ACCA PM知识点：General principles about transfer pricing

General principles about transfer pricing

Where there is an external market for the product being transferred

Minimum transfer price

When we consider the minimum transfer price,we look at transfer pricing from the point of view of the selling division.The question we ask is:what is the minimum selling price that the selling division would be prepared to sell for?This will not necessarily be the same as the price that the selling division would be happy to sell for,although,as you will see,if it does not have spare capacity,it is the same.

The minimum transfer price that should ever be set if the selling division is to be happy is:marginal cost+opportunity cost.

Opportunity cost is defined as the'value of the best alternative that is foregone when a particular course of action is undertaken'.Given that there will only be an opportunity cost if the seller does not have any spare capacity,the first question to ask is therefore:does the seller have spare capacity?

Spare capacity

If there is spare capacity,then,for any sales that are made by using that spare capacity,the opportunity cost is zero.This is because workers and machines are not fully utilised.So,where a selling division has spare capacity the minimum transfer price is effectively just marginal cost.However,this minimum transfer price is probably not going to be one that will make the managers happy as they will want to earn additional profits.So,you would expect them to try and negotiate a higher price that incorporates an element of profit.

No spare capacity

If the seller doesn’t have any spare capacity,or it doesn’t have enough spare capacity to meet all external demand and internal demand,then the next question to consider is:how can the opportunity cost be calculated?Given that opportunity cost represents contribution foregone,it will be the amount required in order to put the selling division in the same position as they would have been in had they sold outside of the group.Rather than specifically working an'opportunity cost'figure out,it’s easier just to stand back and take a logical approach rather than a rule-based one.

Logically,the buying division must be charged the same price as the external buyer would pay,less any reduction for cost savings that result from supplying internally.These reductions might reflect,for example,packaging and delivery costs that are not incurred if the product is supplied internally to another division.It is not really necessary to start breaking the transfer price down into marginal cost and opportunity cost in this situation.

It’s sufficient merely to establish:

(i)what price the product could have been sold for outside the group

(ii)establish any cost savings,and

(iii)deduct(ii)from(i)to arrive at the minimum transfer price.

At this point,we could start distinguishing between perfect and imperfect markets,but this is not necessary in Performance Management.There will be enough information given in a question for you to work out what the external price is without focusing on the market structure.

We have assumed here that production constraints will result in fewer sales of the same product to external customers.This may not be the case;perhaps,instead,production would have to be moved away from producing a different product.If this is the case the opportunity cost,being the contribution foregone,is simply the shadow price of the scarce resource.

In situations where there is no spare capacity,the minimum transfer price is such that the selling division would make just as much profit from selling internally as selling externally.Therefore,it reflects the price that they would actually be happy to sell at.They shouldn’t expect to make higher profits on internal sales than on external sales.

Maximum transfer price

When we consider the maximum transfer price,we are looking at transfer pricing from the point of view of the buying division.The question we are asking is:what is the maximum price that the buying division would be prepared to pay for the product?The answer to this question is very simple and the maximum price will be one that the buying division is also happy to pay.

The maximum price that the buying division will want to pay is the market price for the product–ie whatever they would have to pay an external supplier for it.If this is the same as the selling division sells the product externally for,the buyer might reasonably expect a reduction to reflect costs saved by trading internally.This would be negotiated by the divisions and is called an adjusted market price.

Where there is no external market for the product being transferred

Sometimes,there will be no external market at all for the product being supplied by the selling division;perhaps it is a particular type of component being made for a specific company product.In this situation,it is not really appropriate to adopt the approach above.In reality,in such a situation,the selling division may well just be a cost centre,with its performance being judged on the basis of cost variances.This is because the division cannot really be judged on its commercial performance,so it doesn’t make much sense to make it a profit centre.Options here are to use a cost based approach to transfer pricing but these also have their advantages and disadvantages.【点击免费下载>>>更多ACCA学习相关资料】

Cost based approaches

Variable cost

A transfer price set equal to the variable cost of the transferring division produces very good economic decisions.If the transfer price is$18,Division B’s marginal costs would be$28(each unit costs$18 to buy in then incurs another$10 of variable cost).The group’s marginal costs are also$28,so there will be goal congruence between Division B’s wish to maximise its profits and the group maximising its profits.If marginal revenue exceeds marginal costs for Division B,it will also do so for the group.

Although good economic decisions are likely to result,a transfer price equal to marginal cost has certain drawbacks:

Division A will make a loss as its fixed costs cannot be covered.This is demotivating.

Performance measurement is also distorted.Division A is condemned to making losses while Division B gets an easy ride as it is not charged enough to cover all costs of manufacture.This effect can also distort investment decisions made in each division.For example,Division B will enjoy inflated cash inflows.

There is little incentive for Division A to be efficient if all marginal costs are covered by the transfer price.Inefficiencies in Division A will be passed up to Division B.Therefore,if marginal cost is going to be used as a transfer price,it at least should be standard marginal cost,so that efficiencies and inefficiencies stay within the divisions responsible for them.

Full cost/Full cost plus/Variable cost plus

A transfer price set at full cost or better,full standard cost is slightly more satisfactory for Division A as it means that it can aim to break even.Its big drawback,however,is that it can lead to dysfunctional decisions because Division B can make decisions that maximise its profits but which will not maximise group profits.For example,if the final market price fell to$35,Division B would not trade because its marginal cost would be$40(transfer-in price of$30 plus own marginal costs of$10).However,from a group perspective,the marginal cost is only$28($18+$10)and a positive contribution would be made even at a selling price of only$35.Head office could,of course,instruct Division B to trade but then divisional autonomy is compromised and Division B managers will resent being instructed to make negative contributions which will impact on their reported performance.Imagine you are Division B’s manager,trying your best to hit profit targets,make wise decisions,and move your division forward by carefully evaluated capital investment.

The full cost plus approach would increase the transfer price by adding a mark-up.This would now motivate Division A,as profits can be made there and may also allow profits to be made by Division B.However,again this can lead to dysfunctional decisions as the final selling price falls.

The difficulty with full cost,full cost plus and variable cost plus is that they all result in fixed costs and profits being perceived as marginal costs as goods are transferred to Division B.Division B therefore has the wrong data to enable it to make good economic decisions for the group–even if it wanted to.In fact,once you get away from a transfer price equal to the variable cost in the transferring division,there is always the risk of dysfunctional decisions being made unless an upper limit–equal to the net marginal revenue in the receiving division–is also imposed.

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