{"id":229,"date":"2021-01-26T22:27:32","date_gmt":"2021-01-26T22:27:32","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/?post_type=chapter&#038;p=229"},"modified":"2021-08-12T17:09:29","modified_gmt":"2021-08-12T17:09:29","slug":"transfer-pricing","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/chapter\/transfer-pricing\/","title":{"raw":"Transfer Pricing","rendered":"Transfer Pricing"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li>Compare and contrast transfer pricing options<\/li>\r\n<\/ul>\r\n<\/div>\r\n<img class=\"size-medium wp-image-1774 alignright\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5469\/2021\/01\/17223638\/jose-pinto-_tXpT0WORrQ-unsplash-200x300.jpg\" alt=\"Car hub caps\" width=\"200\" height=\"300\" \/>Segments within companies often exchange products with each other. The Pontiac, Buick, and other divisions of General Motors buy and sell automobile parts from each other, for example. No market exchange takes place, so the company sets transfer prices that represent revenue to the selling division and costs to the buying division.\r\n\r\nA <strong>transfer price<\/strong> is an artificial price used when goods or services are transferred from one segment to another segment within the same company. Accountants record the transfer price as a revenue of the producing segment and as a cost, or expense, of the receiving segment. Usually, no cash actually changes hands between the segments. Instead, the transfer price is an internal accounting transaction.\r\n\r\nSegments are generally evaluated based on some measure of profitability. The transfer price is important because it affects the profitability of the buying and selling segments. The higher the transfer price, the better for the seller. The lower the transfer price, the better for the buyer.\r\n\r\nIdeally, a transfer price provides incentives for segment managers to make decisions not only in their best interests but also in the interests of the entire company. In practice, companies mostly base transfer prices on (1) the market price of the product, (2) the cost of the product, or (3) some amount negotiated by the buying and selling segment managers.\r\n\r\nFor example:\r\n\r\nThe BWB Company makes bugles. Right now, the company buys the mouthpiece for $8 from several outside vendors. Other variable costs are $9, plus $10,000 in fixed costs. The bugles sell for $30, and the company is producing and selling 1,000 units per month. The contribution margin statement currently looks like this:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>BWB Company\r\nContribution Margin Income Statement\r\nFor the Month ended ______<\/caption>\r\n<thead>\r\n<tr class=\"u-sr-only\">\r\n<th scope=\"col\">Description<\/th>\r\n<th scope=\"col\">Amount<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales<\/td>\r\n<td class=\"r\">$\u00a0 30,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Variable Costs<\/td>\r\n<td class=\"r\">\u00a0 17,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Contribution Margin<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>13,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Fixed Costs<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Operating Income<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$ \u00a0 3,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n\r\nConcerned with supply issues, BWB Company management has purchased a small supplier of mouthpieces. That company, MP Co., sells 600 mouthpieces per month for $10 each and has $3 per unit in variable costs plus $2,500 in fixed costs. None of those 600 mouthpieces are sold to BWB, and the company has a capacity of 1,000 units per month. The current contribution margin income statement for MP Co. at 600 units per month looks like this:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>MP Co.\r\nContribution Margin Income Statement\r\nFor the Month ended ______<\/caption>\r\n<thead>\r\n<tr class=\"u-sr-only\">\r\n<th scope=\"col\">Description<\/th>\r\n<th scope=\"col\">Amount<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales<\/td>\r\n<td class=\"r\">$ \u00a0 6,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Variable Costs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,800<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Contribution Margin<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Fixed Costs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Operating Income<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$ \u00a0 1,700<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n\r\nBWB upper management has asked the managers of the bugle production to get together with the management of MP Co. to negotiate a transfer price.\r\n\r\nHere are the normal constraints that the negotiators would consider:\r\n<ol>\r\n \t<li style=\"font-weight: 400;\" aria-level=\"1\">The minimum price the selling division would reasonably consider would be equal to variable costs because that division would lose money if it accepted less.