Question

1. Briefly explain four reasons why transfer pricing is important for multinational corporations.

2. Identify one of the main advantages and two behavioural implications of the use of the following transfer pricing methods:

a. Full Cost Based Transfer Price

b. Negotiation Based Transfer Price

Note: There should be two advantages and four behavioural implications in total – i.e. each transfer pricing method will have one advantage and two behavioural implications.

Answer 1

Negotiated transfer pricing. It may be necessary to negotiate a transfer price between subsidiaries, without using any market price as a baseline. This situation arises when there is no discernible market price because the market is very small or the goods are highly customized. This results in prices that are based on the relative negotiating skills of the parties.

Advantage : full autonomy of buying and selling divisions.

In actual full cost approach, transfer price is based on the total product cost per unit which will include direct materials, direct labour and factory overhead. When full cost is used for transfer pricing, the selling division can not realise a profit on the goods transferred. This may be disincentive to the selling division. Further, full cost transfer pricing can provide perverse incentives and distort performance measures. A full cost transfer price would have shutdown the chances of any negotiation between divisions about selling at transfer prices.

1.Full cost pricing method is very simple in the calculation of price of export.

2. Assurance of reasonable return to the exporter