(65)---TRANSFER PRICING (5).

Negotiated transfer prices.

A transfer price based on opportunity cost is often difficult to identify, for lack of suitable information about costs and revenues in individual divisions.
In this case it is likely that transfer prices will be set by means of negotiation. The agreed price may be finalized from a mixture of accounting arithmetic, polities and compromise.

• A negotiated price might be based on market value, but with some reductions to allow for the internal nature of the transaction, which savers external selling and distribution costs.
• Where one division receives near- finished goods from another, a negotiated price might be based on the market value of the end product. Minus an amount for the finishing work in the end product, minus an amount for the finish in work in the receiving division.

Behavioral implications.
Even so, inter-departmental disputes about transfer prices are likely to arise and these any need the intervention or mediation of head office to settle the problem. Head office management any then imposes a price which maximizes the profit of the company as a whole. On the other hand, head office management might restrict their intervention to the task of keeping negotiations in progress until a transfer price is eventually settled. The more head office has to impose its won decisions on profit centers, the less decentralization of authority there will be and the less effective the profit center system of accounting will be for motivating divisional managers.

Transfer pricing in a multinational company.

As we have seen the level at which a transfer price should be set is not a straight forward decision for organizations. The situation is even less clear cut for organizations operating in a number of counties, when even more factors need to be taken into consideration. Moreover, the manipulation of profit through the use of transfer pricing is a common area of confrontation between multinational organizations and host country governments.

Factors/explanations,

Exchange rate fluctuation -the value of a transfer to goods between profit centers in different countries could depend on fluctuations in the currency exchange rate.

Taxation in different countries- if taxation on profits is 20% of profits in country A and 50% on profits in country B, company will presumably try to ‘manipulate’ profits (by mans of raising or lower transfer prices or by invoicing the subsidiary in the high – tax country for “services” provided by the subsidiary for in low-tax country) so that profits are maximized for a subsidiary in country A by reducing profits for a subsidiary in country. Artificial attempts are reducing tax liabilities could, however, upset a country’s tax officials if they discover it and may lead to some form the penalty. Many tax authorities have the power to modify transfer prices in computing tariffs or taxes on profit, although a genuine arms-length market price should pass muster.

Import tariffs- suppose that country A imposes an important tariff of 20% on the value goods imported. Multi-national company has a subsidiary in country A which imports goods form a subsidiary in country B. in such a situation, the company would minimize costs by keeping the transfer price to a minimum value.

Exchange controls- if a country imposes restriction on the transfer of profits from domestic subsidiaries to foreign multinationals, the restrictions on the transfer can be overcome if head office provides some goods or services to the subsidiary and charges exorbitantly high prices, disguising the ‘ profits’ as sales revenue, and transferring them form one country to the other. The ethics of such an approach should, of course, be questioned.

Anti- dumping legislation- governments may take action to protect home industries by preventing companies form transferring goods cheaply into their countries. They may do this, for example, by insisting on the use of a fair market value for the transfer price.

Competitive- transfer pricing can be used to enable profit centers to match or undercut local competitors.