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Cost Accounting Videos 27 videos

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Cost Accounting: How Does Transfer Pricing Work? 2 Views


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Description:

How does transfer pricing work? Transfer pricing allows companies to set prices when exchanging goods between their subsidiaries or companies that are part of their supply chain. It’s involved in accounting and helps these companies with tax liability within these exchanges that happen really frequently.

Language:
English Language

Transcript

00:00

And finance Allah Shmoop How does transfer pricing work Oh

00:07

all right You work at the multinational multi divisional conglomerate

00:11

Global Mega Giga Tek Co You had the purchasing team

00:16

at Fragrance to the bed It's the firm's perfumed diaper

00:20

division for babies who really like to be you know

00:23

pampered your product combines perfume Fragrance is with specialty diapers

00:27

for that upper class baby ready for a night out

00:30

pretends like Coco not caca and Low Do not quite

00:34

ready for du toilette To create the product you buy

00:36

diapers from one source and perfume from another source Then

00:40

your team of highly trained spritz ologists applies the perfume

00:44

to the diapers Luckily global Mega Giga Techo has a

00:48

diaper division and a perfume division or a maybe unluckily

00:51

for you life just got more complicated because of transfer

00:55

pricing Well the company bigwigs air happy that everything stays

00:58

in house You can get all your raw materials from

01:01

within the global mega family and that's great But it's

01:05

also a headache Why Well because if you bought diapers

01:09

from one vendor you'd have a market price for them

01:11

You'd negotiate hard and pick the best deal for your

01:14

company from the eighteen purveyors of fine nappies for the

01:17

spirited pre millennial set Same deal with the perfume but

01:21

here that's not the case because you're essentially buying from

01:24

well yourself And that's a problem because the prices now

01:27

aren't quote market unquote They're kind of made up sorta

01:32

Yes you can get in the zone of a market

01:34

price but often there really isn't a kind of market

01:37

clearing price for a million nappies like nobody else buys

01:40

them in that kind of bulk And then how do

01:42

you account for shipping charges and well breakage or ribcage

01:45

or whatever else costs money in acquiring those diapers Luckily

01:48

there exists the magic of transfer pricing transfer pricing tracks

01:52

expenses for separate departments within the same firms that do

01:56

internal business with each other like it more or less

01:59

sets the A price right sets the transfer prices prices

02:02

which you're transferring stuff from one division to another Well

02:05

the goal is to fairly attribute pricing to each division

02:08

such that everyone feels equally unfairly treated You could imagine

02:13

that the manager of the diaper sales division has her

02:15

own income statement and she probably earns her bonus based

02:18

on how profitable that division runs that year Well if

02:21

the big bad boss at corporate wants to show more

02:23

profit in the Global Mega Diaper Corp Then that boss

02:27

will lean on Missa Schimmel bottom to sell or rather

02:30

to transfer price her diapers at very cheap prices so

02:34

that Diaper Corp looks much more profitable than it really

02:37

would be or it paying market prices for its well

02:40

very raw materials Meanwhile the same thing's going on at

02:43

Globo sent Corp the higher the price they get for

02:46

the perfume they send you the better their numbers will

02:49

look More bonuses more promotions more cover stories in perfume

02:54

industry monthly On the other side of things you have

02:56

a similar incentive to get prices down like that's your

02:59

job The less you pay for the raw materials while

03:02

the better your profits look again Big bonuses at stake

03:05

here inside the division Better chance to climb that day

03:08

You know Slippery corporate ladder Yes these accounting gymnastics may

03:11

seem silly All the money just ends up in the

03:13

same big mega glop Huge corporate bottom line in the

03:17

end right Well if you send money to global mega

03:19

Diaper Corp Well it shows up on their quarterly reports

03:23

The Wall Street The Net Number two Global won't change

03:26

whether the diapers and perfume are transfer priced expensive or

03:29

transfer price cheap It's all global mega Giga Tech owes

03:34

money in the end literally but it matters for internal

03:37

accounting is that you have to think about it and

03:39

do it There are bonuses and the egos and all

03:41

the corporate game of thrones stuff at stake here But

03:43

there are legitimate business reasons to transfer Pricing allows accountants

03:47

