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Management Accounting Research on Transfer Pricing Methods
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One of the main purposes of conducting this research report is to show own understanding related to management accounting in addition to its application. In general management accounting which is in other words also known as managerial accounting, the executives make utilization of the requirement of bookkeeping facts and figures with an intention to develop inform themselves prior to the make any settlement inside their company which helps their administration as well as act of command operations. The study will help us in analyzing the utilization of inside bookkeeping methods in addition to this it will also help in learning the basic examination of the consequences of the equivalent to effect on execution, too as an examination of the procedures themselves.
(a) Preparation of Profit and loss account
Transfer Pricing Ostweiler to Brees for internal purchase of widget Oil. Here in the case Brady Ltd face is managing business between two separate departments Ostweiler & Brees while evaluating the relationship of a purchaser department and connection between units of a solitary organization. Under such conditions, an organization needs to decide the internal best possible transfer pricing model so as to sustain growth in both the units .The below case shows profit for both scenarios where Brees able to sell out 300,000 bottles against 240,000 bottles even after reducing the cost of the product . So, if the final sales of bottles can be maintained at 300,000 then even with reduced transfer price from £300.00 to £270.00 Brees will be able to gather more revenue and profit eventually.
A transfer pricing analysis is based on various key elements that needs to be balanced for the yearly budget and planning few of them include managing inventory. The scenario 2 clearly shows that though Brees had to pay less as transfer pricing to Ostweiler internally and resulted in higher revenue.
Date: 1 June 2020
June - Scenario 1
June - Scenario 2
Internal Transfer Cost for Brees
Price per Tonne
Price per bottle
Total Revenue & Gains (B)
Net Profit (B-A)
(b) Critically evaluate the need for effective transfer pricing and
Methods That May Be Adopted to Achieve This
Traditionally, transfer pricing is understood as pricing the goods and services that are exchanged between autonomous profit-center divisions within a firm (Hirshleifer 1956). Transfer pricing methods are contingent on different business circumstances of the company. Taxation of transfer pricing within related groups of entities is a key issue faced by both international and domestic tax systems across the world between tax authorities and multinational corporations.
Business transactions between multinational companies and their associated enterprises in different tax jurisdictions with different or same taxation systems are perceived to be a point of contention with the respective tax administration (Barnhouse et al. ). The perception is that of tax evasion by entering into these transactions with prices that are not market-driven, these prices are often inconsistent with the amount that would have otherwise transacted between an unrelated entity and the corporation. In short, the companies manipulate their intra-firm transactions in order to minimize worldwide tax burdens.
The profitableness of employing a transfer pricing strategy is subject to the prices in which the intra-firm transactions take place. Thus for businesses, it is important to fully comprehend the effectiveness of transfer pricing and utilize the benefits highlighted by it in for performance evaluation and such. With the application of transfer pricing, the company in effect also influences the taxable income and the free cash flow and aggregately the wealth of shareholders. For the above-mentioned reasons including the increased scrutiny of tax administration in cases of transfer pricing, entities should employ pricing that doesn't risk non-compliance of tax laws and regulations.
One major objective behind transfer pricing is to procure profit from each of the units of the business entity separately. Such a pricing strategy would provide a performance evaluation for different units of the entity. The second objective is related to the allocation of resources to each of these units in the company. Transfer pricing would allow companies in determining an effective resource-allocation strategy between different departments.
Transfer pricing is very useful in terms of effective allocation of revenue and expenses to different divisions or units or even subsidiaries of a business organization or a group of entities in a systematic manner. The distribution of the profit and expenses in these units is more or less under the discretion of the companies. An effective transfer pricing would complement the process of key decision making in the organization in key matters like optimization of financial resources. A well-formulated transfer pricing system will assist the company's management in terms of delegated responsibilities and making way for minimal intervention from the top management.
A complex and complicated transfer pricing will reverse the very objective of implementing the transfer pricing system in the first place. As an entity grows and the business becomes more complex and expands to more jurisdiction the process of transfer pricing also becomes difficult. An effective strategy for transfer pricing should be simple to comprehend, not just the managers of the company but also to the tax administration.
An effective tax pricing strategy will eliminate the risk of double taxation, which often happens in business cases where multiple jurisdictions are involved. It provides a reasonable system to avoid the tax confusion that may arise in multinational companies dealing with tax systems that are different from the domestic regulation. By effectively minimizing compliance risk and risk of double taxation, firms make advances against the net effective global tax burden.
The negotiated transfer price between different units or subsidiaries will have a direct effect on the performance and the consequent decisions of production, cost, expenditure, etc. This is a good case for promoting healthy intra-firm competitiveness, and can have a profound, but perhaps arbitrary, effect on the reported performance and subsequent decisions made. Firms would also have precise coordination of objectives for every unit or subsidiary and an ease of performance evaluation and along with meeting organizational goals.
Let's discuss some methods to achieve transfer pricing efficiently. If the products or services that are transacted internally in the firm have a competitive market, the transfer price should be equivalent to that of the market price to ensure a fair taxation. The OECD (The Organisation for Economic Co-operation and Development) has published guidelines along this idea of arms-length price of the controlled transactions (OECD 2017). This price is what two independent enterprises would make transactions in when their commercial and financial relations are determined by the market forces and thus under uncontrolled circumstances.
