Exam: Transfer Pricing Methods and Divisional Performance Metrics

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Business Exam Questions
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Table of Contents
Question 3........................................................................................................................................3
Question 4........................................................................................................................................4
Reference list...................................................................................................................................5
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Question 3
One of the most widely used methods that can be used for pricing of goods and services
throughout the world is transfer pricing. However, the transfer pricing methods can be of diverse
kinds. The two most significant transfer-pricing methods that companies use include negotiated
transfer prices and market based transfer prices. According to Parhizi et al. (2018), the transfer
pricing method that uses the prices of similar goods or services, which are externally available,
are used up is called the market based transfer prices. On the other hand, another appropriate
pricing method that can be used is the negotiated transfer prices (Schuster, 2018). This method is
used under the situations within which there exist imperfections of the market for several
intermediate products of which, there is no information available or the ones that are non-
deliverable in an arm-length fashion.
Both these transfer price methods have merits as well as demerits. Enhanced quality of services,
improved flexibility, lowering costs of administration and better decision-making are the merits
of market based transfer prices. However, the factors such as temporary nature of market prices,
the unavailability of market prices available externally, and the chances of having imperfect
market prices for the items that have been transferred. On the other hand, the merits of the
negotiated transfer prices are the support this method provides towards organisational goals and
strategies, promoting goal congruence of an entire business as well as to promote divisional
autonomy. However, there are demerits of this transfer price method as well. The demerits of this
method are that this measure might lead to the occurrence of various conflicts among divisions,
the tendencies of negotiated transfer prices includes being non-optimal as well as the time
consuming nature of the entire procedure of negotiation.
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Question 4
In order to invest into decision-making and measuring a company’s divisional performance, the
two most significant measures that can be used include net residual income and return on capital
employed. According to Jones (2015), the return on capital employed, also known as ROCE or
ROI (return on investment), refers to the measure that can be used to measure an organization’s
profitability and efficacy in terms of its capital, which the organisation has invested is derived.
The Residual Income (RI), on the contrary, refers to an organisation’s controllable contribution
less the investment’s cost of capital that is controllable through divisional managers and can be
measured (Murtala et al., 2015).
Among the ROCE’s merits lies its easy understandability by managers, the availability of the
data needed along with acting as a comparative metric for businesses and their various divisions.
On the contrary, the demerits of ROCE are that it makes it easier to make sub-optimal planning
decisions, they lack a universal formula and there lies the absence of goal congruence
encouragement. The merits of the RI method is that it helps in encouraging a company’s
management in making investments optimally while its demerits include the difficulty of the
measure in comparing investments that are of diverse sizes and measuring absolute income only.
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Reference list
Jones, G.T., 2016. Increasing Return. Cambridge University Press.
Murtala, S., Ibrahim, M., Lawal, S. and Abdullahi, B.B., 2018. Capital structure and return on
capital employed of construction companies in Nigeria. African Journal of Accounting, Auditing
and Finance, 6(1), pp.1-20.
Parhizi, S., Khodaei, A. and Shahidehpour, M., 2018. Market-Based Versus Price-Based
Microgrid Optimal Scheduling. IEEE Transactions on Smart Grid, 9(2), pp.615-623.
Schuster, P., 2015. Negotiated Transfer Prices. In Transfer Prices and Management
Accounting (pp. 43-50). Springer, Cham.
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