Comprehensive Report on Transfer Pricing Methods and Applications

This report provides a comprehensive analysis of transfer pricing, a crucial concept in financial accounting, particularly for multinational corporations. It explores various transfer pricing methods, including market-based, full-cost, cost-plus, and negotiated transfer prices, evaluating their advantages and limitations. The report delves into the strategic management accounting aspect, assessing costs and incomes. Furthermore, it examines relevant costs and incomes crucial for decision-making, such as future cash flows, avoidable costs, opportunity costs, and incremental costs, while also differentiating them from irrelevant costs like sunk and committed costs. The report emphasizes the importance of qualitative factors in accounting decision-making, providing a holistic view of transfer pricing's role in financial management.

MANAGING ACCOUNTING
AND CONTROL

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
PART A...........................................................................................................................................1
PART B............................................................................................................................................4
a) Critically evaluating relevant costs and income in given scenarios...................................4
b) Qualitative factors needed in accounting decision making................................................6
CONCLUSION................................................................................................................................7
REFERENCES................................................................................................................................9

INTRODUCTION
Transfer pricing is the price at which parent company sells its products and services to its
subsidiary firm. In short, exchange of goods and service internally at the workplace of a parent
company is considered as transfer pricing. Under this, it is not necessary that both parent and
subsidiary firms should be located in same area. The present project shows about several kinds of
the transfer prices are used by an organisation at its working environment. Further, various prices
of transferring are critically evaluated in the current assignment using their advantages and
limitations. The second part of project explains about strategic management accountant (SMA)
which helps to the firm in assessing costs as well as incomes of the enterprise. Besides this,
expenses and profits related to SMA are critically evaluated. At the end of study, qualitative
factors which need to take into account at the time of making decisions are analysed.
PART A
Market based transfer prices
A method of transfer pricing in which charges of the products and services are
determined by parent company by considering market conditions is known as market based
transfer prices. Further, such kind of prices are prevailing in the market and used by another
firms as well instead of only parent company. It is the best method of transfer pricing because it
is supportive to the firms to generate more profit and returns as compared to other strategies.
According to Rugman and Eden, (2017) market based transfer price is helpful for the
firm in order to generate more benefits and gain advantages in the situation of cut throat
competition. It allows the parent company for making solution or eliminating disputes from the
buyer or its small division. When the firm uses this particular method then become highly
supportive to save or reduce administrative costs. Due to this, such overhead expenses decline
and ultimately firm is able to earn additional benefits. It forces to the selling divisions in order to
become a rivalry firm in the market conditions and industry. Further, any kind of penalties are
not required to bear to the buying division which is great benefit of This method.
However, Rossing Cools and Rohde, (2017) criticised that, market based transfer price
does not helps to gain any kind of margins which are generated due to efficiency of the
subsidiary or divisions. Further, this method totally ignores negotiation and in case if any buying
division try to negotiate then parent firm can refuse to sale. Therefore, it directly sales the goods
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and services to other firms or consumers. Another issue associated with this is that, it creates
condition of internal shortage of required products or materials at the working place. If the
selling divisions generates a huge income then also parent firm can come under losses (Bakker
and Obuoforibo, 2009). In addition to this, when enterprise is going to use this method then
responsibility of profit and investment centres enhance up to the higher extent.
Full cost transfer prices
A method of transfer pricing in which all the incurred expenses for producing goods and
services like fixed and variables are taken into account for determining price is considered as full
cost transfer pricing. As per this, at the initially total cost of production and units are computed
after that total expenses are divided by volume. Whatever outcome comes that will be used in
form of transfer pricing.
Full cost transfer pricing is highly supportive for parent firms to gain assured return from
the buyer which is its subsidiary division. It is very simple and understandable method and
calculation of it is also very easy. Due to this, fair as well as profitable price of the products and
services can be determined. Apart from this, full cost transfer price is supportive to set plausible
charges where economical decisions can be made by the enterprise (Full Cost Pricing |
Objectives | Advantages | Disadvantages, 2017). At the workplace of parent firm when any kind
of uncertainty occurs then also this method helps to deal with such contingency conditions. With
this tool, there are any kinds of losses are not associated and due to this it can be said that, firm
always gain benefits when it incorporates transfer price.
