Business Exam Questions on Transfer Pricing and Divisional Performance

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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
Transfer pricing is one of the most commonly used methods of pricing across the globe.
However, there are various kinds of transfer pricing methods. Among them, the market based
transfer prices and negotiated transfer prices are the two most important ones. According to Villa
and Katok (2018), negotiated transfer prices can be defined as the most suitable pricing method
in the situations where there is the existence of market imperfections for intermediate products,
which are the cases in which products are not deliverable even within an arm-length fashion or
the cases in which market participants do not have availability of information. On the other hand,
market-based transfer prices refer to the prices of similar products or services externally
available is used (Johnson et al., 2018).
However, there are both advantages and disadvantages of these two types of transfer prices. The
advantages of market-based transfer price include improved quality of services, higher
flexibility, lower costs required for administrative purposes and acts as an aid for better
decisions. However, the disadvantages of the market-based transfer prices are that market prices
might be temporary, the non-availability of external market prices, internal transfers has lower
prices than external sales and there might be imperfect external markets for the item transferred.
On the contrary, the advantages of negotiated transfer prices include the support that it provides
to the goals and strategies of an organisation, promotion of the goal congruence of an overall
organisation and the promotion of divisional autonomy. The disadvantages of the negotiated
transfer pricing is that this pricing method might be leading to conflicts between divisions, the
result of the negotiated transfer prices have less tendencies of being optimal while the process of
negotiation might be time consuming in nature.
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Question 4
It is important for all organisations to measure their divisional performance. Return on capital
employed and net residual income are the two most important measures, which can be used in
order to measure divisional performance and investment in decision-making. Return on capital
employed (ROCE), which is also called ROI (Return on Investment), is the measure using which
the efficiency and the profitability of a company in terms of the capital that it has invested is
found out (Jones, 2016). On the other hand, according to O'Hanlon and Peasnell (2015), the
Residual Income, also called RI, can be referred to as the controllable contribution of a company
less the cost of capital charged on the investment, which is controllable by the divisional
management. The advantages of the ROCE method are that it is commonly understood and used
by managers; the data needed for it is easily available and acts as a useful comparative tool for
divisions and business. The drawbacks of the method include making sub-optimal planning
decisions easy, the lack of a universal formula and the lack of encouraging goal congruence.
The advantages of RI include encouraging managers for making investments as soon as the RI is
positive in nature. However, among the disadvantages of the RI method is that it helps in
measuring the absolute income of an organisation and is difficult in terms of comparing
investment with different sizes.
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Reference list
Johnson, N.B., Loeffler, C. and Pfeiffer, T., 2018. An Evaluation of Alternative Market‐Based
Transfer Prices. Contemporary Accounting Research, 35(4), pp.1868-1887.
Jones, G.T., 2016. Increasing Return. Cambridge University Press.
O'Hanlon, J. and Peasnell, K., 2015. Residual Income and EVA®. Wiley Encyclopedia of
Management, pp.1-5.
Villa, S. and Katok, E., 2018. Negotiating Transfer Prices for Improving Supply Chain
Transshipments.
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