Transfer pricing (2)
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Transfer pricing (2)






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Transfer pricing (2) Transfer pricing (2) Presentation Transcript

  • By- sobic agarwal
  • In managerial accounting, when different divisions of a multi-entity company are in charge of their own profits, they are also responsible for their own "Return on Invested Capital". Therefore, when divisions are required to transact with each other, a transfer price is used to determine costs. Transfer prices tend not to differ much from the price in the market because one of the entities in such a transaction will lose out: they will either be buying for more than the prevailing market price or selling below the market price, and this will affect their performance.
  • (i) Market-based transfer prices (ii) Full-cost based transfer prices (iii) Negotiated transfer prices
  •  Market conditions which are appropriate for adoption are generally appropriate in a perfect market, where there is homogeneous product with only one price for both sellers and buyers and no buying or selling costs.  The adoption of market-based transfer price in a perfectly competitive market meet the criteria of a good transfer price, that is it will promote goal congruent decisions, preserve divisional autonomy and provide an equitable basis for performance evaluation.
  •  Market conditions which are appropriate for adoption in an imperfect market, it may be unwise to always set transfer price exactly at the variable costs of production, as such prices do not provide for the replacement of fixed assets.  The Supply Division (SD) will want to base the transfer price on total absorption cost to ensure that it will provide a contribution to cover the fixed overheads.
  •  In this situation, it is more appropriate to adopt negotiated transfer prices. If both managers had been provided with all the information and were educated to use information correctly, it is likely that a negotiated solution would have emerged which would have been acceptable to both the divisions and the group.  • When there is unused capacity, the transfer price range for negotiations generally lied between the minimum price at which SD is willing to sell (its marginal cost) and the maximum price BD is willing to pay (the external supplier price net off any external purchase related costs).
  •  The importance of transfer pricing from the perspective of tax authorities relates to the fact that the setting of prices for the provision of services or the sale of tangible or intangible property has a significant impact on the profitability of the local entity or entities which is the basis for local tax determination. For this reason, tax authorities in multiple jurisdictions have increased control mechanisms to evaluate intercompany transactions.  A great number of countries uses transfer pricing as a mechanism to allocate benefits within a multinational group with the ultimate goal to ensure taxable basis protection, especially that of jurisdictions with higher tax rates.