In contrary to this, Sikka and Willmott, (2010) criticised that, it not considers two types
of costs which are like marginal and incremental whereas covers only average expenses incurred.
When demand fluctuates or increase and decrease then it does not cover this aspect which
sometimes become issue of bearing losses. When the firm manufactures multiple range of
products then calculation of average fixed costs is quite difficult. In this condition, management
of parent firm cannot make effective pricing decisions.
Cost-plus a mark-up transfer prices
It is the method which is used to determine and uses limits calculated after indirect and
direct costs and also operation expenses. Cost is calculated in reference to accounting values that
are accepted for that industry in the region where the products are produced.
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In the opinion of Cooper and et.al., (2017) the biggest advantage is that the company
knows the amount of expenditure that it has incurred on making a product. Therefore, they can
add profit margin to it, which helps in achieving desired revenue for the firm. It is the easiest
way and flexible in nature because one just has to add to all the cost and then the profit to it and
will give the price of the product. Corrective actions can be taken immediately as company has
its own data for deciding the cost and escalations can be made. This is fair method of price
fixation, this ensures that product will cover its cost, so it is good method. It has assured profit
and if price is greater than the cost, risk is covered which adds to huge profits.
In opposite to this Hickman, (2016) states that this method does not take into account
future demand of the concerned product as such there is no base before deciding the price of the
product. This adds to serious and biggest limitation to this method of deciding the cost and price
of the product. Next, it does not take into account the competitors actions and its effects on
pricing of the product, as if, one depends only on this method can lead to failure of the business
in the market. It also results in over estimating price of product as it includes sunk cost and
ignores opportunity cost. Also, it is on certain basis a bit biased regarding the profit margin to be
added to the price of the product. It ignores demand and it does not take into account buyer's
needs which is unfavourable.
Negotiated transfer prices
This is an internal book keeping of the organisation. This results from the selling and
buying divisions. By setting market prices, firm can analyses that how many goods producing at
each step of the production process.
According to Jost, Pfaffermayr and Winner, (2014) major advantage is that it preserves
the autonomy of the divisions. It is very consistent with the advantage of decentralisation.
Managers have better information about main costs and benefit of transfer than others company.
It’s easy to operate and managers knows what they want. It is more executable and more
practical. It is easier to implement. Another advantage is that manager will focus on other vital
issues in spite of this it enhances and saves valuable time on other issues. Manager’s morale is
boosted as this method takes care of the interest of the divisions which it undertakes. Managers
get more and more experience by performing it which leads to bright future of the company.
It has been critically evaluated by Klassen, Lisowky and Mescall, (2016) that, it creates
conflicts among the managers of different departments. Failed negotiated department will have a
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conflict with the successful ones. This might result into tensed work atmosphere, which may
bring disintegration in the firm. Domination also plays a major role in the firm because
dominating division may influence transfer price in its favour which ultimately creates biased
behaviour among the divisions. It is very time-consuming job and requires lot of time to operate.
Hence, fair deal may not be achieved in this scenario. It is not relevant because it only measures
the performance of the divisions and nothing else. Company relying that it will become failure in
its operation or not. It is sub optimal as it creates biasness among the departments. It has lack of
goal congruence among managers in different parts of the firm (Munira, 2017). There is
insufficient information available to top management, as a result, it increases costs of detailed
information. It brings lack of co-ordination among managers in many parts of the organisation.
PART B
a) Critically evaluating relevant costs and income in given scenarios
For the purpose of decision making there are various relevant and irrelevant costs and
incomes that are to be considered by the management in making decisions like:
 Continuing a part of business or shutting it down
 Pricing of various products and services
 Making or buying decisions
According to, Abrahamson, Berkowitz and Dumez, (2016), while making decisions,
future costs and revenues are assigned in relevant costing. It includes only those inflows and
outflows of cash, which will have a significant impact on decision making. While, in contrary to
this according to Brown-Liburd, Issa and Lombardi, (2015) marginal costing can be used in
making decisions which will assign only variable costs to appropriate products and services.
However, there is a common convergence between both methods, variable costs affect decision
making as it is commonly a future cost and so will be considered as relevant costs. Following are
the types of relevant costs:
Future cash flows: Those future expenses that will be incurred in making future economic
decisions are considered as relevant costs. And those future inflows of cash that will be
associated by decisions will be considered as relevant incomes.
