TRANSFER PRICING CHAPTER 12 APPENDIX A

WHAT IS A TRANSFER PRICE? THE “PRICE” ASSIGNED TO GOODS OR SERVICES TRANSFERRED BETWEEN UNITS OF AN ENTITY. FOR EXAMPLE: A GENERAL MOTORS SUBSIDIARY MAY SELL WHEELS TO THE BUICK DIVISION

PURPOSE OF TRANSFER PRICE TRANSFER PRICES HAVE MANY PURPOSES PROFIT CENTERS MANAGEMENT EFFICIENCIES UNION CONTRACT ASPECTS TAX ASPECTS

PROFIT CENTERS THERE ARE THREE TYPES OF CENTERS: REVENUE CENTERS – ONLY REVENUE IS MEASURED COST CENTERS – ONLY COST IS MEASURED PROFIT CENTERS -- BOTH REVENUE AND COST ARE MEASURED

EXAMPLE OF COST CENTER AND PROFIT CENTER WHEN I HAVE EXAMS DUPLICATED, I CAN HAVE THEM DUPLICATED IN THE COLLEGE OF BUSINESS’ WORD PROCESSING CENTER OR I CAN HAVE THEM DUPLICATED IN THE UNIVERSITY’S REPROGRAPHICS CENTER

COLLEGE OF BUSINESS IF I HAVE THE WORD PROCESSING CENTER DUPLICATE THE EXAMS, THE ACCY. DEPT. IS NOT CHARGED ANYTHING. THE COLLEGE ALLOCATES A BUDGET TO THE WORD PROCESSING CENTER. IF I HAVE THE REPROGRAPHICS CENTER DUPLICATE THE EXAMS, THE ACCY. DEPT. IS CHARGED FOR EACH COPY.

DESCRIPTION OF EACH UNIT THE COLLEGE’S WORD PROCESSING CENTER IS A COST CENTER. IT ONLY ACCUMULATES COST. THE UNIVERSITY’S REPROGRAPHIC CENTER IS A PROFIT CENTER. THE CHARGE TO THE ACCY. DEPT. IS REVENUE TO THE REPRO. CENTER AND THE COST OF THE PAPER IS THE COST TO THE REPRO. CENTER.

MANAGEMENT EFFICIENCIES IF THE DEPT THAT USES THE SERVICES OF ANOTHER DEPT. IS NOT CHARGED FOR THOSE SERVICES, THEY WILL TEND TO USE THEM INEFFICIENTLY. MANAGEMENT DOES NOT HAVE TO EXERCISE AS MUCH SUPERVISION OF THEIR EMPLOYEES BECAUSE THE USES OF THE SERVICES WILL BE SUPERVISED BY THE USER (BUYER).

UNION CONTRACT ASPECTS MANAGEMENT MAY AGREE TO GIVE THE HIGHER WAGE DEMANDED BY THE UNION BUT EXPLAIN THAT A CERTAIN NUMBER OF THE EMPLOYEES (UNION MEMBERS) WILL HAVE TO BE RELEASED BECAUSE THE TRANSFER PRICE WILL BE INCREASED AND THUS DEMAND FOR THE SERVICES WILL BE REDUCED.

TAX ASPECTS THE TRANSFER PRICE DETERMINES WHERE PROFITS WILL BE REPORTED. MANAGEMENT WILL TEND TO TRANSFER PROFITS TO LOWER TAX JURISDICTIONS CALIFORNIA DEALT WITH THIS ISSUE BY ESTABLISHING A “UNITARY” TAX SYSTEM. A PORTION OF A COMPANY’S WORLD-WIDE PROFITS IS TAXED IN CALIFORNIA. THE TRANSFER PRICE DETERMINES THE CUSTOM’S TAX ON IMPORTS.

HOW TO SET THE TRANSFER PRICE COST BASED MARKET BASED NEGOTIATED ECONOMIC BASED

COST BASED THE TRANSFER PRICE CAN BE A PERCENTAGE OF VARIABLE COSTS (E.G., 120%) OR FULL COST (E.G. 190%) PRO: INFORMATION IS READILY AVAILABLE CON: DOES NOT ENCOURAGE EFFICIENCY IN PRODUCTION BECAUSE THE COSTS ARE TRANSFERRED TO THE BUYING DIVISION.

MARKET BASED ESTIMATE THE MARKET PRICE AND SET THE TRANSFER PRICE ACCORDINGLY. PRESUMABLY, THE TRANSFER PRICE WILL BE LESS THAN THE MARKET PRICE. PRO: ENCOURAGES EFFICIENCIES IN PRODUCTION CON: INFORMATION IS NOT READILY AVAILABLE

NEGOTIATED THE BUYER AND SELLER GET TOGETHER AND AGREE ON A PRICE PRO: EACH SIDE IS INVOLED IN THE PROCESS AND THEREFORE SHOULD BE SATISFIED WITH THE RESULT. CON: MAY MEASURE NEGOTIATING ABILITY AS MUCH AS MANAGEMENT ABILITY

ECONOMIC MANAGEMENT ESTIMATES THE TRASFER PRICE THAT WILL MAXIMIZE PROFITS FOR THE FIRM AS A WHOLE. I CALL THIS A “DICTATED” TRANSFER PRICE PRO: PRESUMABLE THE TRANSFER PRICE WILL OPTIMIZE THE FIRMS PROFITS CON: BOTH SIDES WILL PROBABLY BE DISSATISFIED BECAUSE IT IS NOT CLEAR HOW THE TRANSFER PRICE WAS SET.

A NOTE IN USING A TRANSFER PRICE, BUYERS SHOULD GENERALLY HAVE THE RIGHT TO PURCHASE FROM OUTSIDE AND THE SELLING UNIT SHOULD HAVE THE RIGHT TO SELL TO OTHERS INSTEAD OF INSIDERS.