L14 Tp Cost Based Method

Methods of TP II ) Cost Based TP: A) Variable Cost as TP: ● TP be set at Variable cost of production of Div A * Rational - After all FC is a sunk cost for Div A. This TP forces Div A to not to earn any profit but also not to recover even its operating cost. But from company wide perspective this TP is best

10/17/08

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Methods of TP

II ) Cost Based TP: -

B) Full Cost/Absorption Cost: ● TP is set at VC + FC of production of Div A. This gives an opportunity to Div A to recover its operating cost * In this approach FC of Div A appears as VC of Div B, In a broader perspective of firm it is wrong conception. * Such conception may leads to incorrect decision on the part of Div B and subverts the firm’s goal. * Do not provide any incentive for cost control. (since actual cost = TP). 10/17/08

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Methods of TP II ) Cost Based TP: C) Standard Cost as TP: ● Actual Cost as TP leads to passing inefficiencies of Div A to Div B therefore ……. * Scientifically Predetermined product cost would be a better yard stick to control actual cost. * Ensures operating efficiency of Div A by motivating it to contain its actual cost in predetermined limit.

10/17/08

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Methods of TP II ) Cost Based TP: D) Modified Cost as TP: ● Mere recovery of Cost does not provide any profit perspective to Div A. It lacks motivation for Div A to earn profit. Therefore TP can be set as:TP = Cost + Mark up {Markup = Certain % of cost or lump sum amount} • However taking cost as actual cost again introduces its inherent drawback. Therefore best approach would be TP = Std. Cost + Markup 10/17/08

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General Rule for TP Minimum TP = VC per unit + Contribution lost per unit Div A must recover its entire VC and also the Contribution lost. (Contribution Lost – the amount that Div A would otherwise have earned through selling in external market) ● This makes Div A indifferent as to the sale to outsider or inter divisional transfer

10/17/08

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Conclusion on Transfer Pricing Highest TP = Market Price Lowest TP = Variable Cost Min. TP = VC + Contribution Lost

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Thanks………

10/17/08

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Methods of TPOther Approaches to Transfer Pricing I) Two Step Pricing

Div A will Charge actual Variable Cost (based on actual volume) Plus (based on agreed upon volume) agreed amount will be charged per PERIOD basis (to compensate (FC + Profit) )

II) Profit Sharing Div A will transfer the product at standard variable cost to Div B. After selling the final product, the contribution earned by Div B will be shared by both.

III) Two Sets of Prices Credit the A’s account by MP Charge Total Std.Cost to B’s account & Charge the difference to HQ account. While consolidating the BU accounts reverse the difference. 10/17/08

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Considerations in – Transfer Pricing in MNC’s 1. Taxation – tax heavens, double taxations 2. Govt. Regulations – Arms length price (in absence of which BU can set TP to minimize the tax liability) 3. Tariffs – They are certain % of import value, therefore lower the TP lower will be the tariffs. 4. Foreign Exchange Control – e.g. limit on FE spending for import. 5. Shifting of funds to desired location. 6. Joint Ventures – May enforce the specific TP. 10/17/08

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7. Transaction, Operation and Economic

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