\r\n<ul>\r\n \t<li style=\"font-weight: 400;\" aria-level=\"2\">If the segment (MP Co.) is operating at capacity, management of that segment could shift production\/sales over to BWB, but would only do that at the current market price of $10. If the segment is operating below capacity, which is the case in this situation, then the management of MP Co. should be willing to take a lower price, all the way down to the variable cost of $3 per unit. In this case, since current sales of 600 units to outside parties covers both variable and fixed costs, MP Co. could produce 400 more units, and since it is now a wholly-owned subsidiary, it could transfer those units at cost, just as if it was a department in the whole process.<\/li>\r\n<\/ul>\r\n<\/li>\r\n \t<li style=\"font-weight: 400;\" aria-level=\"1\">The buying division would not reasonably consider a transfer price that was above what that division could buy the item for on the open market.\r\n<ul>\r\n \t<li style=\"font-weight: 400;\" aria-level=\"2\">BWB is currently buying them from other suppliers at $8, so a transfer price of $10 wouldn\u2019t make sense.<\/li>\r\n<\/ul>\r\n<\/li>\r\n<\/ol>\r\nTherefore the negotiating range for our example would be $3 to $10 for MP Co., but BWB wouldn\u2019t go above $8, so the combined negotiating range would be $3 - $8.\r\n\r\n<img class=\"aligncenter wp-image-1496 size-full\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5469\/2021\/01\/10204532\/Screen-Shot-2021-05-10-at-1.41.31-PM.png\" alt=\"A bar graph is shown with a single bar. On the y-axis is dollars. Between $0 to $3, the bar is orange and labeled as \u201cVariable Costs ($3)\u201d. Between $3 and $10, the bar is green and labeled \u201cContribution Margin ($7)\u201d. To the right, there is a bracket labeling the area between $3 and $7 as the Negotiable Range. The $8 mark is labeled as the Current External Purchase Price and the $10 mark is labeled as the Current External Sales Price. \" width=\"685\" height=\"497\" \/>\r\n\r\nHere is a pro forma contribution margin income statement for MP Co. based on a transfer price of $3 per mouthpiece for an additional 400 units (reaching the capacity of 1,000 total) transferred to BWB:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>MP Co.\r\nContribution Margin Income Statement\r\nFor the Month ended ______<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">Outside<\/th>\r\n<th class=\"r\" scope=\"col\">Transfer<\/th>\r\n<th class=\"r\" scope=\"col\">Total<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales<\/td>\r\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 6,000<\/td>\r\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 \u00a0 7,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Variable Costs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,800<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 3,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Contribution Margin<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4,200<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Fixed Costs<\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Operating Income<\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 \u00a0 1,700<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n\r\nMP Co. is now operating at capacity and transferring 400 units per month to the bugle segment at cost.\r\n\r\nAnd here is the bugle segment now purchasing 400 mouthpieces internally with an assigned price of $1,200 and the other 600 externally for $9 each ($4,800) for a total cost of $6,000.\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>BWB Company\r\nContribution Margin Income Statement\r\nFor the Month ended ______<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">Outside<\/th>\r\n<th class=\"r\" scope=\"col\">Transfer<\/th>\r\n<th class=\"r\" scope=\"col\">Total<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 18,000<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 12,000<\/td>\r\n<td class=\"r\">$\u00a0 \u00a030,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Variable Costs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 10,200<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 15,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Contribution Margin<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 7,800<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 7,200<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 15,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Fixed Costs<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Operating Income<\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 5,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\">\r\n<thead>\r\n<tr>\r\n<th scope=\"col\">Variable Costs<\/th>\r\n<th class=\"r\" scope=\"col\">600 Units<\/th>\r\n<th class=\"r\" scope=\"col\">400 Units<\/th>\r\n<th class=\"r\" scope=\"col\">Total<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Materials for bell housing<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 \u00a05,400<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 3,600<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 \u00a09,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Mouthpieces - purchased outside<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\r\n<td><\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Mouthpieces - transferred in<\/td>\r\n<td><\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 10,200<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 4,800<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 15,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n&nbsp;\r\n\r\n<\/div>\r\nLet\u2019s throw one more twist into the scenario. After the segment managers have met, upper management overrides their decisions in order to shift company profits from BWB to MP Co. because MP Co. operates in a country with a lower tax rate.