Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 53

Transfer Pricing—International Example A subsidiary company located in country A purchases $100 worth of goods. It then repackages, exports, and sells those goods to the parent company, located in country B, for $200. The parent company sells the goods for $300. Therefore, both entities have a $100 profit. Assume that the income tax rate in country A is 20 percent, while the tax rate in country B is 60 percent.

Required

1. Given the above facts and assumptions, what is the company’s combined (i.e., worldwide) after-tax income for this transaction? (Show calculations.)

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2. Consider now a transfer-pricing approach in which the subsidiary sells the goods to the parent company for $280, and the parent company then sells the goods for $300. What is the revised worldwide (i.e., combined) after-tax profit for this transaction? (Show calculations.)

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3. What is the effect of the transfer-pricing decision when the income-tax rates for the two countries in question are equal?

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4. What limitations exist regarding the setting of transfer prices for multinational transfers?

Step 1 of 5

Transfer pricing is the price calculation approach where the good is been sold from one unit to another unit of same firm. There are different methods to calculate transfer pricing like variable cost method, full cost method, market price method, etc.