to figure out the true cost and profitability of different

03:50

products This information allows global mega tow make informed decisions

03:54

about production distribution and marketing like what products are worth

03:57

keeping which ones should expand or killed If a manager

04:01

just grabbed a bunch of diapers or walked off with

04:03

a drum full of perfume without charging those cost to

04:05

their division wealth and when all the beans are coming

04:07

at the end of the day it would be impossible

04:09

to track the cross it took to actually make those

04:11

items So they all have to be tracked And the

04:13

resulting numbers would then cloud how well or poorly each

04:16

division was doing And you can imagine that there have

04:18

been times in business when an internal division is simply

04:21

poorly run like what if the perfume business could only

04:24

make that perfume for one hundred dollars a gallon But

04:27

the manager of Frog Rasta Beibei could by that same

04:30

identical perfume from another vendor for only seventy dollars a

04:34

gallon Well since the perfume diaper people are bonus on

04:36

profits why shouldn't they be allowed to buy that product

04:39

the best way they can buy it And it may

04:41

mean that the global sent division should in fact be

04:44

tossed out you know like a an old diaper and

04:47

shut down So transfer pricing shines a bright light on

04:50

the line operations of a business and allows managers to

04:53

figure out the true value of each of their products

04:56

without accurate transfer pricing A big company like global Mega

04:59

wouldn't be able to identify which products are inside really

05:02

profitable divisions and which ones are a drag on the

05:05

firm's finances So to get the diapers on Global Mega

05:08

Stipe ER division well you'll have to pay for the

05:10

product right It's time to go over now to the

05:12

Diaper Co And buy some diapers Well how do you

05:15

set that price Well there are three basic methods First

05:18

some details about the diapers A package of one hundred

05:20

diapers retails for fifty bucks It cost the diaper unit

05:23

twenty bucks to produce Okay now here the three methods

05:26

One pay for the cost of producing the diapers So

05:29

under the first method you'll just reimburse the diaper unit

05:32

for its costs in producing them You pay him twenty

05:35

bucks for the hundred diapers That's it The second method

05:37

You pay full retail price you'd give diaper code that

05:40

fifty dollars that they would have gotten if the diapers

05:43

had been sold at their store All right Third method

05:45

a negotiated amount somewhere in between Yeah some figure higher

05:50

than the cost but not quite the full retail price

05:53

So basically you'd get on the phone with some sales

05:55

guy at Diaper Co And basically just work out a

05:57

deal The transfer price you pay will depend on the

06:00

situation If diaper code isn't working at capacity you know

06:03

a price that cost or close to it makes sense

06:06

They can crank up production than pretty easily without causing

06:09

a problem that I propose you get wouldn't get made

06:11

if he didn't want them to be made However if

06:14

Diaper Cho is constantly selling out well then a transfer

06:17

price at or near retail price would make sense They

06:20

have orders piling up and if a cell to you

06:22

for a cheap price they're losing money selling to others

06:25

at a much higher price They're having trouble filling all

06:28

their orders Every diaper you take is a diaper then

06:31

that they can't sell to a retail price paying customer

06:34

You're literally costing them sales when you get the diapers

06:37

for closer to twenty bucks than fifty So you should

06:39

be treated Don't just like any other customer right Well

06:42

turns out diaper Cho is near capacity You'll have to

06:45

pay near full price However you negotiate a volume discount

06:48

and so you pay forty five bucks per package of

06:50

one hundred diapers Meanwhile you get another ten percent off

06:53

by promising that Jimmy the best softball player at Fragrance

06:56

Beibei will play for Diaper Co At the next company

06:59

picnic so you end up paying forty dollars fifty cents

07:02

for one hundred count package Alright now time to buy

07:04

the perfume when you call over global sent Corp They

07:07

have a deal for you Owed it to Tidewater Hasn't

07:10

been selling very well And they have a lot of

07:12

it sitting in the warehouse and are happy to get

07:14

rid of it You Khun basically get it at cost

07:17

Plus you talked them into letting you use some of

07:18

their pre cut budget just to take the extra barrels

07:21

of perfume off their hands So yeah that's transfer pricing

07:24

We could go into more depth but for now we'll 00:07:26.773 --> [endTime] just start with a spritz yellow

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