\r\n\r\nHere is the consolidated income statement for the two combined companies with a transfer pricing of $3 per unit:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>BWB Company - consolidated\r\nContribution Margin Income Statement\r\nFor the Month ended ______<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">BWB<\/th>\r\n<th class=\"r\" scope=\"col\">MP Co.<\/th>\r\n<th class=\"r\" scope=\"col\">Total<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 30,000<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 7,200<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 37,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Variable Costs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 15,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 3,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 18,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Contribution Margin<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 4,200<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 19,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Fixed Costs<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 10,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 12,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Operating Income<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a05,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 1,700<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a06,700<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n&nbsp;\r\n\r\n<\/div>\r\nUpper management requests a revision of the transfer price to $8, which is the current market price for the bugle division. This will increase revenue to MP Co. in the lower tax rate country and away from BWB in the higher tax rate country. Transferring 400 units at $8 to BWB results in gross intercompany sales of $3,200 with no increase in cost, effectively shifting $2,000 of operating income to MP Co. from BWB.\r\n\r\nOutside sales = 600 units at $10\r\n\r\nInternal transfers = 400 units at $8\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>MP Co.\r\nContribution Margin Income Statement\r\nFor the Month ended ______<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">Outside<\/th>\r\n<th class=\"r\" scope=\"col\">Transfer<\/th>\r\n<th class=\"r\" scope=\"col\">Total<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales<\/td>\r\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 6,000<\/td>\r\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 3,200<\/td>\r\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 9,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Variable Costs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,800<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 3,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Contribution Margin<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4,200<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 6,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Fixed Costs<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Operating Income<\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$ \u00a0 \u00a0 \u00a0 \u00a0 3,700<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>BWB Company\r\nContribution Margin Income Statement\r\nFor the Month ended ______<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">Outside<\/th>\r\n<th class=\"r\" scope=\"col\">Transfer<\/th>\r\n<th class=\"r\" scope=\"col\">Total<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 18,000<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 12,000<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 30,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Variable Costs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 10,200<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 6,800<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 17,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Contribution Margin<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 7,800<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 5,200<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 13,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Fixed Costs<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Operating Income<\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a03,000<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\">\r\n<thead>\r\n<tr>\r\n<th scope=\"col\">Variable Costs<\/th>\r\n<th class=\"r\" scope=\"col\">600 Units<\/th>\r\n<th class=\"r\" scope=\"col\">400 Units<\/th>\r\n<th class=\"r\" scope=\"col\">Total<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Materials for bell housing<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 \u00a05,400<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 3,600<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 \u00a09,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Mouthpieces - purchased outside<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\r\n<td><\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Mouthpieces - transferred in<\/td>\r\n<td><\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 3,200<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 3,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 10,200<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 6,800<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 17,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n\r\nHowever, the total operating income on the consolidated statement is the same:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>BWB Company - consolidated\r\nContribution Margin Income Statement\r\nFor the Month ended ______<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">BWB<\/th>\r\n<th class=\"r\" scope=\"col\">MP Co.<\/th>\r\n<th class=\"r\" scope=\"col\">Total<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 30,000<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 9,200<\/td>\r\n<td class=\"r\">$\u00a0 \u00a0 39,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Variable Costs<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 17,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 3,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 20,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Contribution Margin<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 13,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 6,200<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 19,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Fixed Costs<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 10,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 12,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Operating Income<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a03,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 3,700<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a06,700<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n&nbsp;\r\n\r\n<\/div>\r\nIn this example, upper management requested the adjustment to the transfer price to reduce taxes. However, financial reporting of transfer pricing has strict guidelines and is closely watched by tax authorities. Extensive documentation is often required by auditors and regulators. If the transfer value is done incorrectly or inappropriately, the financial statements may need to be restated, and fees or penalties could be applied.\r\n\r\nFor instance, the U.S. tax code requires that transfer pricing should be the same for intercompany transactions as it would have been if the company had done the transaction with a party or customer outside the company. According to the IRS website, transfer pricing is defined as follows:\r\n<p style=\"padding-left: 30px;\">The regulations under section 482 generally provide that prices charged by one affiliate to another, in an intercompany transaction involving the transfer of goods, services, or intangibles, yield results that are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances.<\/p>\r\nHere is a more in-depth analysis of transfer pricing with excess capacity:\r\n\r\n<iframe src=\"\/\/plugin.3playmedia.com\/show?mf=6352596&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=vyQ9k3uhPCo&amp;video_target=tpm-plugin-9i8s8cl0-vyQ9k3uhPCo\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe>\r\n\r\nYou can view the <a href=\"https:\/\/oerfiles.s3.us-west-2.amazonaws.com\/Managerial+Accounting\/Transcripts\/TransferPricingWithExcessCapacity_transcript.txt\" target=\"_blank\" rel=\"noopener\">transcript for \"Transfer Pricing (with Excess Capacity)\" here (opens in new window)<\/a>.\r\n\r\nAnd without excess capacity:\r\n\r\n<iframe src=\"\/\/plugin.3playmedia.com\/show?mf=6352597&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=YipuWMxYvI0&amp;video_target=tpm-plugin-45y59hqo-YipuWMxYvI0\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe>\r\n\r\nYou can view the <a href=\"https:\/\/oerfiles.s3.us-west-2.amazonaws.com\/Managerial+Accounting\/Transcripts\/TransferPricingNoExcessCapacity_transcript.txt\" target=\"_blank\" rel=\"noopener\">transcript for \"Transfer Pricing (No Excess Capacity)\" here (opens in new window)<\/a>.\r\n\r\nNow, check your understanding of transfer pricing.\r\n<div class=\"textbox tryit\">\r\n<h3>Practice Question<\/h3>\r\n[ohm_question hide_question_numbers=1]220636[\/ohm_question]\r\n\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li>Compare and contrast transfer pricing options<\/li>\n<\/ul>\n<\/div>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"size-medium wp-image-1774 alignright\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5469\/2021\/01\/17223638\/jose-pinto-_tXpT0WORrQ-unsplash-200x300.jpg\" alt=\"Car hub caps\" width=\"200\" height=\"300\" \/>Segments within companies often exchange products with each other. The Pontiac, Buick, and other divisions of General Motors buy and sell automobile parts from each other, for example. No market exchange takes place, so the company sets transfer prices that represent revenue to the selling division and costs to the buying division.