.u. in divn A 3 4 2

 Problem Statement
35

Product Y can be transferred to Division B, but the maximum quantity that might be
required for transfer is 300 units of Y.

The maximum external sales are:

X: 800 units; Y: 500 units; Z: 300 units

Instead of receiving transfers of product Y from Division A, Division B could buy similar
product in the open market at slightly cheaper price of Rs. 45 p.u.

What should the transfer price be for each unit for 300 units of Y, if the total labour hours
available in Division A are:
3,800 hours 5,600 hours
 Solution: (i) Hours required to
meet maximum demand
36

External sales Hours reqd p.u. Total Hrs

(i) (ii) (iii)=(i) x (ii)
X 800 units 3 2,400
Y 500 units 4 2,000
Z 300 units 2 600
Total 5,000
 Contribution Per Unit
37

Product X Y Z
Rs. Rs. Rs.
Selling Price 48 46 40
Less: Variable cost 33 24 28
Contribution p.u. (A) 15 22 12
Labour hrs reqd p.u.(B) 3 4 2
Contb p. hr (A)/ (B) 5 5.5 6
Ranking III II I
 3,800 Hours
38

(a) If only 3,800 hours are available in Division A:

 300 units of Z (maximum), which will take 600 hrs.
 500 units of Y (maximum), which will take 2,000 hrs.
 400 units of X to use remaining hrs. 1,200 hrs.
3,800 hrs.
Transfer price
 (i) Variable cost of Y 24.00
Opportunity cost
 (ii) Contribution relating to ‘X’ forgone for producing
additional units of Y (4 hrs × Rs. 5*) 20.00
44.00

*Y takes 4 hours and in each hour production of X would have generated contribution of
Rs. 5.
 5,600 Hours
39

(b) If 5,600 hours are available

 Maximum time required to meet external sales
(Refer to Working note 1) 5,000 hrs.
 Hours now available 5,600 hrs.
 It means 600 hrs can be easily used for the production of Y and
transfer price will be variable cost only i.e. (600 hrs. ÷ 4 hrs) × Rs. 24 Rs. 3,600
Note: Y takes 4 hours per unit

 For producing additional 150 units, production of X will be disturbed.

Variable costs
 (i) 150 units of X @ Rs. 24 Rs. 3,600
Opportunity cost
 (ii) Contribution of ‘X’ units forgone (600 hrs. × Rs. 5) Rs. 3,000* 6,600
 Total price for 300 units 10,200
 Thus, Average transfer price should be Rs. 34 per unit
*Contribution per hr. of X foregone
40 Division and Company Conflict
 Conflicts
41

Where profitability is used as a criteria for evaluating the performance

of each division, conflict arises between a division of the company
and company as a whole

Under decentralisation it is expected that the top management should

not interfere with the decision making process of its subordinates
heading different units

The management of such companies also expects that each division

should not only achieve its own objective necessary for evaluating the
performance but should also achieve the objective of goal
congruence.
 Conflicts
42

If a division fails to achieve the objective of ‘goal congruence’ the

management of the company may dictate their ‘transfer price’

Such interference of management of the company is usually the main

basis of conflict between a division and the company as a whole

Conflict is aggravated if management advocates transfer of goods and

services at cost

The profitability of the transferring division will not be known by the

use of such a transfer price
43 Multinational Transfer Pricing
 Multinational transfer pricing
44

For example, an MNC

Multinational companies might prefer to make its
may use transfer prices to profits in a country, where
minimize worldwide maximum corporate tax
income taxes, import rate is 28%, rather than in
duties, and tariffs. some other place where
the rate is 35%
 Multinational transfer pricing
45

Suppose a division in a high-income-tax-rate country produces

a sub-assembly for another division in a low-income-tax-rate
country.

By setting a low transfer price, the company can recognize

most of the profit from the production in the low-income-tax-rate
country, thereby minimizing taxes.

Likewise, items produced by divisions in a low-income-tax-rate

country and transferred to a division in a high-income-tax-rate
country should have a high transfer price to minimize taxes.
 Multinational transfer pricing
46

Most countries base

import duties on the price
Therefore, low transfer
Sometimes import duties paid for an item, whether
prices generally lead to
offset income tax effects bought from an outside
low import duties.
company or transferred
from another division.
 Multinational transfer pricing
47

Consider a item manufactured by ABC Ltd. (Switzerland) with an 8%

income tax rate and transferred to a division in India with a 40% income
tax rate.

