Question

explain the situations that are related to the transfer of products between divisions located in different countries. illustration 8B-1 from your textbook, Weygandt, Kimmel, & Kieso (2015, p. 337). What conclusion can you come to after analyzing the data in Illustration 8B-1? There, a company's after-tax contribution margins are compared using a unit transfer price of $ 18.00 versus a unit transfer price of $ 11.00 (Weygandt, Kimmel, & Kieso, 2015, p. 337).

Answer 1

Answer:-

Profit of a division is determined by the cost to produce goods subtracted from the revenue to arrive at taxable profits. Company then pays tax on this pre tax income

If a company has 2 divisions, it transfers a finished product from 1 division (Sole division in above case) to another division (Boot) which forms as a raw material for that division.

The receiving division books the cost at which this raw material is transferred at and claims it as an expense to arrive at taxable profit.

In case the tax rates are different between 2 countries, transfer pricing guidelines need to be formed and arrived at.

It is beneficial for the Group to book less revenue in the country where tax rates are high to reduce the tax paid.

In the above example, Tax rates for Sole Division is 30% while for Boot division is 10%. Hence, it is beneficial for the company to transfer the sole to Boot division at low transfer price

It is also clearly evident from the After tax contribution margin for the company is higher when sole is transferred at 11 $ as compared to contribution margin where sole is transferred at 18$.

Company indirectly saves a net profit of 39.6 - 38.2 = 1.4 $. This can also be calculated as (18-11) * (30%-10%) = 7 $ * 20% = 1.4 $ savings

It is suggested to the company to hence maximize its profits by setting transfer price at optimum level which maximizes the revenue of the company ( Which in this case is 11$)

Company should also take care not to set the transfer price below cost in order to avoid tax disputes).