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Transfer Pricing
McGraw-Hill/Irwin
Transfer Pricing
L.O. 1 Explain the basic issues associated with transfer pricing.
Transfer price: The value assigned to the goods or services sold or rented (transferred) from one unit of an organization to another. Treatment is the same as a sale to an outside customer. Revenue to the selling unit Cost to the buying unit
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The Setting
L.O. 2 Explain the general transfer pricing rules and
understand the underlying basis for them.
Padre Papers
Wood Division
Paper Division
Trees
Paper
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LO2
The Setting
Padre Papers Cost and Production Data
Wood Paper
Average units produced Average units sold Variable manufacturing cost per unit Variable finishing cost per unit Fixed divisional cost (unavoidable)
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LO2
The Setting
Padre Papers Resources Flow Wood Division (selling division) Variable cost = $20 Fixed cost = $2,000,000
Wood
Transfer price
Paper Division (buying division) Variable wood cost = ? Variable finishing cost = $30 Fixed cost = $4,000,000
LO2
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LO2
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LO2
$0
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LO2
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LO2
Variable manufacturing cost (Wood Division) per unit Variable finishing cost (Paper Division) per unit Other data: Final market (paper) price Intermediate market (grade A wood) price Intermediate market (grade B wood) price
$120 $ 60 $ 50
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LO2
Wood Sales: $ 50 100,000 (transfer) $120 100,000 (transfer) Variable costs: $ 20 100,000 $ 50 100,000 (transfer) $ 30 100,000 (processing) Fixed costs Operating profit Total company operating profit $5,000,000
Paper
$2,000,000 $1,000,000
$1,000,000
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LO2
Wood Sales: $ 60 100,000 (transfer) $120 100,000 (transfer) Variable costs: $ 20 100,000 $ 60 100,000 (transfer) $ 30 100,000 (processing) Fixed costs Operating profit Total company operating profit $6,000,000
Paper
$2,000,000 $2,000,000
$1,000,000
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Transfer price higher than market: Buying division will not buy Transfer price lower than market: Selling division will not sell
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LO3
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International (or interstate) transfer pricing can affect tax liabilities, royalties, and other payments due to different laws in different countries or states. Company incentive: Increase profit in low-tax country Decrease profit in high-tax country
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Segment Reporting
L.O. 5 Describe the role of transfer prices in segment reporting. The FASB requires companies to report certain information about segments in order to provide a measure of performance for those segments that are significant to the company as a whole.
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End of Chapter 15
McGraw-Hill/Irwin