1. Transfer pricing
Dr. Haider Shah

2. Learning Objectives? To have an overview of transfer pricing system
To understand TP’s effects on divisional performance
To have an overview of international TP

3. Transfer Pricing
Transfer pricing refers to the pricing of goods and services within a multi-divisional organization. Goods from the production division may be sold to the marketing division, or goods from a parent company may be sold to a foreign subsidiary.
Co. B
£10
Co. A
Assembly centre
Receiving Division
Production centre £6
components
Receiving Divisions
Co. A
Co. C
Supplying Division
£10
Assembly centre
Assembly centre

4. Transfer Pricing A transfer price is the price one subunit charges
for a product or service supplied to another
subunit of the same organization.
Intermediate products are the products
transferred between subunits of an organization.

5. Transfer Pricing- objectives
Transfer pricing should help achieve
a company’s strategies and goals by
–intentionally moving profits between divisions
– promoting goal congruence & a sustained high
level of management effort
- providing information for:
making good economic decisions
evaluating the managerial and economic performance of the divisions.
- ensuring that divisional autonomy is not
undermined.

6. Transfer-Pricing Methods
Market-based transfer prices
Cost-based transfer prices
Marginal cost
Full cost
Cost plus markup

7. Example: Oslo & Bergen Expected sales of the final product
Oslo = Supplying division (No external market for the intermediate product)
Bergen = Receiving division (converts intermediate to final product)
Expected sales of the final product
Net selling price (£) Quantity sold Units

8. The costs of each division are:
Oslo Bergen
(£) (£)
Variable cost
per unit
Fixed costs
attributable to the
products
The transfer price of the intermediate product has
been set at £35 based on a full cost plus mark-up.

10. Example: Oslo & Bergen (cont.)
© 2000 Colin Drury

11. Example: Oslo & Bergen (cont.)
© 2000 Colin Drury

12. Bergen Company Oslo £35 TP £23 TP 4000 units £11 TP 5000 units
(Full cost without mark-up)
£11 TP
5000 units
(MC price)
© 2000 Colin Drury

13. Resolving transfer pricing conflicts
1. Adopt a dual rate TP system
Based on two transfer prices
Full cost plus a mark-up for Supplying Division
MC of transfers for Receiving division
Profit on inter-group trading removed by an accounting adjustment.
Not widely used because:
1. Use of two TP ’s causes confusion
2. Seen as artificial
3. Divisions protected from competition
4. Reported inter-divisional profits can be misleading
2. Transfer at MC plus a lump sum fee
Supplying division to cover its fixed costs and earn a profit
through the fixed fee charged for the period.
Receiving division to consider full cost of providing
intermediate products/services
© 2000 Colin Drury

14. Domestic TP Recommendations
Competitive market for the
intermediate product
No market / imperfect market for the
intermediate product
Use MC + lumpsum
(negotiated)
Use standard costs for cost-based TPs

15. Achieves Goal Congruence
Comparison of Methods
Achieves Goal Congruence
Market Price:
Yes, if markets competitive
Cost-Based:
Often, but not always
Negotiated:
Yes

16. Useful for Evaluating Subunit Performance
Comparison of Methods
Useful for Evaluating Subunit Performance
Market Price:
Yes, if markets competitive
Cost-Based:
Difficult, unless transfer
price exceeds full cost
Negotiated:
Yes

17. Comparison of Methods Motivates Management Effort Market Price: Yes
Cost-Based:
Yes, if based on budgeted
costs; less incentive if
based on actual cost
Negotiated:
Yes

18. Preserves Subunit Autonomy
Comparison of Methods
Preserves Subunit Autonomy
Market Price:
Cost-Based:
Negotiated:
Yes

19. Comparison of Methods Other Factors Market Price: No market may exist
Cost-Based:
Useful for determining
full-cost; easy to implement
Negotiated:
Bargaining takes time and
may need to be reviewed

20. Common transfer pricing problems
1. Performance problems
2. Interpersonal disputes 3.
4. Demand fluctuation
5. Product pricing

21. International Transfer-Pricing
Where divisions are located in different countries taxation implications become important
TP has the potential to ensure that most of the profits on inter-divisional transfers are allocated to the low taxation country.

22. International transfer pricing
Supplying
Division
Receiving
Division
Country A (Tax rate = 25%)
Country B (Tax rate = 40%)
Motivation is to use highest possible TP so receiving division will have
high costs and low profits whereas supplying division will have high
revenues and high profits.
TP can also have an impact on ___________and dividend repatriations.
Fiscal authorities react by anti-avoidance legislation e.g. OECD
guidelines based on Arm ’s Length pricing principle.

23. Arm ’s Length Principle
Drawing by David Rooney

24. Arm ’s Length Principle
The parties to a transaction are independent and on an equal footing.
If they had done a transaction with a non-related organisation, they would have charged same price.

25. References & further Reading
Drury. C. Textbook, chapter 21
Ken Garrett (1992), Transfer pricing explained Parts one and two , Accountancy , September/October
Emmanuel, Clive R. (1999), "Income Shifting and International
Transfer Pricing: A Three-Country Example"Abacus, 35 (3), pp
Elliott, J. and Emmanuel, C. (2000), International Transfer Pricing:
Searching for Patterns, European Management Journal ,
Vol. 18, No. 2, pp. 216–222