[COMPANY NAME]

[Company address]

TRANSFER PRICING
[Document subtitle]
Contents
Transfer pricing............................................................................................................. 2
Measures for Performance Evaluation..............................................................................3
Different Methods of Transfer Pricing:............................................................................... 3
Behavioral implication that arose from the negotiation of transfer pricing and their positive and
negative aspects:........................................................................................................... 5
Behavioral problems arising from Absorption manufacturing costs........................................6
Behavioral problems due to revised transfer pricing policy...................................................6
Divisional managers behaviors of selling and buying:.........................................................7
a. Method of cost plus mark up of standard full manufacturing:..........................................7
b. Per unit product market selling price that should be transferred:.....................................7
c. Opportunity cost and out of pocket cost that incur at the time of transferring:....................7
Suggestion of transfer price to the managers of Division Y and Z..........................................7
Suggest the price range within which the transfer price for Dangos would satisfy both divisions
i.e. Division A and B....................................................................................................... 8
Bibliography............................................................................................................. 10
Transfer pricing
Transfer Price is characterized as the price charged by one department of an
organization to another department for the products or services manufactured one
department to another department. The concept of Transfer pricing is most normal in
firms that are vertically incorporated, for example organizations are occupied with a few
diverse worth making operations for an item. Transfer pricing is utilized by Investment
Centers and Profit Centers so as to figure out the product and services cost got from
administration offices and incomes when "offering" an item to another office when that
item has an outside business sector. The cost at which the exchange happens
influences the income reported by every division when exchange of products or
administrations are produced using one benefit focus to another benefit focus inside of
the same organization, a segment of the income of one of the divisions is a segment of
the expense of the other division (Accountingtools, 2015).

Across the globe, the failure of governments is making sure that fiscal policies are
keeping pace with the growing cross-border trade and this is very important factor which
has contributed in increased significance of transfer pricing. Taxation of profits
emanating from global trade by MNEs is still determined by legal structure within
national boundaries. The essential aim behind arms length principle is to figure out
those transactions among the self-governing enterprises also known as "comparable
uncontrolled transactions (OECD.Org, 2013).

The different entities should not be regarded as inseparable parts of one single unified
business; the MNE should instead be regarded as separate entities. With this approach,
the focus becomes the transaction in itself and the nature of that transaction. This
approach will then make it easier to determine whether a transaction, and its conditions,
within an MNE differ from that of a comparable uncontrolled transaction. This type of an
analysis is the core of the arms length principle and the OECD refers to is as a
"comparability analysis".
As stated in the OECD Article 9 that the basis for an arms length principle and the
comparability analysis by showing a need for two different aspects. The first being a
comparison between the conditions laid down for associated enterprises and for
independent enterprises. This comparison is done to assess whether the accounts, for
tax liability, are to be re-calculated or if they are not in as per the Article 9 of the OECD
model. The second aspect aims towards the determination of the accrued profits that
would have occurred if the transaction were at arms length. This part is important as to
the determination of the amount of any re-calculation and re-writing of the tax accounts
(Investopedia, n.d.).

Measures for Performance Evaluation

Most organizations are decentralized. Managers throughout these organizations are
given autonomy to make decisions for their subunits. Decentralization takes advantage
of the specialized knowledge and skills of managers, permits and organization to
respond quickly to events and relives top management of the need to direct the
organizations day to day activities. The great challenge that is faced in effectively
creating the decentralized function of an organization is to get the goal congruence
between the autonomous managers of the organization. It is natural and human nature
that individuals are more concerned to the group performance so the Goal Congruence
is obtained when managers of different department and organizations unite in an
endeavor of an organization so as to accomplish the targeted goals and objectives. To
obtain goal congruence, throughout an organization managers behavior must be
directed toward top managements goals. Successful managers not only have their
concerns on these organizational goals but also have been given positive incentives to
achieve them (lafayette, 2009).