<\/p>\n<p>A <strong>transfer price<\/strong> is an artificial price used when goods or services are transferred from one segment to another segment within the same company. Accountants record the transfer price as a revenue of the producing segment and as a cost, or expense, of the receiving segment. Usually, no cash actually changes hands between the segments. Instead, the transfer price is an internal accounting transaction.<\/p>\n<p>Segments are generally evaluated based on some measure of profitability. The transfer price is important because it affects the profitability of the buying and selling segments. The higher the transfer price, the better for the seller. The lower the transfer price, the better for the buyer.<\/p>\n<p>Ideally, a transfer price provides incentives for segment managers to make decisions not only in their best interests but also in the interests of the entire company. In practice, companies mostly base transfer prices on (1) the market price of the product, (2) the cost of the product, or (3) some amount negotiated by the buying and selling segment managers.<\/p>\n<p>For example:<\/p>\n<p>The BWB Company makes bugles. Right now, the company buys the mouthpiece for $8 from several outside vendors. Other variable costs are $9, plus $10,000 in fixed costs. The bugles sell for $30, and the company is producing and selling 1,000 units per month. The contribution margin statement currently looks like this:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>BWB Company<br \/>\nContribution Margin Income Statement<br \/>\nFor the Month ended ______<\/caption>\n<thead>\n<tr class=\"u-sr-only\">\n<th scope=\"col\">Description<\/th>\n<th scope=\"col\">Amount<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales<\/td>\n<td class=\"r\">$\u00a0 30,000<\/td>\n<\/tr>\n<tr>\n<td>Variable Costs<\/td>\n<td class=\"r\">\u00a0 17,000<\/td>\n<\/tr>\n<tr>\n<td>Contribution Margin<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>13,000<\/td>\n<\/tr>\n<tr>\n<td>Fixed Costs<\/td>\n<td class=\"r\">10,000<\/td>\n<\/tr>\n<tr>\n<td>Operating Income<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$ \u00a0 3,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<p>Concerned with supply issues, BWB Company management has purchased a small supplier of mouthpieces. That company, MP Co., sells 600 mouthpieces per month for $10 each and has $3 per unit in variable costs plus $2,500 in fixed costs. None of those 600 mouthpieces are sold to BWB, and the company has a capacity of 1,000 units per month. The current contribution margin income statement for MP Co. at 600 units per month looks like this:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>MP Co.<br \/>\nContribution Margin Income Statement<br \/>\nFor the Month ended ______<\/caption>\n<thead>\n<tr class=\"u-sr-only\">\n<th scope=\"col\">Description<\/th>\n<th scope=\"col\">Amount<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales<\/td>\n<td class=\"r\">$ \u00a0 6,000<\/td>\n<\/tr>\n<tr>\n<td>Variable Costs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,800<\/td>\n<\/tr>\n<tr>\n<td>Contribution Margin<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4,200<\/td>\n<\/tr>\n<tr>\n<td>Fixed Costs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\n<\/tr>\n<tr>\n<td>Operating Income<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$ \u00a0 1,700<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<p>BWB upper management has asked the managers of the bugle production to get together with the management of MP Co. to negotiate a transfer price.<\/p>\n<p>Here are the normal constraints that the negotiators would consider:<\/p>\n<ol>\n<li style=\"font-weight: 400;\" aria-level=\"1\">The minimum price the selling division would reasonably consider would be equal to variable costs because that division would lose money if it accepted less.\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"2\">If the segment (MP Co.) is operating at capacity, management of that segment could shift production\/sales over to BWB, but would only do that at the current market price of $10. If the segment is operating below capacity, which is the case in this situation, then the management of MP Co. should be willing to take a lower price, all the way down to the variable cost of $3 per unit. In this case, since current sales of 600 units to outside parties covers both variable and fixed costs, MP Co. could produce 400 more units, and since it is now a wholly-owned subsidiary, it could transfer those units at cost, just as if it was a department in the whole process.<\/li>\n<\/ul>\n<\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\">The buying division would not reasonably consider a transfer price that was above what that division could buy the item for on the open market.\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"2\">BWB is currently buying them from other suppliers at $8, so a transfer price of $10 wouldn\u2019t make sense.<\/li>\n<\/ul>\n<\/li>\n<\/ol>\n<p>Therefore the negotiating range for our example would be $3 to $10 for MP Co., but BWB wouldn\u2019t go above $8, so the combined negotiating range would be $3 &#8211; $8.