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Avoidable costs: Those costs that are directly related to the specific decisions will only be
considered as relevant cost. That means if the decision is not being implemented, such costs can
be avoided.
Opportunity costs: Inflows of cash that will be sacrificed in order to make and implement
management decisions will also be considered as relevant cost for decision making. For example,
in making a decision of making a product instead of buying, cost that will incurred which instead
could have been invested for returns. In this case amount of returns will be the opportunity cost
of making product.
Incremental cost: While making decisions if there are different alternatives, incremental and
differential cost between these alternatives will also be considered as relevant cost. Suppose the
management have different options for pricing methods like mark-up pricing and competitive
pricing. Pricing under competitive method gives more profit to the company instead of mark-up
pricing, but management want to use mark-up pricing as it will provide a fixed percentage of
profit on sale of products and services. The extra profit which the company could get using
competitive method, will be relevant cost for decision making.
According to Kool, Shenhav and Botvinick, (2017), various types of costs are assigned to
products and services out of which some are irrelevant for the decision-making purpose. Such
types of costs include:
Sunk cost: It relates to those expenses which have already been incurred in the past. These
expenses have already been done and does not relate or will have an impact on future decisions.
Therefore, these costs will not be considered as relevant cost for decision making.
Committed cost: Those costs that are committed to be incurred in future and cannot be avoided
are not relevant costs. Because irrespective of the decision making, these costs will be incurred.
Therefore, these are irrelevant to the decision making.
Non- cash expenses: Many non- cash expenses are also part of company expenses like
depreciation, these expenses are not relevant in decision making as these expenses have no effect
on cash flows.
General Overheads: Expenses like general and administrative overheads that does not affected
by decisions being considered must not be considered as relevant cost for decision making. For
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example, choosing a method of pricing will not affect salary expenses of office staff. Therefore,
such kind of expenses must be considered as irrelevant for future economic decision making.
In the decision of product mix, resources are not enough in meeting the demand of
potential sales, therefore, decisions had to make about the preferred mix of products to be
produced using available resources effectively and efficiently. There could be many limiting
factors, one of these factors could be sales. If there is a specific limit of sales volume, resources
of organisation may be insufficient in order to meet the level of demand. According to Mishra,
Prasad, Srinivasan and ElHafsi, (2017), in the accounting of limiting factor, increase in
contribution will make increase in profit to the organisation.
b) Qualitative factors needed in accounting decision making
In context of making the favourable earning there are needs of making the adequate
decisions which are relevant mainly with the purchasing or producing a product. Professionals in
the premises measures the cost of the material in relation with buying and outsourcing decision
(How to: Qualitative Measures for Make-or-Buy Decisions, 2017). Thus, such analysis helps
them in come up with the effective solution and they can generate innovative ideas to lower
down such costs. Hence, there is need to analyse the qualitative factors of the firm before making
any decisions such as:
Qualitative analysis on the basis of cost: Managerial professionals need to evaluate the
amount of payments they are made to the suppliers, distributors in context with purchasing the
goods. Hence, it can be said that they need to measure such expenses and take decision regarding
to lower down such costs, finding new suppliers etc. thus, it includes both kinds of costs such as
fixed costs and marginal cost in making the production (Johnson, Larson and DeMersseman,
2017). However, these are the costs which are need to be analysed by the strategic management
accountant in order with having the effective pricing decisions. Hence, a part from these there is
need to make the proper analysis of the use of number of machines efforts and employees in the
completion of manufacturing the goods. Hence, there will be evaluation of the cost incurred over
them such as salary, bonus, allowances etc. which are had to be paid by organisation.
Factors influencing production decision: It includes all the relevant factors which are
being obstacle in manufacturing the products such as quality of product, company's experience as
well as the cost incurred in such tasks need to be analysed by them (Dragomir, Avram and
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Domnişoru, 2016). The strategic management accountant need to analyse the costs over
production of such material as well as timely examine the quality of such goods which must meet
the consumer requirements and must be in the budgets of organisation.