In addition, suppose India imposes an import duty equal to 20% of the

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

Suppose the full unit cost of the item is Rs. 100, and the variable cost is
Rs. 60. If tax authorities allow either variable- or full-cost transfer prices,
which should ABC Ltd choose?
 By transferring @ Rs.100 in place
of Rs. 60, Co gains Rs. 4.80 p.u.
48

Income of the Swiss division is Rs. 40 higher; therefore it pays 8% x

Rs. 40 more income taxes (Rs. 3.20)

Income of the Indian division is Rs. 40 lower; therefore it pays

40% x Rs. 40 less income taxes (Rs.16.00)

Import duty is paid by the India division on an additional Rs.100 –

Rs.60 = Rs.40; therefore it pays 20% x Rs.40 more duty (Rs. 8)

Net saving from transferring at Rs. 100 instead of Rs. 60 Rs. 4.80
 Multinational transfer pricing
49

In case a country
restricts the amount
of dividend paid to
Financial
foreign owners, it Transfer pricing is
restrictions imposed
may be easier for a more complex in a MNCs try to achieve
by some
company to get multinational more objectives
governments may
cash from a foreign company than it is through transfer
be avoided by an
division in form of in a domestic pricing policies
effective use of
payments for company.
transfer price
product transferred
rather than cash
dividend
50 Illustration 4
 Illustration-4
51

C Ltd consists of the Semi-conductor Division and the Minicomputer

Division each of which operates as an independent profit centre. Semi-
conductor Division employs craftsmen, who produce two different
electronic components, the new-high performance Super-chip and an
older product called Okay-chip. These two products have the following
cost characteristics:

Super Chip Okay Chip

Material Parts Rs.20 Parts Rs.10

Labour 2 hours x Rs. Rs.280 ½ hour x Rs.70

140 Rs.140

Annual Overhead in Semi-conductor Division is Rs. 40,00,000 all fixed.

Owing to high skill level necessary for the craftsmen, the Semi-conductor
Division’s capacity is set at 50,000 hours per year.

51
 Illustration-4
52

 To date, only one customer has developed a product utilising super-

chip, and this customer orders a maximum of 15,000 super-chips per
year at a price of Rs. 600 per chip. If C cannot meet his entire demand,
the customer curtails his own production. The rest of the
semiconductor’s capacity is devoted to Okay-chips, for which there is
unlimited demand at Rs. 120 per chip.
 The Mini-computer Division produces only one product, a process
control unit, which requires a complex circuit board imported at a price
of Rs. 600. The control unit’s costs are:

Material Circuit board Rs.600

Other Parts Rs.80
Labour 5 hours @ Rs.100 Rs.500

52
 Illustration-4
53

 The Mini-Computer Division is composed of only a small assembly plant and all
overhead is fixed at a total of Rs. 8,00,000 per year. The current market price for the
control unit is Rs. 1,400 p.u.
 A joint research project has just revealed that with minor modifications, a single
super-chip could be substituted for the circuit board currently used by the Mini-
computer division. The modification would require an extra one hour of labour by
Mini-computer’s staff, for a total of 6 hours per unit.
 Mini-computer has therefore asked Semi-conductor division to declare a transfer
price at which Semi-conductor division would sell super-chip internally.

 Required :
 Mini-computer expects to sell 5,000 control units this year. From the overall view
point of C, how many super-chips should be transferred to Mini-computer Division to
replace circuit boards ?
 If the demand for the control unit is sure to be 5,000 units, but its price is uncertain,
what should be the transfer price of super-chip to ensure proper decisions ? (All
other data unchanged)
 If demand for the control unit rises to 12,000 units at a price of Rs. 1,400 per unit,
how many of 12,000 units should be built using Super-chip ?
 Solution
54

1. Contribution per hour of Super-chips and Okay-chips:

Super-Chips Okay-Chips
Selling price p.u. (Rs.) 600 120
Less: Variable cost p.u. (Rs.) 200 80
Contribution p.u. (Rs.) 300 40
Hours reqd p.u. 2 0.5
Contb per hr 150 80
(Rs.300/2 hrs) (Rs.40/0.5 hrs)

2 . Details of hours utilised in meeting the demand of 15,000 units of Super-chips and
utilising the remaining hours for Okay-chips out of available hours of 50,000 per annum:

Hours utilised for 15,000 units of Super-chips (15,000 units × 2 hours)= 30,000
Hours utilised for 40,000 units of Okay-chips (40,000 units × 0.5 hours)= 20,000
50,000

54
 Solution
55

3 . Contribution of process control unit (using imported complex circuit board): Rs.
 Selling price per unit : (A) 1,400
Variable costs :
 Circuit board (Imported) 600
 Other parts 80
 Labour cost (5 hours × Rs. 100) 500
 Total variable cost : (B) 1,180
 Contribution per unit (Rs.) {(A) – (B)} 220
4 . Contribution of a process control unit (using a Super chip) :
 Selling price per unit : (A) 1,400
Variable costs :
 Super chip (Material + Labour costs) 300
 Other parts 80
 Labour cost (6 hours × Rs. 100) 600
 Total variable cost : (B) 980
 Contribution per unit : {(A) – (B)} 420
Incremental contribution per unit of a process control unit, when instead of using imported complex
circuit board Super-chip is used : Rs. 200 (Rs. 420 – Rs. 220)
 Solution
56

(i) Super-chip to be transferred to Mini Computer Division to replace Circuit Boards:

 Out of 50,000 available hours 30,000 hours are utilised for meeting the demand of 15,000
units of Super-chips, the rest 20,000 hours may be used for manufacturing 40,000 Okay-
chips, which yields a contribution of Rs. 40 per unit for Rs. 80/- per hour or a contribution
of Rs. 160 per two-equivalent hours.

