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Transfer Pricing Example: The High Value Computer (HVC) Key Assumptions

1) HVC has a computer manufacturing unit and an x-chip product unit that can either sell chips internally or externally. 2) Three transfer pricing options are considered: market price, variable cost, and a negotiated price between the two. 3) The negotiated price of $72.50 per chip results in the highest combined post-tax operating income for HVC by balancing the tax implications between its US and South Korean units.

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Rusheel Chava
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102 views

Transfer Pricing Example: The High Value Computer (HVC) Key Assumptions

1) HVC has a computer manufacturing unit and an x-chip product unit that can either sell chips internally or externally. 2) Three transfer pricing options are considered: market price, variable cost, and a negotiated price between the two. 3) The negotiated price of $72.50 per chip results in the highest combined post-tax operating income for HVC by balancing the tax implications between its US and South Korean units.

Uploaded by

Rusheel Chava
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as XLSX, PDF, TXT or read online on Scribd
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Transfer Pricing Example: The High Value Computer (HVC)

Key assumptions:
The computer manufacturing unit can buy the x-chip inside or outside
the firm.
The x-chip product unit can sell inside or outside the firm.
The x-chip product unit is at full capacity in units
One x-chip is needed for each computer manufactured by HVC.
Other information:
Sales price of computer for HVC’s computer manufacturing unit
Variable manufacturing cost of the computer manufacturing unit
(excluding x-chip) ($400 parts and $250 labor)
Variable x-chip manufacturing cost for HVC’s x-chip product unit
Price of x-chip from outside supplier, to HVC’s computer manufacturing
unit
Variable cost to computer manufacturing unit to add needed component
to outside supplier’s x-chip
Price of x-chip from HVC’s x-chip product unit to outside buyer
Variable selling cost to the x-chip product unit for outside sales
150 150000

$850 850

$650 650
$60 60

$85 85

$5 5
$95 95
$2 2
OPTION 1: X=CHIP PRODUCTS ARE SOLD TO OUTSIDERS
850
650
60
85
5
95
2
OPTION 1: X=CHIP PRODUCTS ARE SOLD TO OUTSIDERS

Sales
Less: Variable costs
Chip
Other variable costs
TOTAL VARIABLE COST
CONTRIBUTION MARGIN

OPTION 2: X=CHIP PRODUCTS ARE SOLD TO HVC UNIT at $ 60

Sales
Less: Variable costs
Chip
Other variable costs
TOTAL VARIABLE COST
CONTRIBUTION MARGIN

MINIMUM TRANSFER PRICE = Incremental cost of the product division + O

Variable manufacturing cost


Opprtunity cost ($95 - $62)
Minimum Transfer price
150

90

62
CONTRIBUTION INCOME STATEMENT (''000)

CHIP
COMPUTER PRODUCT
MANUFACTURER UNIT UNIT TOTAL
127500 14250 141750

13500
97500
111000 9300 120300
16500 4950 21450 33

CONTRIBUTION INCOME STATEMENT (''000)

CHIP
COMPUTER PRODUCT
MANUFACTURER UNIT UNIT TOTAL
127500 9000 136500

9000
97500
106500 9000 115500
21000 0

he product division + Opportunity cost to the organization, if any because of transfer

$ $
60
33
93
Income Tax Planning Opportunities: International Transfer Pricing
To illustrate the tax planning opportunities associated with the setting of inte
prices, refer to facts presented in Exhibit 19.11 and assume the following: (1
transfers take place within HVC), (2) the x-chip product unit is located in Sou
the computer manufacturing unit is located in the United States; (3) the x-ch
incurs no fixed costs, and fixed costs for the computer manufacturing unit, p
to $2,000,000; and (4) income tax rates are as follows: Korea, 40%, and the U
30%. Under these assumptions, the amount of operating income (i.e., pretax
under each of the three transfer pricing options, for both units and for HVC a
shown in Exhibit 19.12. The negotiated transfer price of $72.50 per unit was
taking a simple average of the market price per chip ($85) and the variable c
($60). Thus, the highly condensed income statement presented in Exhibit 19
anticipated profit situation, before tax and before customs/import duties, fo
sfer Pricing
ith the setting of international transfer
me the following: (1) option 2 (i.e., all
unit is located in South Korea, while
d States; (3) the x-chip product unit
manufacturing unit, per year, amount
orea, 40%, and the United States,
g income (i.e., pretax profits) shown
h units and for HVC as a whole, is
$72.50 per unit was determined by
5) and the variable cost of the x-chip
esented in Exhibit 19.12 reflects the
ms/import duties, for HVC as a whole.
OPERATING INCOME('000 OMMITTED)
Per Unit
VOLUME (IN 000) 150

X-CHIP PRODUCT UNIT (SELLER)


Revenue
Costs: Variable costs 60
Operating Income

COMPUTER MANUFACTURING (HVC) UNIT (BUYER)


850
Revnue
Costs:
Transferred costs
Variable mnf costs 650
Fixed costs
Operating Income

COMBINED OPERATING INCOME

TAXATION ASPECTS OF TRANSFER PRICING

X-CHIP PRODUCT UNIT (SELLER)


Operating income before tax
Less: Tax @40% 0.4
After Tax Operating Income

COMPUTER MANUFACTURING UNIT (BUYER)


Operating income before tax
Less: Tax @30% 0.3
After Tax Operating Income

COMBINES AFTER TAX OPEARTING INCOME


TRANSFER PRICING OPTIONS
MARKET PRICE COST PRICE NEGOTIATED PRICE
85 60 72.5

12750 9000 10875


9000 9000 9000
3750 0 1875

127500 127500 127500

12750 9000 10875


97500 97500 97500
2000 2000 2000
15250 19000 17125

19000 19000 19000

TRANSFER PRICING
TRANSFER PRICING OPTIONS
MARKET PRICE COST PRICE NEGOTIATED PRICE
85 60 72.5

3750 0 1875
1500 0 750
2250 0 1125

15250 19000 17125


4575 5700 5137.5
10675 13300 11987.5

12925 13300 13112.5

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