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter wp-image-1496 size-full\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5469\/2021\/01\/10204532\/Screen-Shot-2021-05-10-at-1.41.31-PM.png\" alt=\"A bar graph is shown with a single bar. On the y-axis is dollars. Between $0 to $3, the bar is orange and labeled as \u201cVariable Costs ($3)\u201d. Between $3 and $10, the bar is green and labeled \u201cContribution Margin ($7)\u201d. To the right, there is a bracket labeling the area between $3 and $7 as the Negotiable Range. The $8 mark is labeled as the Current External Purchase Price and the $10 mark is labeled as the Current External Sales Price.\" width=\"685\" height=\"497\" \/><\/p>\n<p>Here is a pro forma contribution margin income statement for MP Co. based on a transfer price of $3 per mouthpiece for an additional 400 units (reaching the capacity of 1,000 total) transferred to BWB:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>MP Co.<br \/>\nContribution Margin Income Statement<br \/>\nFor the Month ended ______<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">Outside<\/th>\n<th class=\"r\" scope=\"col\">Transfer<\/th>\n<th class=\"r\" scope=\"col\">Total<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales<\/td>\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 6,000<\/td>\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 \u00a0 7,200<\/td>\n<\/tr>\n<tr>\n<td>Variable Costs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,800<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 3,000<\/td>\n<\/tr>\n<tr>\n<td>Contribution Margin<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4,200<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4,200<\/td>\n<\/tr>\n<tr>\n<td>Fixed Costs<\/td>\n<td><\/td>\n<td><\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\n<\/tr>\n<tr>\n<td>Operating Income<\/td>\n<td><\/td>\n<td><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 \u00a0 1,700<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<p>MP Co. is now operating at capacity and transferring 400 units per month to the bugle segment at cost.<\/p>\n<p>And here is the bugle segment now purchasing 400 mouthpieces internally with an assigned price of $1,200 and the other 600 externally for $9 each ($4,800) for a total cost of $6,000.<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>BWB Company<br \/>\nContribution Margin Income Statement<br \/>\nFor the Month ended ______<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">Outside<\/th>\n<th class=\"r\" scope=\"col\">Transfer<\/th>\n<th class=\"r\" scope=\"col\">Total<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales<\/td>\n<td class=\"r\">$\u00a0 \u00a0 18,000<\/td>\n<td class=\"r\">$\u00a0 \u00a0 12,000<\/td>\n<td class=\"r\">$\u00a0 \u00a030,000<\/td>\n<\/tr>\n<tr>\n<td>Variable Costs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 10,200<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 15,000<\/td>\n<\/tr>\n<tr>\n<td>Contribution Margin<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 7,800<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 7,200<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 15,000<\/td>\n<\/tr>\n<tr>\n<td>Fixed Costs<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 10,000<\/td>\n<\/tr>\n<tr>\n<td>Operating Income<\/td>\n<td><\/td>\n<td><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 5,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<thead>\n<tr>\n<th scope=\"col\">Variable Costs<\/th>\n<th class=\"r\" scope=\"col\">600 Units<\/th>\n<th class=\"r\" scope=\"col\">400 Units<\/th>\n<th class=\"r\" scope=\"col\">Total<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Materials for bell housing<\/td>\n<td class=\"r\">$\u00a0 \u00a0 \u00a05,400<\/td>\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 3,600<\/td>\n<td class=\"r\">$\u00a0 \u00a0 \u00a09,000<\/td>\n<\/tr>\n<tr>\n<td>Mouthpieces &#8211; purchased outside<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\n<td><\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\n<\/tr>\n<tr>\n<td>Mouthpieces &#8211; transferred in<\/td>\n<td><\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 10,200<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 4,800<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 15,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<\/div>\n<p>Let\u2019s throw one more twist into the scenario. After the segment managers have met, upper management overrides their decisions in order to shift company profits from BWB to MP Co. because MP Co. operates in a country with a lower tax rate.<\/p>\n<p>Here is the consolidated income statement for the two combined companies with a transfer pricing of $3 per unit:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>BWB Company &#8211; consolidated<br \/>\nContribution Margin Income Statement<br \/>\nFor the Month ended ______<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">BWB<\/th>\n<th class=\"r\" scope=\"col\">MP Co.