Transfer Pricing And Management Accounting For Business Responsibility Centers

Transfer Pricing Defined

Describe about the Management Accounting for Business Responsebility Centers.

A significant aspect of decentralised companies is responsibility centres. These centres are analysed on the grounds of different accounting figures like ROI, standard cost or divisional profit. One purpose of the management accounting mechanism is hence to tie a dollar value to transactions amidst various responsibility centres. Transfer price fits here as it is the price charged by company’s one division from the other for the goods transferred to the latter (Holtzman and Nagel, 2014). The present report discusses transfer pricing, its different types and its use at length.

Transfer Pricing Defined

In its essence, transfer pricing is a model of selling a product from one business unit or division of an organisation to other. Transfer price is basically the value charged for intra-company goods that the organisationalgroups purchase from one another. Coordinating the management of both the buying and selling decision is one of the primary purposes of transfer pricing. It is not essential that any money changes hands between the concerned segments (Schuster, 2015). The transfer price may just be utilised for the purpose of internal record keeping. It is revenue for the centre selling the products and expense for the one buying the products. The product which is transferred can be categorised on two measures. The first on is whether or not the product has a readily available outer market price. The second is whether or not the buying segment will sell it in the same form or will it turn into an input for the marketing division’s own manufacturing process (Ceteris, 2010).

The below-mentioned reasons are the primaryobjectives of establishing transfer pricing scheme –

Yield separate revenue figures for every business unit and hence analyse the performance of every unit separately (Fernandes, Pinho and Gouveia, 2015).

Assist in the synchronisation of manufacturing, pricing and sales decisions of the distinct business units. Through transfer prices, managers become aware of the value that their services and products carry for other divisions of the entity (OECD, 2009).

It enables the firm to produce profit or cost data for every segment separately.

Transfer price not only impacts the recognised profit for every division but also influences resource allocation.

When transnational corporations move goods across international boundaries, transfer rates are appropriate in the computation of income taxes and are at times pertinent to legislative issues and global trade (Wittendorff, 2010).

Purpose of Using Transfer pricing

Transfer at cost – Entities employing transfer at cost method acknowledge that sales by global associates add to business profitability by yielding economies of scale in local manufacturing systems. This pricing method enables minimum duties. The firms making use of this approach do not expect a profit on transfer sale; instead, their expectation is related to their partner generating revenues by eventual sale (Drury, 2008). This transfer pricing method is used because companies presume that low costs will result in better performance of the partner, which eventually profits the whole company.

Cost-plus pricing –Organizations adopting the cost-plus pricing system believe in showing the profit accruing from any service or product at each stage of its movement through the company and its subsidiaries, business units or affiliates. This approach may lead to a price which may not be competitive or related to the demand in global markets. This is a widely used method because the management needs a projection of the long run marginal cost to make decisions (Chand, 2015).

Market-based price – This is obtained from the priceneeded to stay competitive in the global marketplace. This limitation in this method is cost. Nonetheless, there exists a significant amount of difference in the way cost is characterised. As with volume, cost usually reduces, a choice needs to be made between existing or planned levels of volume as the basis of pricing (Bakker, 2009). For employing this approach to penetrate a market which is very small with the intention of supporting local production, third nation sourcing might be needed. This allows the organisation to set up its franchise or name without having to invest in a physical set up. This is also suitable for a perfect market, where the products are homogeneous with the same price for both buyers and seller and no selling or purchasing costs. Adopting market-based transfer pricing in such a market matches the standards of a sound transfer price i.e. it will preserve divisional independence, will endorse consistent goal decisions and offer a consistent basis to evaluate performance (Muhammadi, Ahmed and Habib, 2016).

Negotiated Transfer Pricing–In this case, the company does not outline the rules for determining the transfer price. Business unit managers are motivated to negotiate a reciprocally satisfying transfer price. This approach is basically merged with free sourcing. However, in certain organisations, the head office holds the right to arbitrate the process of negotiation and enforce an adjudicated solution (Drury, 2008). In a market which is imperfect, transfer prices established at the planned or current market price do not tend to be the most favourable. In such situations, it is suitable to follow the negotiated approach. In cases of unused capacity, the range of transfer price negotiation usually falls between the maximum rate the buying segment is ready to pay and the minimum price at which the selling division is ready to sell (Rossing and Rohde, 2014).

Different Types of Transfer Price

Transfer prices are based on total actual cost and not appropriated as the basis for divisional performance measurement because:

As it do not leads to an optimal decision for the company.

It provides small amount of incentive for sales department to control manufacturing costs as all the cost incurred will be recovered.

