Question

Question Two Peter Chou is the general manager of Madari Ltd. He believes that intragroup transactions can be included within consolidated financial statements as long as the transaction represents fair value. That is, the value of the transaction is equivalent to an ‘arm’s length’ transaction.  

Required Prepare a persuasive, but concise (no more than 350 words), response to Peter Chou. Mr. Chou is not an accountant so ensure that your explanation is understandable to a nonaccountant.

Answer 1

Transfer price sets price for internally trasfered goods and service .An intermediate product is a good or service tyat is transfered betwen two segments of a company .Company srtategy is greatly affected by te choice if transfer prices.If te company wants the business units to behave independenly and keep managers motivated to achive company goal ,transfer price should be set at arms length,as if the party were ant external client, when n external supplier or customer exist for aproduct or service , the arms length price an impartial or fair market price is more difficult to determine . Four models that can be used to set transfer price are MArket price ,negotiated price. variable cost and full cost

market price model is true arms length model because it sets the price for goods or service at going market price this model can be used only when an item has a market ,item such as work in progress inventory may not have a market price .business that use this model should take into account te reduced selling and marketing cost in the price

The negotiated price model sets the transfer price through negotiation between the buyer and seller , when different business units experience conflicts negotiation or even arbitration may be needed to keep the company as a whole functioning efficiently .Negotiated price can make both the buying unit and selling unit less autonomous

The variable cost model sets transfer prices at the units variable cost or the actual cost to produce goods or service less all fixed cost ,this method will lower the selling units profit and increases the buying units profit due to low prices .Variable cost works well if the selling division has excess (unused) capacity and if the main objective
of the transfer price is to satisfy the internal demand for goods.A transfer price equal to variable cost encourages the buying division to purchase the item internally

The full cost method includes all materials, labor, and a full allocation of overhead in determining a transfer
price. In other words, the transfer price is the inventory cost of the item, calculated using absorption costing.
Nothing is added for a markup. The use of full cost as the transfer price is well understood by the managers of both the buying andthe selling divisions and the cost information is easily available in the accounting records.Because the product is transferred at cost, intra-company profits do not need to be eliminated fromincome statements and inventories in consolidated financial statements