Transfer Pricing

Group 4
Amora |Azucena |Basa |Branzuela |Diaz | Ligutom
Mendoza | Saavedra | Seguisabal | Sy |Veloso
 Transfer Pricing
When divisions transfer products or
render services to each other, a transfer
pricing is used to charge for the products
or services
 TRANSFER PRINCING
Transfer pricing is the method used to sell a product from one
subsidiary to another within a company.

Costs transferred from one department of a company to

another department of a company.

Relates to the price applied to intercompany transactions.

These transactions can include the sales of products, the
provision of a service, the lending of money and the use of
(intangible) assets.
 TRANSFER PRICE
A transfer price is the price at which divisions of a
company transact with each other, such as the
trade of supplies or labor between departments.

A transfer price is the price at which the

subsidiaries of a business sell to each other.

A transfer price can also be known as a transfer

cost.
 TRANSFER PRICING SETTING

Padre Papers

Wood Division Paper Division

Wood for
Trees Paper
making paper

15 - 5
 KEY EQUATION

Transfer price = Differential cost

to selling division + Opportunity cost of
selling internally
 BENEFITS OF TRANSFER PRICING
Divisions can be evaluated as profit or
investment centers.
Divisions are forced to control costs and
operate competitively.
If divisions are permitted to buy component
parts wherever they can find the best price
(either internally or externally), transfer
pricing will allow a company to maximize its
profits.
 Commonly Used Transfer Prices
Market price approach sets the price at which
the product transferred could be sold to
outside buyers.
Negotiated price approach allows decentralized
managers to agree (negotiate) among
themselves.
Cost price approach (variable or full) uses a
variety of cost concepts for setting the
transfer price.
 TRANSFER PRICING METHODS
Market Rate Transfer Pricing
In the presence of competitive and stable external
markets for the transferred product, many firms
use the external market price as the transfer price.

The simplest and most elegant transfer price is to

use the market price.
 TRANSFER PRICING METHODS
Market Rate Transfer Pricing
By doing so, the upstream subsidiary can sell
either internally or externally and earn the same
profit with either option.

When transferred goods are recorded at market

prices, divisional performance is more likely to
represent the real economic contribution of the
division to total company profits.
 TRANSFER PRICING METHODS
Negotiated Transfer Pricing
Negotiate a transfer price between subsidiaries,
without using any market price as a baseline.

This arises when there is no discernible market

price because the market is very small or the
goods are highly customized. This results in prices
that are based on the relative negotiating skills of
the parties.
 NEGOTIATED TRANSFER PRICING
Formula:
Increase in Supplying Divisions Income from
Operations = (Transfer Price Variable Cost
per Unit) * Units Transferred

Increase in Purchasing Divisions Income from

Operations = (Market Price Transfer Price) *
Units Transferred
 TRANSFER PRICING METHODS
Negotiated Transfer Pricing
Negotiated transfer pricing has the advantage of
emulating a free market in which managers buy
and sell from each other in a manner that
simulates arms-length transactions.

Negotiated prices are generally preferred as a

middle solution between market prices and cost-
based prices.
 TRANSFER PRICING METHODS
Cost-Based Transfer Pricing
Each subsidiary transfer its products to other
subsidiaries at cost, after which successive
subsidiaries add their costs to the product.

This means that the final subsidiary that sells the

completed goods to a third party will recognize the
entire profit associated with the product.

It is used when external markets do not exist or are

not available to the company or when information
about external market prices is not readily available
 TRANSFER PRICING METHODS
Cost-Based Transfer Pricing
The transfer price is based on the production cost
of the upstream division. A cost-based transfer
price requires that the following criteria be
specified:
Actual cost or budgeted (standard) cost.
Full cost or variable cost.
The amount of markup, if any, to allow the upstream
division to earn a profit on the transferred product.
 Commonly Used Transfer Prices

Variable Cost Full Cost Market Price

per Unit $10 per Unit $13 per Unit $20

Negotiated Price
 TRANSFER PRICING METHODS
Adjusted Market Rate Transfer Pricing
If it is not possible to use the market pricing
technique then use the general concept, but
incorporate some adjustments to the price.
 TRANSFER PRICING METHODS
Contribution Margin Transfer Pricing
If there is no market price at all from which to
derive a transfer price, then an alternative is to
create a price based on a components
contribution margin.
 TRANSFER PRICING METHODS
Cost-Plus Transfer Pricing
In a controlled transaction involving tangible
property, the cost plus method focuses on the
related manufacturing company as the tested
party in the transfer pricing analysis.

