Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 22

International Transfer Prices: Ethical Issues

Trans Atlantic Metals has two operating divisions. Its forging operation in Finland forges raw metal, cuts it, and then ships it to the United States where the company’s Gear Division uses the metal to produce finished gears. Operating expenses amount to $10 million in Finland and $30 million in the United States exclusive of the costs of any goods transferred from Finland. Revenues in the United States are $75 million.

If the metal were purchased from one of the company’s U.S. forging divisions, the costs would be $15 million. However, if it had been purchased from an independent Finnish supplier, the cost would be $20 million. The marginal income tax rate is 60 percent in Finland and 40 percent in the United States.

Required

a. What is the company’s total tax liability to both jurisdictions for each of the two alternative transfer pricing scenarios ($15 million and $20 million)?

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b. Is it ethical to choose the transfer price based on the impact on taxes?

Step 1 of 5

Transfer pricing

Transfer pricing is the amount charged by one business unit of a company to another business unit for the products supplied. Each business unit is considered as separate responsibility centers and sale from one business unit to another business unit is consider as sale to an outsider. The sales based on transfer pricing are recorded in the accounting books of a firm and transfer prices are used for decision making, merchandise costing and performance assessment.