Transfer pricing

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This is a short and concentrated ppt presentation on the "Transfer Pricing" mainly in the accounting.

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Transfer pricing

  1. 1. TRANSFER PRICING PREPARED BY: Jerina Podo
  2. 2. Outline:  Definition and Overview  Transfer pricing purposes  Transfer pricing – accounting  Transfer price -Methods Of Transfer Pricing  Influence of transfer pricing  Disadvantages of transfer pricing application  Transfer Pricing- Example  Conclusion
  3. 3. Definition and Overview  Transfer pricing is the price at which divisions of a company transact with each other.  When business units or divisions within the organization buy goods and services from one another, the value or amount recorded in a firm’s accounting records as revenue to the selling unit and cost to the buying unit.  Any correction of transfer pricing in the case of international transactions can only be done through Transfer Pricing Commission in General Directorate of Taxation at the Ministry of Finance.
  4. 4. Transfer Pricing Purposes       Evaluating financial performance of different business units (profit centers) of a conglomerate Shift earnings from a high tax jurisdiction to a low-tax one Enables multinational corporation's to attribute net profit (or loss) before tax among the countries where it does business Uses of Transfer pricing: a.)Reduces taxes paid b.)Reduces tariffs c.)Avoids exchange controls
  5. 5. Government Reactions     Governments are aware of risk that multinationals will use transfer pricing to avoid paying income and other taxes. Most governments publish guidelines regarding acceptable transfer pricing for tax propose. Across counties these guidelines can conflict, creating the possibility of double taxation when price accepted to the country is disallowed by another. The Organization for Economic Cooperation and Development (OECD) developed transfer pricing guidelines in 1979 that have been supplemented and mandated several time since then.
  6. 6. Transfer Pricing- Accounting If intra-company transactions are accounted for at prices in excess of cost, appropriate elimination entries should be made for external reporting purposes. Examples of items to be eliminated for consolidated financial statements include:  • Intracompany receivables and payables.  • Intracompany sales and costs of goods sold.  • Intracompany profits in inventories
  7. 7. Methods Of Transfer Pricing  1. Market-based Transfer Pricing transfer price is determined by the market, based on the trading of the same product or service in normal conditions. • 2. Negotiated Transfer Pricing This method is based on an agreement between two division managers, who determine an acceptable price to sell / buy products that circulate among them. Main restrictions of this method are:  Negotiated price may not be optimal transfer price.  Conflicts may arise between the divisions.  Spent a lot of time for negotiations.  3. Cost-based Transfer Pricing In the absence of an established market price many companies base the TP on the production cost of the supplying division.  Full (absorption) cost; either standard or actual. Popular because of its simplicity and clarity.  Cost-plus For transfers at full cost the buying division takes all the gains from trade while the supplying division receives none. To overcome this problem the supplying division is frequently allowed to add a mark-up in order to make a "reasonable" profit. The transfer price may then be viewed as an approximate market price.
  8. 8. Influence of Transfer Pricing 1. Decision-making influence - the transfer price provides the necessary information that helps the management of each division to make appropriate decisions regarding different issues 2. Evaluation of the performance of the division - the transfer price is an income for selling division and a cost for the buying division 3. Coordination of the interests of managers and shareholders - Setting the transfer price should first serve for the shareholder profit maximization, a goal that should be considered by managers. 4. Reducing the amount of income tax - selling products / services in different countries with different tax regimes, benefits by shifting profits from high tax rate countries in the lower ones. 5. Promote and ensure the autonomy of the divisions - Setting transfer prices should be in line with the realization of the overall objectives of the company, but it should not affect the autonomy of the divisions, which operate as a separate entity.
  9. 9. DISADVANTAGES OF TRANSFER PRICING APPLICATION Tax authorities, including:  1. Avoiding tax - companies operating in countries with different tax jurisdictions, deliberately use transfer prices to shift much longer range of earnings in countries with lower corporate tax.  2. Reduced customs revenues - by moving goods from one place to another, a low transfer price reduces customer tax obligation in countries with a high level of this tax, resulting in a reduction of income to the budget from this source. B. Company itself:  1. Conflicting objectives - There are times when the use of a certain level of transfer price only serves for short-term goals of the company and creates a problem for the long-term perspective. It should therefore encourage a careful decision on prices which will transfer the goods / services from division to another.  2. An incorrect transfer price leads to inaccurate measurement of performance and lowers motivation  Managers  3. Risk to fiscal manipulation -transfer price is an instrument that can potentially be used in conditions where divisions of the same company or related parties operate in countries with different tax regimes.
  10. 10. Transfer Pricing-Example  A Company has offered to purchase 90,000 batteries from the B Copmany for $104 per unit. At a normal volume of 250,000 batteries per year, production costs per battery are:         Direct materials $40 Direct labor $ 20 Variable factory overhead $ 12 Fixed factory overhead $ 42 Total $114 The B Company has been selling 250,000 batteries per year to outside buyers for $136 each. Capacity is 350,000 batteries/year. The A Company has been buying batteries from outside suppliers for $130 each. Should the B Company manager accept the offer? Will an internal transfer be of any benefit to the company?
  11. 11. Transfer Pricing-Example B manager should accept. There is surplus capacity. So the relevant costs to the B Company is the VC = $72 / battery.  The increased A to the B would be 90,000*($104 – 72) = $2.88 M   The company would be better off with an internal transfer. Currently paying $130 for batteries that could be made internally for incremental cost of $72. The company would save 90,000 * (130 – 72) = $5.22 M per year!  The TP range = max. of $130 to low of $72
  12. 12. Conclusion    The transfer price is the price that one division of a company charges another division of the same company for a product transferred between the two divisions so there are no cash flows between the divisions. The transfer price becomes an expense for the receiving manager and a revenue for the supplying manager. The transfer price is used for accounting purposes (legal)

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