Class exercise 3 Transfer Pricing PDF

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Transfer pricing...

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Class exercise 3 Transfer Pricing - ABC Group The ABC Group has three Divisions A, B and C and these have the authority to either buy from each other internally at an agreed transfer price or else externally at the prevailing market price. Managers would normally select either the cheapest option or the option with the greatest net benefit. A Division has some spare capacity and is considering two mutually exclusive alternatives: Option 1 - supply 3,000 units internally to C Division for £2,000 per unit. This would involve buying components from B Division at a transfer price of £900 each (one component per unit). In addition, conversion costs of £750 per unit (a variable cost) would be incurred. The components made by B Division would have a variable cost of £450 each per unit. Option 2 - sell 3,500 units externally to the WWF Company for £1,500 per unit. In this case, the required components from B Division would have a transfer price of £750 each. The variable cost to B Division would be £375 each and the conversion costs incurred by A Division would be £600 per unit. If option 2 is taken then C Division will obtain the 3,000 units from XYZ, an external company, for £6.5million. In order to supply C division, XYZ would buy components from B division for £600 each. The variable cost of these components to B Division would be £300 each. Required (a)

Evaluate which of the two options would be preferred by the senior management of A Division. (10 marks)

(b)

Evaluate which of the two options would be preferred by the senior management of the ABC Group. (20 marks)

(c)

Indicate the principal methods of determining transfer prices in multinational corporations and indicate what effects these can have on sister-companies trading with each other when performance measurement is based on a profit centre or investment centre basis. (20 marks)...