L13 Tp Mkt Based Method

Transfer Pricing – The Concept Division A

ABC Co Ltd.

Division C

Division B * Div A’s Output is Div B’s Input, and A supplies the product to B * It is a transfer transaction and not a sale transaction in its pure sense. * Value charged by Div A to Div B is called Transfer Price. * And method followed to arrive at TP is called Transfer Pricing 10/17/08

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How am I concerned with TP? ● Objective of MCS is to measure and evaluate and if needed control the managerial actions/decisions. ● Usually the profit is the best measure of the performance of any business unit & is a prime function of Price ● Inappropriate/discretionary pricing for inter-divisional transfer of good/services draws a wrong performance picture. ● Hence appropriate pricing policy helps in ASSESSING THE REALISTIC PERFORMANCE of the division. ● Hence a well-established TP acts as a tool of Managerial Control in itself. 10/17/08

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Significance of TP ● To measure the Real Performance and Profitability of the division. ● To allow Autonomy to divisional functioning without subverting the firm’s goal. ● To Achieve Goal Congruence . ● To keep up motivation of all concerned divisions. ● To ensure the cost control at every division.

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Methods of TP I) Market Price Based TP: A) Market Price as TP: ● Essentials * Div A’s product having open market. * Market forces determine the PRICE. * Then MP is best TP. ● Advantages * Div A can not pass its inefficiencies to Div B * Acceptable to Div A and Div B. * It is opportunity cost for Div A. * Creates competitive environment. 10/17/08

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Methods of TP I) Market Price Based TP: B) Modified Market Price (MMP): ● TP lower than MP may be set to compensate various factors such as – * Saving on selling and transportation costs. * Guaranteed take off by Div B. * Quantity, Quality and Delivery aspects of transfer. An unbiased negotiation may lead to acceptable TP by both divisions. Thus TP becomes an agreed upon price between them. 10/17/08

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Methods of TP I) Market Price Based TP: C) TP Lower than MP: WHEN - ● Div A is not able to sale its product at MP. Div B is able to get it below MP. Establishment of TP in such situation depends on the amount of IDLE capacity Div A is having…..

If Div A operating at its full capacity- No question of reducing MP. If Div A running with idle capacity – Opportunity cost of Div A is zero, and whatever it can earn over and above its VC is well and good. (Below BEP it FC recovery and above BEP it is profit) & Non reduction of MP in such situation leads to reduction of firms profits. 10/17/08 6 [email protected] [email protected]

● I) Market Price Based TP: A) Advantages 1. True representation of opportunity cost.

2. MP are easily available. erformance of both the divisions is continuously harnessed. 4. Sales price variance gives a better control data. A) Limitations of MP as TP – 1. Div A has no outside market.

competitive market for Div A’s product. (Div A is price leader) 3. Wide fluctuations in MP. ( leads to inconsistent results) 4. What is right MP? Ex-factory/ Wholesalers/Customers

P includes selling and distribution cost. (which is absent in TP.)

. Quantity discounts/special discount plays important role in MP. 7. After sales service do matters in MP. Dumping price can be anything (when Div A builds idle stock) 10/17/08

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Thanks….

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