Chap015 - Chapter 15 - Transfer Pricing 15 Transfer Pricing...

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Unformatted text preview: Chapter 15 - Transfer Pricing 15 Transfer Pricing Solutions to Review Questions 15-1. A transfer price is used to record the revenue or the cost from a sale between units (e.g., divisions) of a firm. It allows the completion of separate financial statements within the firm. 15-2. Yes, transfer prices exist in centralized organizations to record the transfer of goods and services from one unit to another for the same reasons such organizations allocate costs (e.g., inventory valuation, cross-department monitoring). 15-3. Market-based transfer pricing is considered optimal under many circumstances because it preserves divisional autonomy, yet encourages division managers to make economically optimal decisions for the company if divisions operate at capacity and there are no market transaction costs. 15-1 Chapter 15 - Transfer Pricing 15-4. The key limitation is that market prices are often not readily available. The limitations of market-based transfer prices exist when the market price does not reflect the opportunity cost of the goods and services, for example when idle capacity is present. Also, temporary short-run fluctuations in market prices could lead to suboptimal long-run decisions. The limitation of cost-based transfer pricing is that it requires the computation of cost. The resulting transfer price might distort decision-making and lead to disputes between divisions. 15-5. Direct intervention might be preferable when transfers between units are rare or where the decision resulting from decentralized decision-making is considered too harmful to allow. The advantage of direct intervention is it promotes short-run profits by ensuring proper action. The disadvantages of such a practice are that top management will become too involved in pricing disputes, and division managers will lose flexibility and autonomy in their decision making. The company also loses the other advantages of decentralization. 15-2 Chapter 15 - Transfer Pricing 15-6. Reasons not to use market prices include situations where: (1) market prices are not readily available, (2) market prices lead to suboptimal behavior (for example, when the supplier division has idle capacity), or (3) the company is not otherwise indifferent between internal and external buying. 15-7. When actual costs are used as a basis for the transfer, any variances or inefficiencies in the selling division are passed along to the buying division. To promote responsibility in the selling division and to isolate variances within divisions, standard costs are usually used as a basis for transfer pricing in cost-based systems. (Note: Standard cost transfer pricing is only appropriate if standard costs are up to date and reflect reasonable estimates of cost.) 15-8....
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This note was uploaded on 02/01/2011 for the course ACCT 111 taught by Professor Na during the Spring '10 term at Cornell University (Engineering School).

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Chap015 - Chapter 15 - Transfer Pricing 15 Transfer Pricing...

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