Calculation of contribution margin
Data available:
Particular	Cleaning and Scrapping Division	Processing Division
Transfer price from cleaning and scrapping	0	77
Direct Material	18	5
Direct Labour	12	10
Manufacturing Overhead	40	25
Total direct cost	70	117

	Calculation  of variable manufacturing overhead
	Particular	Cleaning and Scrapping Division	Processing Division
	Total Manufacturing Overhead	40	25
	75% variable in cleaning & scrapping dept.	30
	40% variable in processing division		10
Calculation of total variable cost
Particular	Cleaning and Scrapping Division	Processing Division
Transfer price		77
Direct Material	18	5
Direct Labor	12	10
Variable Manufacturing Overhead	30	10
Variable Selling cost	5	0
Total variable cost	65	102

Calculation of selling price
Particular	Cleaning and Scrapping Division	Processing Division
Price at which it can be sold in open market	95	160
Total selling price	95	160

Formula for contribution margin = Selling Price – Product variable cost

Selling Price

Contribution Ratio
Particular	Cleaning and Scrapping Division	Processing Division
Selling Price	100	160
Variable Cost	65	102
Contribution Margin	35	36.25

Calculation of price range
Normal markup per unit
Particular	Cleaning and Scrapping Division	Processing Division
Variable cost per unit	60	102
Fixed Overhead per unit	10	15
Variable selling cost	5	0
Total cost	75	117
Normal markup per unit	20	43
Market price per unit	95	160
Production capacity	400000	400000

Price range for cleaning and scrapping division

As per the economic transfer pricing rule the minimum price is the marginal cost and the maximum price is fixed by the receiving department.

$65 – $ 95

Price range for processing division

As explained above regarding the rule of economic transfer pricing the minimum price will be calculated and the maximum price will include margin also.

$75 – $160

As the division is having an opportunity to sell goods externally instead of selling it to other department. The minimum transfer price would be cost plus their profit margin. In present case the normal profit markup is 10% of the cost.

Calculation of lowest transfer price acceptable to cleansing & scrapping division according to general transfer pricing rule
Particular	Cleaning and Scrapping Division
Variable cost per unit	60
Fixed Overhead per unit	10
Variable selling cost	5
Total cost	75
Normal markup per unit	7.5
Market price per unit	95
Production capacity	400000

The selling variable cost will be included in case the goods are to be sold externally and not while selling goods to another division; as no selling variable cost is paid in that case.

Conclusion

In vertically integrated firms, there are mainly two segments, a manufacturing and a buying division. In such companies, there is a regular exchange of goods and services among their departments to facilitate business operations. Transfer pricing is hence, the internal prices of goods developed with two main purposes: coordination (to arrive at decisions most appropriate for the business), and profit allocation (for assessing segment profits and to measure performance. The paper also discussed the different types of transfer prices (Lin and Chang, 2010.). From the different types of transfer pricing techniques, the cost based approach is the most widely used and is followed by the market-based approach. Transfer pricing also becomes suitable in respect of legislative issues such as global trade disputes etc.

References

Bakker, A., 2009. Transfer Pricing and Business Restructurings: Streamlining All the Way. IBFD.

Ceteris., 2010. Guide to International Transfer Pricing: Law, Tax Planning and Compliance Strategies. Kluwer Law International.

Chand, S., 2015. 5 Types of Transfer Pricing Methods used in International Marketing. [Online]. Available through:<https://www.yourarticlelibrary.com/product-pricing/5-most-important-types-of-transfer-pricing-methods-used-in-international-marketing/5820/>. [Accessed on 16^th September 2016].

Drury, C., 2008. Management and Cost Accounting. Cengage Learning EMEA.

Fernandes, R., Pinho, C. and Gouveia, B., 2015. Supply chain networks design and transfer-pricing. The International Journal of Logistics Management, 26(1), pp.128 – 146.

Holtzman, Y. and Nagel, P., 2014. An introduction to transfer pricing.Journal of Management Development, 33(1), pp.57 – 61.

Lin, C. and Chang, H., 2010. Motives of transfer pricing strategies – systemic analysis. Industrial Management & Data Systems, 110(8), pp.1215 – 1233.

Muhammadi, H. A., Ahmed, Z. and Habib, A., 2016. Multinational transfer pricing of intangible assets: Indonesian tax auditors’ perspectives. Asian Review of Accounting, 24(3), pp.313 – 337.

OECD., 2009. OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2009. OECD Publishing.

Rossing, P. C. and Rohde, C., 2014. Transfer pricing: aligning the research agenda to organizational reality. Journal of Accounting & Organizational Change. 10(3), pp.266 – 287.

Schuster, P., 2015. Transfer Prices and Management Accounting. Springer Briefs in Accounting, 10.

Wittendorff, J., 2010. Transfer Pricing and the Arm’s Length Principle in International Tax Law. Kluwer Law International.