<\/th>\n<th class=\"r\" scope=\"col\">Total<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales<\/td>\n<td class=\"r\">$\u00a0 \u00a0 30,000<\/td>\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 7,200<\/td>\n<td class=\"r\">$\u00a0 \u00a0 37,200<\/td>\n<\/tr>\n<tr>\n<td>Variable Costs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 15,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 3,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 18,000<\/td>\n<\/tr>\n<tr>\n<td>Contribution Margin<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 4,200<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 19,200<\/td>\n<\/tr>\n<tr>\n<td>Fixed Costs<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 10,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 12,500<\/td>\n<\/tr>\n<tr>\n<td>Operating Income<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a05,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 1,700<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a06,700<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<\/div>\n<p>Upper management requests a revision of the transfer price to $8, which is the current market price for the bugle division. This will increase revenue to MP Co. in the lower tax rate country and away from BWB in the higher tax rate country. Transferring 400 units at $8 to BWB results in gross intercompany sales of $3,200 with no increase in cost, effectively shifting $2,000 of operating income to MP Co. from BWB.<\/p>\n<p>Outside sales = 600 units at $10<\/p>\n<p>Internal transfers = 400 units at $8<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>MP Co.<br \/>\nContribution Margin Income Statement<br \/>\nFor the Month ended ______<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">Outside<\/th>\n<th class=\"r\" scope=\"col\">Transfer<\/th>\n<th class=\"r\" scope=\"col\">Total<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales<\/td>\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 6,000<\/td>\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 3,200<\/td>\n<td class=\"r\">$ \u00a0 \u00a0 \u00a0 \u00a0 9,200<\/td>\n<\/tr>\n<tr>\n<td>Variable Costs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,800<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 1,200<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 3,000<\/td>\n<\/tr>\n<tr>\n<td>Contribution Margin<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4,200<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 6,200<\/td>\n<\/tr>\n<tr>\n<td>Fixed Costs<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\n<\/tr>\n<tr>\n<td>Operating Income<\/td>\n<td><\/td>\n<td><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$ \u00a0 \u00a0 \u00a0 \u00a0 3,700<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>BWB Company<br \/>\nContribution Margin Income Statement<br \/>\nFor the Month ended ______<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">Outside<\/th>\n<th class=\"r\" scope=\"col\">Transfer<\/th>\n<th class=\"r\" scope=\"col\">Total<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales<\/td>\n<td class=\"r\">$\u00a0 \u00a0 18,000<\/td>\n<td class=\"r\">$\u00a0 \u00a0 12,000<\/td>\n<td class=\"r\">$\u00a0 \u00a0 30,000<\/td>\n<\/tr>\n<tr>\n<td>Variable Costs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 10,200<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 6,800<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 17,000<\/td>\n<\/tr>\n<tr>\n<td>Contribution Margin<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 7,800<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 5,200<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 13,000<\/td>\n<\/tr>\n<tr>\n<td>Fixed Costs<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 10,000<\/td>\n<\/tr>\n<tr>\n<td>Operating Income<\/td>\n<td><\/td>\n<td><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a03,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<thead>\n<tr>\n<th scope=\"col\">Variable Costs<\/th>\n<th class=\"r\" scope=\"col\">600 Units<\/th>\n<th class=\"r\" scope=\"col\">400 Units<\/th>\n<th class=\"r\" scope=\"col\">Total<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Materials for bell housing<\/td>\n<td class=\"r\">$\u00a0 \u00a0 \u00a05,400<\/td>\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 3,600<\/td>\n<td class=\"r\">$\u00a0 \u00a0 \u00a09,000<\/td>\n<\/tr>\n<tr>\n<td>Mouthpieces &#8211; purchased outside<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\n<td><\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 4,800<\/td>\n<\/tr>\n<tr>\n<td>Mouthpieces &#8211; transferred in<\/td>\n<td><\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 3,200<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 3,200<\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 10,200<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 6,800<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 17,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<p>However, the total operating income on the consolidated statement is the same:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>BWB Company &#8211; consolidated<br \/>\nContribution Margin Income Statement<br \/>\nFor the Month ended ______<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">BWB<\/th>\n<th class=\"r\" scope=\"col\">MP Co.