Management Accounting For Transfer Pricing

Documentation

Discuss about the Management Accounting for Transfer Pricing.

The transfer price is referred as the price at which various divisions of the company transact in business. It is considered to be a trade of labour and goods between departments of a company. The individual entity of a multi entity fund treats the price of the goods and of labour separately. In multi entity corporations different division of the entity is in charge of their own profit, and their calculation of ROIC. The division who are in charge of their profit need to transact among them, and the transfer price concept is used to measure up the price of the goods. The transfer price market acknowledged the market rate of the goods. The goods transferred or to be transferred from one entity to another entity shall fix their price no less than the market rate. If they set the price of the goods lower than market rate, one entity is going to lose its profit.

There are regulations in place that guide the transfer pricing concept. There has to be fairness and accuracy in transfer pricing among the entities. In the matter of transfer pricing, the regulation of the arms length is followed and the entities should establish pricing policy based on the transactions done between parties not related to each other but at arm’s length (Investopedia, 2016).

Transfer pricing requires strict documentation. The transactions involved in the transfer pricing requires close monitoring by the department and by the auditor. It is expected that all the deals related to the transfer pricing would be viewed and monitored in various department; any kind of discrepancy can lead to higher tax payment, regulatory penalty and restatement fees. It has to be ensured that profit for every department is booked properly and the price at the arm’s length concept is applied in the transfer pricing. It is well known fact that 60% of the goods sold internationally are between related companies (ATO, 2016).

The transfer pricing (TP) landscape in Australia is evolving. The tax authorities in Australia are planning to approach the transfer pricing concept by reference to ‘arm’s length conditions’. There are respective treaties accepted by Australia in TP will be applied. It is expected that new TP concept will incorporate the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines. The new TP laws were introduced in Australia after loss of commissioner in Full Federal Court case of Commissioner of Taxation vs. SNF (Australia) Pty Ltd. The holistic view of TP rules on arm’s length conditions including cross border transactions is acknowledged by Government of Australia and the plan was to incorporate OECD’S Base Erosion and Profit Shifting (BEPS) strategy (Kpmg, 2014).

Different transfer pricing

According to OECD transfer pricing assessment methods has evolved over the time. In international marketing five different transfers pricing methods are used by the industries. The TP methods are as following:

Transfer At cost:

The companies generally use the “transfer at cost” approach which contributes to the corporate profitability in domestic manufacturing industries. This policy also helps to keep duties at a minimum. The companies do not have any profit expectation from transfer price.

Cost-Plus Pricing:

The cost-Plus pricing method suggests that companies have taken the position that profit must be shown at every stage of movement of the goods through the corporate system. The cost-plus pricing method may imply that price of the goods become completely unrelated to competitive or demand conditions in the international market. It is often seen that most of the exporters use that method.

Market based Transfer price:

In the market based transfer price the price of the goods to be derived from the international market. There is however considerable degree of variation how profit is to be determined. To enter the new market at the market based price would not help new entrant in the market.

“Arm’s-Length” Transfer Pricing:

It is called the price which is reached between unrelated parties in a similar transaction and these kinds of transactions are called as “arm’s-length” transfer pricing. The arm’s-length price can be seen as not the single price but the range of price.

It is often seen that high tax countries do use the policy of reallocation of income and expenses to maximize national tax revenues. The rates determined by the tax department are insensitive to the business and to the income of the companies (Chand, 2016).

Conclusion:

OECD is working overtime to set the principal of TP right among member countries. The assessment of the price of the goods transferred to one entity to another entity needs to be fixed based on some regulations and methods to be adopted by various countries. There are five methods being applied by OECD to ascertain the price of the goods to be transferred genuinely.

One of such method is known as CUP method, according to this method price of the property or goods transferred under controlled transactions to be compared with the price of the product under uncontrolled transaction. This method can be applied for all types of transactions but it has to be applied in a reasonable and reliable manner. The resale price method is used by the entities which has purchased some product from the associated entity at some price and resold to another entity. The resale price is effectively reduced by the appropriate gross margin. The cost plus method can also be followed where appropriate mark up to be added to the cost of the product to determine the price of the goods.

Tax Regulations and Transfer Prices

The transactional net margin method is based on the net profit methods. The net profit is to be compared from the uncontrolled transactions in the business entity. The arm’s length price is to be compared with the actual price at which the transactions have taken place (OECD, 2010).

The transfer pricing is nothing but transfer of the goods to one entity to another entity at price. In large companies operate divisions for production of goods. If one division releases the goods at the manufactured price, the efficiency of the division cannot be understood at the cost price. It is also seen that individual entity treats the price of the goods and of labour separately. It is obvious that in multi entity corporations’ different division charge profit, and calculate ROIC independently. The division charge of their profit need to transact among them, the valuation concept of the price based on transfer price arm’s length concept is used to measure up the price of the goods. The transfer price market acknowledged the market rate of the goods. Transfer pricing requires strict documentation. The transactions involved in the transfer pricing requires close monitoring by the department and by the auditor.