The cost plus method may also be used in the case

of services rendered.
 PROBLEM 1: Computer Solutions
Corporation
Computer Solutions Corporation manufactures
and sells various high-tech office automation
products. Two divisions of Office Products Inc. are
the Computer Chip Division and the Computer
Division. The Computer Chip Division
manufactures one product, a "super chip," that
can be used by both the Computer Division and
other external customers. The following
information is available on this month's
operations in the Computer Chip Division:
 PROBLEM 1: Computer Solutions
Corporation
Selling price per chip $50

Variable costs per chip $20

Fixed production costs $60,00

0
Fixed SG&A costs $90,00
0
Monthly capacity 10,000 chips
External sales 6,000 chips
Internal sales 0 chips

Presently, the Computer Division purchases no chips from the

Computer Chips Division, but instead pays $45 to an
external supplier for the 4,000 chips it needs each month.
 PROBLEM 1: Computer Solutions
Corporation
1. Assume that next month's costs and levels of
operations in the Computer and Computer
Chip Divisions are similar to this month. What
is the maximum of the transfer price range for
a possible transfer of the chip from one
division to the other?
a. $50
b. $45
c. $35
d. $30
 PROBLEM 1: Computer Solutions
Corporation
Answer:
1. B
$45 is the external price paid for the chip.
 PROBLEM 2: Watts Corporation
Watts Corporation produces various products used in
the construction industry. The Plumbing Division
produces and sells 100,000 copper fittings each month.
Relevant information for last month follows:
Total sales (all external) $250,000
Expenses (all on a unit base):
Variable manufacturing $0.50
Fixed manufacturing .25
Variable selling .30
Fixed selling .40
Variable G&A .15
Fixed G&A .50
Total $2.10
 PROBLEM 2: Watts Corporation
Top-level managers are trying to determine
how a transfer price can be set on a transfer of
10,000 of the copper fittings from the
Plumbing Division to the Bathroom Products
Division.
 PROBLEM 2: Watts Corporation
2. A transfer price based on variable cost will be
set at ___________ per unit.
a. $0.50
b. $0.80
c. $0.95
d. $0.75
 PROBLEM 2: Watts Corporation
Answer:
2.C
Variable costs = $(0.50 + 0.30 + 0.15) = $0.95
 PROBLEM 2: Watts Corporation
3. A transfer price based on full production cost
would be set at ___________ per unit.
a $0.75
.
b $2.10
.
c $1.45
.
d $1.60
.
 PROBLEM 2: Watts Corporation
Answer
3. A
Total manufacturing costs = $(0.50 + 0.25) = $0.75
 PROBLEM 2: Watts Corporation
4. A transfer price based on market price would
be set at ___________ per unit.
a $2.10
.
b $2.50
.
c $1.60
.
d $2.25
.
 PROBLEM 2: Watts Corporation
Answer:
4. B
Market Price $250,000
External Sales 100,000 units
Price per Unit $2.50/unit
 PROBLEM 3: Sulphur Steel
Corporation
The Wire Products Division of Sulphur Steel
Corporation produces "bales" of steel wire that
are used in various commercial applications. The
bales sell for an average of $20 each and The
Wire Products Division has the capacity to
produce 10,000 bales per month. The Consumer
Products Division of Sulphur Steel Corporation
uses approximately 2,000 bales of steel wire each
month in its production of various appliances.
The operating information for the Wire Products
Division at its present level of operations (8,000
bales per month) follows:
 PROBLEM 3: Sulphur Steel
Corporation
Sales (all external) $160,000
Variable costs per bale:
Production $5
Selling 2
G&A 3
Fixed costs per bale (based on a 10,000
unit capacity):
Production $2
Selling 3
G&A 4
The Consumer Products Division currently pays $15 per
bale for wire obtained from its external supplier.
 PROBLEM 3: Sulphur Steel
Corporation
5. If Wire Products Division transferred 2,000
wire bales to the Consumer Products Division
at 200 percent of full absorption cost, what
would be the transfer price?
 PROBLEM 3: Sulphur Steel
Corporation
Answer: #5

Full absorption cost: Variable Production Cost = $ 5

Fixed Production Cost = 2

Total full absorption cost $ 7

Doubled x 2

Transfer price $14

 PROBLEM 3: Sulphur Steel
Corporation
6. If the Consumer Products Division agrees to
pay the Wire Products Division $16 for 2,000
bales this month, what would be Consumer's
change in total profits?
 PROBLEM 3: Sulphur Steel
Corporation
Answer: #6

Proposed transfer price per unit $16

Consumer's current market purchase price per

15
unit
Increase in cost per unit of wire to Consumer's
$ 1

Times units purchased x 2,000

Decrease in profit due to increased costs $2,000

 PROBLEM 4: Modine Manufacturing
Modine Manufacturing, a division of Datson
Corporation, produces car radiators. Modine
sells radiators to auto parts stores, as well as
to Datson. The following information is
available for Modine's radiators:
Fixed costs per unit $ 90
Variable cost per unit 60
Selling price per unit 215
 PROBLEM 4: Modine Manufacturing
Datson can purchase comparable radiators from an outside
supplier for $200. In order to ensure a reliable supply,
Datson's management ordered Modine to provide 100,000
radiators per year at a transfer price of $200 per unit.
Modine is currently operating at full capacity. It could avoid
$4 per unit of variable selling costs by selling internally.

Instructions
1. Compute the minimum transfer price that Modine should
be required to accept.
2. Compute the increase (decrease) in contribution margin for
Datson for this transfer.
 PROBLEM 4: Modine Manufacturing
Answers:
1. The minimum transfer price that Modine
should accept is: ($60 $4 + ($215 $60) = $211

2. The decrease in contribution margin per unit

to Datson is:
Contribution margin lost by Modine ($215 $60) $155
Increased contribution margin to vehicle division ($200 $56) 144
Net decrease in contribution margin $ 11

Total contribution margin decrease is: $11 100,000 units = $1,100,000

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