The two most common methods to arrive at transfer pricing are the cost plus method and resale price method. In the cost plus method the transfer price is arrived by adding an appropriate markup of the product to the supplier cost, such that it takes the current market conditions into consideration (Asia 2017). The cost plus method has the advantage of straight forward calculation and simplicity. The advantage of the cost plus method is that as it is based on the internal cost, information and the documentation would be easily accessible for the firms given there is an efficient system in place.
Another method is the resale price method where the price of the product or service bought from the intra-firm unit or subsidiary is compared with the sale of the same product/service to an external party which is independent of the firm. As this method is based on the resale price, it is in compliance with the demand drive price in the market.
The tax administrations globally follow various criteria in determining what transfer pricing method is compatible in what business circumstances such as the character of property/product/service exchanged, terms of contract, financial circumstances and business strategies of the firms.
An effective transfer pricing always begins from a thorough process of documentation. A regular record of the intra-firm transactions through accurate invoice along with concise agreements between the different units or subsidiaries of the firm partaking in the transaction is crucial. The handiness of the data, along with its coverage and reliability is vital for the application of a transfer pricing method. Maintaining a functional profile of the firm will help in establishing responsibilities and assessing the assets employed in different subsidiaries and laying out the risks attached to the related transaction entity. A firm's database, dialogues between management, website and notes to the account section are all major source in arriving at its functional profile. As such transactions are recurrent in most of the cases, firms should regularly assess the efficacy and compliance of the same with concerned tax jurisdiction. A one time, global transfer pricing strategy is most likely to rebound as regulations change time to time in various tax systems.
(c) Discuss how non-financial measures might be of use in the evaluation
Performance measurement is important for the improvement of the organization's performance.
These sets of measures are key to running business operations efficiently and support numerous decision-making procedures using the information collected and analysed on different metrics, These metrics are generally categorised under financial and non-financial performance measures.
A major benefit of non-financial performance measures is that it is more aligned towards the long-term strategies and objectives of the organisation, unlike the measurements based on the financial metrics. Financial measures are often focused on short term performance which is not always useful in measuring non-financial objectives like product development or knowing the competitive market.
Likewise non-financial measures can be used towards a strategic achievement, product and process quality, customer satisfaction and organisational learning (Mavrinac and Anthony Siesfeld 1998). Such performance measurement would include the customer's perspective, efficiency of internal processes, prospects of research and innovation within the business entity (Kaplan and Norton 2008).
Even measurements like the skills and capabilities of the employees, possibility of technological interventions, understanding the concepts of power and satisfaction will significantly contribute towards performance measurement for the organisation. The concept of 'intangible assets' is gaining traction in the literature of performance assessment for organisations. It is not just the traditional 'hard assets' which are quantifiable that add value to an investment but also intangible assets like brand value, sustainable investing, employee relations, management capabilities etc... Broadly, the non financial performance measurement is a systematic assessment of the human, information and organizational capital.
Investment in most of the non financial performance criteria's makes way for a significant leap in the economic performance of a firm in newer ways like gaining traction, loyalty of customers, sustained shareholder investment, employee retention etc., in addition to balance sheet numbers. The selection of criteria's should be defined by a systematic assessment and analysis of the available information through identifying the value drivers for each organisation. Documentation along with consistent inventory of the measures is very significant in both financial and non-financial performance measurements.
To conclude, the idea is not that financial performance measures are not relevant, but in the changing times where advancement in information technology, transformative manufacturing revolution and knowledge market has took a front seat, it is important for any business entity to have multiple ways to assess its performance in a holistic way rather than exclusively focusing on financial indicators.
After completing the above done study now it is clear to us how to use practically the process and steps to have a proper managerial accounting system. The study has also helped in identifying the profit and loss for the company named Brady Ltd. Based on the profit and loss account statement out of the given two scenarios it has been identified that scenario 1 in earing profit as compared to scenario 2.
- Asia, T. P. (2017) The Five Transfer Pricing Methods Explained. Available at: https://transferpricingasia.com/2017/03/17/five-transfer-pricing-methods-examples/ (Accessed: 23 November 2020).
- Barnhouse, N. C., Booth, A. and Wester, K. (no date) 'Transfer Pricing', SSRN Electronic Journal. doi: 10.2139/ssrn.2196826.
- Hirshleifer, J. (1956) 'On the Economics of Transfer Pricing', The Journal of Business, p. 172. doi: 10.1086/294110.
- Kaplan, R. S. and Norton, D. P. (2008) 'Mastering the management system', Harvard business review, 86(1), pp. 62–77, 136.
- Mavrinac, S. and Anthony Siesfeld, G. (1998) 'Measures that Matter: An Exploratory Investigation of Investors' Information Needs and Value Priorities', The Economic Impact of Knowledge, pp. 273–293. doi: 10.1016/b978-0-7506-7009-8.50021-5.
- Oecd and OECD (2017) 'Transfer Pricing Methods', OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, pp. 97–145. doi: 10.1787/tpg-2017-6-en.