Different Methods of Transfer Pricing:

There are different methods of transfer pricing which are given as follows:

1. Market Price:
The current price is set as transfer price of selling the division product in an arm's length
transaction. In case when the external price exists for the products this price is
considered to be the best transfer price for the performance measurement and for
profitability. The arm's lengths transaction is satisfied by taxing authorities. Moreover the
management of the buying department is satisfied that they are getting the product at
the right price while on the other hand the management of the selling department is also
satisfied that they are selling the product at the fair price (Transferpricing, 2014).
2. Variable Cost of Production plus opportunity cost:
In this method of transfer pricing, profit margin is also include along with the variable
production cost as profit margin is established by selling the products internally in the
organization more willingly than externally. (TP, n.d.)
3. Variable Cost of Production:
This method of transfer pricing functions admirably when sales department has
abundance limit and when the principle goal of the exchange cost is basically to fulfill
the inner products demand. This strategy utilizes the sales departments variable costs
just and because of this it is not proper if the vender is a benefit or speculation focus, as
it will diminish the gainfulness (Elizabeth Hughes, 2010).

4. Full Cost:
This method can also be recognized as the Absorption Costing as this comprises over
the full cost such as overhead, labor and material cost. As goods and services are
transferred at cost, so this method is mainly recommended for external reporting, in
addition to this, there is no need exclude the internal margin of profit of the organization
in consolidation account of inventories. The cost is calculated by taking all the expanses
which incurred on the project (Accounting plus, n.d.).

5. Cost Plus:
This method of transfer pricing add up the percentage of costs or fixed amount to the
production cost for forecasting a average markup profit which could be departments or
companys policy. It can be used if there is no market price available or the market price
keeps fluctuating frequently. It either uses standard or actual costs. Standard cost is that
cost which the management of the company set at the start of the project and then cost
is calculated on the basis of that standard. In cost plus method, the cost of the project
is also calculated on actual basis which mean that when the management of company
start any new project than all the expenses incurred on the project are calculated at the
time when they incur and at their exact amount (Transferpricing, 2014).

6. Negotiated Price:
This method is used when the two i.e. buying and selling division are in disagreement
but for resolution, negotiation can bring about. In addition to this, so as to be
successful, neither negotiating party can be supposed to have an iniquitous position of
bargaining. Sometime negotiations are time consuming and may require frequent
revisions to price. In case when management of different departments are not agree at
single price than in that case the management evaluate different factors, on the basis of
which decision is taken by the management of departments by negotiating (Elizabeth
Hughes, 2010).

7. Arbitrary Pricing:
Central management can set the transfer pricing for reducing the tax or achieving the
some other overall objectives. The central management objective is considered the
most important objective and with the help of this method that objective can be achieved
easily. It is the fact that the key management of any company has key role in the
success of the company, so by the adoption of those methods the key management of
the company can evaluate the main and important objective of the company in more
productive way. (Ross, 1995)

Behavioral implication that arose from the negotiation of transfer pricing and
their positive and negative aspects:
After employing the negotiated transfer pricing when goods are exchanged between the
divisions some positive and negative transfer pricing implications arise

Positive aspects:
Some of the positive aspects for negotiating the transfer price are as follows:
Negotiation will be made on the product price between both the divisions and
there will be a agreed price which will be considered the best deal possible
During negotiation the independence of the divisions will be affected.
Negative aspects:
Some of the negative aspects for negotiating the transfer price are as follows:
When transfer pricing has been set after negotiation that pricing will not be
optimal for the whole organization.
Due to this process harsh feelings and the conflicts could arise (Chegg, 2013).

Behavioral problems arising from Absorption manufacturing costs

If the actual full manufacturing cost system is used there will be behavior problems
which can arise and those are following:

If the organization is the decentralized structure then the full cost transfer pricing
system is not suitable as selling unit is unable to realize the profits in case when
the division which are autonomous are used to assessed through the profitability
measures. Decentralized structure of the company is that structure in which there
are different levels of departments in company and there is small level of direct
interaction of key management of the company with the middle level of company.
In this method the decisions made are not goal congruent as the unit is bought
by the buying unit outside the price which is too much low as compared to the
method of full cost of selling per unit. Sale of per unit should reduce the price at
the transfer price if it is not operating a full cost capacity. The company
performance will be optimizing due to this price reduction which eventually give
great level of benefits to the company.

