Question

The Nature and Wildlife Corporation has manufacturing facilities in country A and an assembly plant in country B. In June 2017, the company will ship 1,000 units with a production cost of $65 per unit to its plant in country B. Its operating expenses in country A are $15,000 for the month. The income tax rate in country A is 20% and in country B it is 40%. The company plans to have a transfer price of $100 per unit. The final product can be sold in country B for $140. Country B’s operating expenses are $10,000 during the month.

How much will the combined profits of the two operations be in April 2018?

Could the company benefit by changing the transfer price to $120?

Now, suppose the income tax rate in country A is 40% while in country B it is 20%. What will the combined profit be if all of the other numbers are the same as they were in the original assignment description?

What would be the result in question 3 if the company decreased its transfer price to $90?

Answer 1

Solution 1:

Nature and Wildlife corporation
Income Statement - Apr'18 (Transfer price - $100)
Particulars	Country A	Country B	Total
Revenue	$100,000.00	$140,000.00	$240,000.00
Production Cost (1000*65)	$65,000.00	$0.00	$65,000.00
Transferred In Cost (1000*100)	$0.00	$100,000.00	$100,000.00
Gross Profit	$35,000.00	$40,000.00	$75,000.00
Operating expenses	$15,000.00	$10,000.00	$25,000.00
Income before tax	$20,000.00	$30,000.00	$50,000.00
Income Tax (20%, 40%)	$4,000.00	$12,000.00	$16,000.00
Net Income after Tax	$16,000.00	$18,000.00	$34,000.00

Solution 2:

Nature and Wildlife corporation
Income Statement - Apr'18 (Transfer price - $120)
Particulars	Country A	Country B	Total
Revenue	$120,000.00	$140,000.00	$260,000.00
Production Cost (1000*65)	$65,000.00	$0.00	$65,000.00
Transferred In Cost (1000*100)	$0.00	$120,000.00	$120,000.00
Gross Profit	$55,000.00	$20,000.00	$75,000.00
Operating expenses	$15,000.00	$10,000.00	$25,000.00
Income before tax	$40,000.00	$10,000.00	$50,000.00
Income Tax (20%, 40%)	$8,000.00	$4,000.00	$12,000.00
Net Income after Tax	$32,000.00	$6,000.00	$38,000.00

As total net income is increased by $4,000 by changing transfer price from $100 to $120 due to lower tax in country A, hence company benefited by changing the transfer price to $120.

Solution 3:

Nature and Wildlife corporation
Income Statement - Apr'18 (Transfer price - $100)
Particulars	Country A	Country B	Total
Revenue	$100,000.00	$140,000.00	$240,000.00
Production Cost (1000*65)	$65,000.00	$0.00	$65,000.00
Transferred In Cost (1000*100)	$0.00	$100,000.00	$100,000.00
Gross Profit	$35,000.00	$40,000.00	$75,000.00
Operating expenses	$15,000.00	$10,000.00	$25,000.00
Income before tax	$20,000.00	$30,000.00	$50,000.00
Income Tax (40%, 20%)	$8,000.00	$6,000.00	$14,000.00
Net Income after Tax	$12,000.00	$24,000.00	$36,000.00

Solution 4:

Nature and Wildlife corporation
Income Statement - Apr'18 (Transfer price - $90)
Particulars	Country A	Country B	Total
Revenue	$90,000.00	$140,000.00	$230,000.00
Production Cost (1000*65)	$65,000.00	$0.00	$65,000.00
Transferred In Cost (1000*100)	$0.00	$90,000.00	$90,000.00
Gross Profit	$25,000.00	$50,000.00	$75,000.00
Operating expenses	$15,000.00	$10,000.00	$25,000.00
Income before tax	$10,000.00	$40,000.00	$50,000.00
Income Tax (40%, 20%)	$4,000.00	$8,000.00	$12,000.00
Net Income after Tax	$6,000.00	$32,000.00	$38,000.00