<\/th>\n<th class=\"r\" scope=\"col\">Total<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales<\/td>\n<td class=\"r\">$\u00a0 \u00a0 30,000<\/td>\n<td class=\"r\">$\u00a0 \u00a0 \u00a0 9,200<\/td>\n<td class=\"r\">$\u00a0 \u00a0 39,200<\/td>\n<\/tr>\n<tr>\n<td>Variable Costs<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 17,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 3,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 20,000<\/td>\n<\/tr>\n<tr>\n<td>Contribution Margin<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 13,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 6,200<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 19,200<\/td>\n<\/tr>\n<tr>\n<td>Fixed Costs<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 10,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 12,500<\/td>\n<\/tr>\n<tr>\n<td>Operating Income<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a03,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a0 3,700<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a0 \u00a06,700<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<\/div>\n<p>In this example, upper management requested the adjustment to the transfer price to reduce taxes. However, financial reporting of transfer pricing has strict guidelines and is closely watched by tax authorities. Extensive documentation is often required by auditors and regulators. If the transfer value is done incorrectly or inappropriately, the financial statements may need to be restated, and fees or penalties could be applied.<\/p>\n<p>For instance, the U.S. tax code requires that transfer pricing should be the same for intercompany transactions as it would have been if the company had done the transaction with a party or customer outside the company. According to the IRS website, transfer pricing is defined as follows:<\/p>\n<p style=\"padding-left: 30px;\">The regulations under section 482 generally provide that prices charged by one affiliate to another, in an intercompany transaction involving the transfer of goods, services, or intangibles, yield results that are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances.<\/p>\n<p>Here is a more in-depth analysis of transfer pricing with excess capacity:<\/p>\n<p><iframe loading=\"lazy\" src=\"\/\/plugin.3playmedia.com\/show?mf=6352596&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=vyQ9k3uhPCo&amp;video_target=tpm-plugin-9i8s8cl0-vyQ9k3uhPCo\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe><\/p>\n<p>You can view the <a href=\"https:\/\/oerfiles.s3.us-west-2.amazonaws.com\/Managerial+Accounting\/Transcripts\/TransferPricingWithExcessCapacity_transcript.txt\" target=\"_blank\" rel=\"noopener\">transcript for &#8220;Transfer Pricing (with Excess Capacity)&#8221; here (opens in new window)<\/a>.<\/p>\n<p>And without excess capacity:<\/p>\n<p><iframe loading=\"lazy\" src=\"\/\/plugin.3playmedia.com\/show?mf=6352597&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=YipuWMxYvI0&amp;video_target=tpm-plugin-45y59hqo-YipuWMxYvI0\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe><\/p>\n<p>You can view the <a href=\"https:\/\/oerfiles.s3.us-west-2.amazonaws.com\/Managerial+Accounting\/Transcripts\/TransferPricingNoExcessCapacity_transcript.txt\" target=\"_blank\" rel=\"noopener\">transcript for &#8220;Transfer Pricing (No Excess Capacity)&#8221; here (opens in new window)<\/a>.<\/p>\n<p>Now, check your understanding of transfer pricing.<\/p>\n<div class=\"textbox tryit\">\n<h3>Practice Question<\/h3>\n<p><iframe loading=\"lazy\" id=\"ohm220636\" class=\"resizable\" src=\"https:\/\/ohm.lumenlearning.com\/multiembedq.php?id=220636&theme=oea&iframe_resize_id=ohm220636\" width=\"100%\" height=\"150\"><\/iframe><\/p>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-229\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Transfer Pricing. <strong>Authored by<\/strong>: Joseph Cooke. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Shared previously<\/div><ul class=\"citation-list\"><li>Hub caps. <strong>Provided by<\/strong>: Unsplash. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/unsplash.com\/photos\/_tXpT0WORrQ\">https:\/\/unsplash.com\/photos\/_tXpT0WORrQ<\/a>. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/about\/cc0\">CC0: No Rights Reserved<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":364389,"menu_order":17,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Transfer Pricing\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"},{\"type\":\"cc\",\"description\":\"Hub caps\",\"author\":\"\",\"organization\":\"Unsplash\",\"url\":\"https:\/\/unsplash.com\/photos\/_tXpT0WORrQ\",\"project\":\"\",\"license\":\"cc0\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-229","chapter","type-chapter","status-publish","hentry"],"part":35,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/229","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/users\/364389"}],"version-history":[{"count":11,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/229\/revisions"}],"predecessor-version":[{"id":2558,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/229\/revisions\/2558"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/parts\/35"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/229\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/media?parent=229"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=229"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/contributor?post=229"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/license?post=229"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}