 In case the company decides to forego the manufacturing of 20,000 units of Okay- chips in
favour of 5,000 additional units of Super-chips to be used by Mini-Computer Division
(instead of complex imported Circuit Board) for manufacturing process control units. This
decision would increase the existing contribution of Mini-Computer Division by Rs. 200/-
per two-equivalent hours

 After taking into account the profit foregone of Okay-chips, the existing contribution of
Mini-Computer Division of C would increase by Rs. 40 per two equivalent hours.

 Hence the entire requirement of 5,000 units of Super-chips be produced and transferred to
Mini-Computer Division.
 Solution
57

(ii) Minimum transfer price of Super-chip to Mini Computer Division :

 = Variable cost of a Super-chip + Opportunity cost of foregoing the
production of an Okay-chip and using the craftsman time for Super-chip
= Rs. 300 + 2 hours × Rs. 80
= Rs. 460
(iii) Super-chips to be produced for the production of 12,000 units of
process control units:
 After meeting out the order of 15,000 Super-chips per year, the concern is
left out with 20,000 hours. Use of Super-chips for control units production
would increase the existing contribution of Mini-Computer Division by Rs.
200/- per unit.
 Out of the remaining 20,000 craftsmen hours, 10,000 units of Super-chips
can be made, which may be used for the production of 10,000 process
control units.
58 Multiple Choice Questions
 Multiple Choice Question-1
59

 In the case of standard cost based transfer pricing, if there is a

variance between the standard and actual cost, how is the same
dealt with?

 A. Variances if any are ignored

 B. Variances are usually absorbed by the supplying unit and
occasionally transferred to the user unit.
 C. Variances cannot arise as the standard cost will be equal to the
actual cost
 D. If actual cost if more than standard cost, the transfer is made at
actual cost. If actual is less, it is made at standard cost.

 Answer:
 Multiple Choice Question-2
60

 Transfer pricing helps in efficient allocation of

financial resources:

 True
 False

 Answer:
 Multiple Choice Question-3
61

 Full cost plus markup pricing suffers from the following defect:

 A. Arbitrary markup percentage can be prejudicial to the

receiving division
 B. Selling expenses are recovered by the supplying unit
without incurring them
 C. It is unclear whether standard cost or actual cost is to be
used
 D. Creates conflicts between the division and the company as
a whole

 Answer:
 Multiple Choice Question-4
62

 Under Bargained method of transfer pricing,

divisional managers have freedom to purchase
their requirement from outside if the prices
quoted by outside party is lower.

 True
 False

 Answer:
 Multiple Choice Question-5
63

 The main objective of multinational transfer

pricing is not to motivate divisional managers.

 True
 False

 Answer:
 Multiple Choice Question-6
64

 “Goal congruence” refers to the alignment of

the divisional objective with the objective of the
company as a whole in intra-company transfer
pricing.

 True
 False

 Answer:
 Multiple Choice Question-7
65

 If a division in a high income tax rate country produces and

transfers a product to a low income tax rate country, the transfer
price should be:

 A. High. Then the multinational company can recognise most of the

profit in the low income tax rate country, thereby minimising taxes
 B. Same. In the overall worldwide tax calculations, it will not have
any effect.
 C. Low. Then the multinational company can recognise most of the
profit in the low income tax rate country, thereby minimising taxes
 D. High. Then the multinational company can recognise less of the
profit in the high income tax rate country, thereby minimising taxes

 Answer
 Multiple Choice Question-8
66

 Transfer pricing can be achieved in a service

organisation with one division.

 True
 False

 Answer:
 Multiple Choice Question-9
67

 Transfer pricing based on actual cost alone is:

 Fair and achieves the objectives of transfer pricing

 Not useful in motivating managers to perform
better
 Reflective of the high efficiency of the division
 None of the above

 Answer:
 Multiple Choice Question-10
68

 If the external market for the transferred good is not

reasonably competitive and there is no idle capacity:

 Incremental cost should be deducted from outlay costs for

determining the maximum transfer price
 Opportunity cost should be added to outlay costs for
determining minimum transfer price
 Incremental cost should be added to outlay costs for
determining minimum transfer price
 Opportunity cost should be deducted from outlay costs for
determining the maximum transfer price

 Answer:
 Lesson Summary
69

We appreciated that in a transfer price scenario, the income of the

supplying division is cost of the receiving division. Hence profitability of
both divisions is affected.

Various methods of transfer pricing can be broadly categorised

under: cost or variant of cost method, market price method and
negotiated price method. Cost method has several sub methods like
actual manufacturing cost, standard cost, full cost and full cost plus
mark up.

Market price based pricing is faced with the difficulty of obtaining market
prices.
 Lesson Summary
70

Negotiated/ Bargained price method develops business like attitude

amongst divisions of the company

Where profitability is used as a criteria for evaluating performance of

each division conflict may arise between the division and the
company as a whole. Goal congruence is essential in intra-company
transfer pricing.

Multinational transfer pricing is driven by factors other than motivating

managers. Here the objective is often to minimize worldwide income
taxes, import duties, and tariffs.
Thank You