Qualitative factors that influences the decision to purchase the products: By
considering the company's decision in context with purchasing the products from outside
supplier there is need to evaluate the expense incurred in making payments to them,
transportation of the material and the storage charges. Hence, these must be analysed by a
strategic management accountant (Peppard and Ward, 2016). Hence, need to examine the quality
of material and the prices of them. Need to compare such material which are offered by other
suppliers and distributors. Hence, this in turn helps the managers in analysing the prices as well
as they could able to make the better bargain in purchasing such products from suppliers.
Completion of tasks can be influenced by qualitative factors: In context with the
completion of the tasks there will be requirement of high rate of costs and the lots of efforts in
purchasing as well as manufacturing the products. For instance, while purchasing material there
will be requirement of workforce efforts to assemble such purchased material and produce it to
the end goods (Garcia and et.al., 2016). Thus, these are to be analysed by the strategic
management accountant in order with evaluate such costs incurred in the completion of tasks.
CONCLUSION
In the present report, there has been discussion and the critically revelation which are
based on the pricing, costing and relevant techniques that used in managerial and accounting
aspects. Hence, the report has also shed some light on the decision-making process of a strategic
management accountant in an organisation which are concern with the operational activities and
the buying or manufacturing decisions. Hence, it can be said that the managers need to analyse
the costs or expense before making any deal and plan the operational activities in accordance
with that. Further it can be said that company's large amount of funds will be required by the
professionals in context with the operational activities so it is to be examine and controlled by
the professionals with effective decisions.
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REFERENCES
Books and Journals
Abrahamson, E., Berkowitz, H. and Dumez, H., 2016. A more relevant approach to relevance in
Management Studies: an essay on performativity. Academy of Management Review.
41(2). pp.367-381.
Bakker, A. and Obuoforibo, B., 2009. Transfer pricing and customs valuation: two worlds to tax
as one. IBFD.
Brown-Liburd, H., Issa, H. and Lombardi, D., 2015. Behavioral implications of Big Data's
impact on audit judgment and decision making and future research directions. Accounting
Horizons. 29(2). pp.451-468.
Cooper, J. and et.al., 2017. Transfer Pricing and Developing Economies: A Handbook for Policy
Makers and Practitioners. World Bank Publications.
Dragomir, V. I., Avram, M. and Domnişoru, S., 2016. Considerations Regarding the Contents of
Internal Control. Ovidius University Annals, Series Economic Sciences. 16(1).
Garcia, S. and et.al., 2016. Corporate sustainability management: a proposed multi-criteria model
to support balanced decision-making. Journal of Cleaner Production. 136. pp.181-196.
Hickman, A., 2016. The Application of Revised Transfer Pricing Rules to Aspects of Business
Models. Intertax. 44(10). pp. 730-734.
Johnson, N. L., Larson, F. and DeMersseman, A., 2017. Who’s Taking the Accounting Class?
Leveraging Professional Scepticism While Teaching Accounting Online. Journal of
Business Case Studies (JBCS). 13(2). pp.73-84.
Jost, S. P., Pfaffermayr, M. and Winner, H., 2014. Transfer pricing as a tax compliance
risk. Accounting and Business Research. 44(3). pp. 260-279.
Klassen, K. J., Lisowky, P. and Mescall, D., 2016. Transfer pricing: Strategies, practices, and tax
minimization. Contemporary Accounting Research.
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Kool, W., Shenhav, A. and Botvinick, M. M., 2017. Cognitive Control as Cost‐Benefit Decision
Making. The Wiley Handbook of Cognitive Control. pp.167-189.
Mishra, B. K., Prasad, A., Srinivasan, D. and ElHafsi, M., 2017. Pricing and capacity planning
for product-line expansion and reduction. International Journal of Production Research.
pp.1-18.
Munira, H., 2017. Transfer pricing in global business and ethical issues. Advances in
Management. 10(2). pp. 1-12.
Peppard, J. and Ward, J., 2016. The strategic management of information systems: Building a
digital strategy. John Wiley & Sons.
Rossing, C.P., Cools, M. and Rohde, C., 2017. International transfer pricing in multinational
enterprises. Journal of Accounting Education.
Rugman, A. M. and Eden, L., 2017. Multinationals and transfer pricing. Routledge.
Sikka, P. and Willmott, H., 2010. The dark side of transfer pricing: Its role in tax avoidance and
wealth retentiveness. Critical Perspectives on Accounting. 21(4). pp. 342-356.
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