Behavioral problems due to revised transfer pricing policy

If the Thompson Corporation decides to change the transfer pricing then it could
cause the behavioral problems as it would be applied to all the divisions
The divisional manager can interpret the change in policy as an attempt to
reduce the freedom of making the decisions and to reduce the autonomy.
Motivation will also be reduced due to this perception.
If the control is lost on the transfer pricing and control on the profitability will be
reduced so they will not be agree to accept the change in the uniform prices.
If the transfer pricing is low from the markets then the selling division will agree to
sell outside in this way they can increase the profitability and the bonuses.
Divisional managers behaviors of selling and buying:

a. Method of cost plus mark up of standard full manufacturing:

As any cost over the standard cost cannot be passed over to the buying division so the
selling cost is motivated to control the cost sop the profit of the selling division will be
reduced. If the market price is higher buying division may be pleased with this transfer
price.

b. Per unit product market selling price that should be transferred:

In this method the buying and the selling department can get the equal chance of
maximizing the profit. Cost is being controlled in this method and divisional managers
also get motivated and the overall company performance is improved. In order to set the
price there should be no clash among the buyers and sellers because these price will
be decided with the consent of all parties.

c. Opportunity cost and out of pocket cost that incur at the time of transferring:
Opportunity cost and out of the pockets are the costs which are incurred by the
company. In this method when the seller is at full capacity and there is an established
market price so this method could be said to be same as the market price. Below this
capacity at any price the transfer pricing is considered the out lay cost this cost could
approximate the variable costs of the goods being transferred.
The price is the best so the both of the parties the buyer and the seller should agree
under this price either party can realize the products under such circumstances. And
overall goal congruence will be promoted under this method.

Suggestion of transfer price to the managers of Division Y and Z.

Transfer price should be OMR 18 because 18 OMR price for the per unit of product is
low as compared to the purchasing cost of Divisions Y that Division is buying from the
outside party but it exceeds from the production cost of Division Z so at the end division
Y and Division Z both took advantage from this transferring of the product as this price.
However, this 18 OMR is the best transfer price on which these both divisions can work
simultaneously and effectively so these both divisions can save their profit and reach at
maximum level.
Suggest the price range within which the transfer price for Dangos would satisfy
both divisions i.e. Division A and B.
Division B of Thomson company is making profit by selling its product outside and if
division B provide its product Dangos to Division A then it have to stop its other second
product Tangos and by stopping the production of Tangos division B will loss revenue of
OMR 300 (OMR 6 * 50 units) and this will be opportunity cost for the company. Division
B is workingon 100% capacity so after closing the manufacturing of Tangos Division B
will focus only on Dangos in order to meet the needs of Division A and other market
parties. So if division A buy product Dangos from division B then this opportunity cost
will become part of the cost of Dangos and it will be added to the cost of the Dangos

Division B will charge variable cost of 10.8 OMR to division A for the Dangos product
per unit and opportunity cost per unit would be OMR 2 (OMR 300 / 150 Units) so total
price would be 12.8 OMR and less 0.5 OMR of advertising and transportation charges
that would be save by transferring products from division B. When division A was
buying product Dantgos from the market so it have to pay the marketing and
transportation cost which is 0.5 OMR per unit so by buying goods from in-house
Division A will also save this 0.5 OMR marketing and transportation cost per unit.
Division B will cover its fixed cost by selling the Dangos to outside party and will charge
only variable cost to the division A in order to reduce the transfer so both companies can
took advantage of it.

So the price of Dangos per unit is OMR 12.3 that would satisfy both divisions.
Bibliography
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