The burden of accounting and documentation is significant as all the deals related to the transfer pricing would be viewed and monitored. Any of the discrepancy of charging lower price to evade tax can lead to regulatory penalty and restatement fees. Each department would look to establish profit from the operation and decide the price at the arm’s length concept. In all such transactions 60% of the goods sold internationally are between related companies (ATO, 2016).

	Cleaning and Scraping  Division	Processing Division
Sales	95	160
Units	400000	400000
Direct material	18	5
Direct labour	12	10
Manufacturing overhead	40	25
Variable Cost
Direct material	18	5
Direct labour	12	10
Manufacturing overhead	30	10
Selling cost	5
Variable Cost	65	25
Fixed Cost	4000000	6000000
Contribution Margin
Sales-Variable Cost	31.58%	84.38%
Sales

The target of the transfer pricing is to ensure that goods produced by one department reaches to other department at the market price. The help of the price of the unrelated divisions is to be accepted for that purpose. Each division would love to buy goods at the lowest cost so that it can maximize the return of the goods.

The target of the divisions would be negotiating the lowest possible price. Here the cost of Cleaning and Scraping Division producing Cruden at $70. If the division decides to sell the Cruden in the open market, it can sell the product at $95 a unit. Processing Division would love to buy the goods at $70. 

The decision of the company is that Cleaning and Scraping Division produces 400,000 units per year and transfers it all to the Processing Division at total actual manufacturing cost plus 10%. If this proposition is acceptable to the Processing Division, then it would buy the goods at 10% mark up resulting into $77.

Conclusion

The target would be negotiating the best deal for the processing division. If processing division is placed at low tax country then the management of the company may decide to sell that product at $70 to the processing division but that may not be acceptable to the tax authorities and they may seek that the sale price of the Cleaning and Scraping Division is listed not below $95, which is the market rate.

According to the transfer pricing rules the goods can be sold to other department at the cost price or at cost plus mark up. It is often seen that large organization transfer goods to no tax processing department at the cost price. The reason for such transfer is to evade tax. If the nest department or any be the assembly department is situated in a low tax country, the goods are transferred to that department at cost price, which saves significant amount of tax for the company (Treasury, 2016).

There are several methods used to assess the transfer price namely; at cost-plus price. The cost plus price is the added mark up with the cost. One department or the entity transfers goods at the cost plus mark up price which is already negotiated between two departments.  The price at the arms length concept can be utilized by the departments also, where the goods is transferred to the price prevailing at the market under unrelated transactions. The better idea would be transfer the goods from Cleaning and Scraping Division to Processing Division at the negotiated price which will be cost plus mark up. Here in this case cost plus 10% would be a better concept.

References:

ATO, 2016. International transfer pricing – introduction to concepts and risk assessment. [Online] www.ato.gov.au Available at: https://www.ato.gov.au/print-publications/international-transfer-pricing—introduction-to-concepts-and-risk-assessment/ [Accessed 08 September 2016].

ATO, 2016. Simplifying transfer pricing record keeping. [Online] www.ato.gov.au Available at: https://www.ato.gov.au/Business/International-tax-for-business/In-detail/Transfer-pricing/Simplifying-transfer-pricing-record-keeping/ [Accessed 08 September 2016].

Chand, S., 2016. 5 Types of Transfer Pricing Methods used in International Marketing. [Online] www.yourarticlelibrary.com Available at: https://www.yourarticlelibrary.com/product-pricing/5-most-important-types-of-transfer-pricing-methods-used-in-international-marketing/5820/ [Accessed 08 September 2016].

Investopedia, 2016. Transfer Price. [Online] www.investopedia.com Available at: https://www.investopedia.com/terms/t/transferprice.asp [Accessed 08 September 2016].

Kpmg, 2014. Global Transfer Pricing Review. [Online] www.kpmg.com Available at: https://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/global-transfer-pricing-review/Documents/australia-2014.pdf [Accessed 08 September 2016].

OECD, 2010. TRANSFER PRICING METHODS. [Online] www.oecd.org Available at: https://www.oecd.org/ctp/transfer-pricing/45765701.pdf [Accessed 08 September 2016].

Treasury, 2016. Income Tax: cross-border profit allocation – review of transfer pricing rules. [Online] treasury.gov.au Available at: https://treasury.gov.au/~/media/Treasury/Consultations%20and%20Reviews/Consultations/2016/OECD%20BEPS%20Transfer%20Pricing%20Recomendations/Key%20Documents/PDF/Transfer%20Pricing%20Guidelines%20Public_Consultation.ashx [Accessed 08 September 2016].