ACC202 Management Accounting for Multinational Transfer Pricing

Derwent Ltd manufactures telecommunications equipment at its plant in Geelong. The company has marketing divisions throughout the world. A Derwent Ltd marketing division in Dallas, USA, imports 10 000 units of product B12 from Australia. The following information is available:

Suppose that the Australian and US tax authorities only allow transfer prices that are between the full manufacturing cost per unit of $800 and a market price of $950, based on comparable imports into the USA. The US import duty is charged on the price at which the product is transferred into the USA. Any import duty paid to the US authorities is a deductible expense for calculating US income taxes due.

Required

1.Calculate the after-tax operating profit earned by the Australian and US divisions from transferring 10 000 units of product B12: 

a) at full manufacturing cost per unit and

b) at market price of comparable imports. (Income taxes are not included in the calculation of the cost-based transfer prices.)

2.Which transfer price should Derwent Ltd select to minimise the total of company import duties and income taxes? Remember that the transfer price must be between the full manufacturing cost per unit of $800 and the market price of $950 of comparable imports into the USA. Explain your reasoning. 

1.b) Multinational transfer pricing, goal congruence (continuation of Scenario 1a)

Suppose that the Australian division could sell as many units of product B12 as it makes at $900 per unit in the US market, net of all marketing and distribution costs.

Required

1.From the viewpoint of Derwent Ltd as a whole, would after-tax operating profit be maximised if it sold the 10 000 units of product B12 in Australia or in the USA? Show your calculations. 

2. Suppose that division managers act autonomously to maximise their division’s after- tax operating Will the transfer price calculated in requirement 2 of Scenario 1a) result in the Australian division manager taking the actions determined to be optimal in requirement 1 of this exercise? Explain. 

3. What is the minimum transfer price that the Australian division manager would agree to? Does this transfer price result in Derwent Ltd as a whole paying more import duty and taxes than in the answer to requirement 2 of Scenario 1a)? If so, by how much?

2 Airline pricing

The management of Eastcoast Airways is thinking about introducing a daily return-flight from Melbourne to the Gold Coast. You are the management accountant at Eastcoast Airways and are working with the marketing manager to recommend the price for a return ticket.

In researching the market, you and the marketing manager:

1.Establish potential demand for the planned flight

2. Distinguish between business and pleasure travellers (pleasure travellers start their travel during one week, spend at least one weekend at their destination and return the following week or thereafter; business travellers usually start and complete their travel within the same work week, i.e. they do not stay over weekends)

3.Estimate the effects of two different prices on the number of seats expected to be sold and the variable cost per ticket (see table below) 

4.Estimate from the records of similar flights that the fuel costs are likely to amount to $18 500

5. Allocate a total of $150 000 to the return flight in respect of aircraft-lease costs, ground services and flight-crew salaries.

You present this information to the management team for discussion at the next management meeting.

Required

Write a report to management recommending that they charge a single price or different prices to business travellers and pleasure travellers.

For the second option, recommend a way in which Eastcoast Airways might implement price discrimination, to ensure that business travellers and pleasure travellers each pay the price the airline seeks to charge. Support your recommendation with clear explanations and relevant calculations.

Answrers :-

Scenario 1a: Multinational transfer pricing, global tax minimisation

Requirement 1:

Particulars	Method A	Method B
	Internal transfers at full manufacturing cost	Internal transfers at market price
US Division:
Revenues:
Cost per unit	$ 800	$ 950
Produced units	10,000	10,000
Revenue	$ 8,000,000	$ 9,500,000
Costs:
Full manufacturing cost	$ 8,000,000	$ 8,000,000
Division operating income	$ -	$ 1,500,000
Division income tax @35%	$ -	$ 525,000
Division after-tax operating income	$ -	$ 975,000
Australian Division:
Revenues:
Cost per unit	$ 1,150	$ 1,150
Produced units	10,000	10,000
Revenue	$ 11,500,000	$ 11,500,000
Costs:
Transferred in-costs	$ 8,000,000	$ 9,500,000
Import duty per unit @15%	$ 120	$ 142.50
Import duties of transferred in-price	$ 1,200,000	$ 1,425,000
Total division costs	$ 9,200,000	$ 10,925,000
Division operating income	$ 2,300,000	$ 575,000
Division income tax @40%	$ 920,000	$ 230,000
Division after-tax operating income	$ 1,380,000	$ 345,000
Total divisional after-tax operating income	$ 1,380,000	$ 1,320,000

Requirement 2:

Although there are several alternatives available for Derwent Limited, the transfer price needs to be either the overall manufacturing cost or the market value of comparable exports for reducing income taxes and import duties. For this to happen, the transfer price is raised by $1 in relation to the overall manufacturing cost of $800, which would result in modifications in cost per unit (Cristea and Nguyen 2016). This could be depicted as follows:

Particulars	Units
Income tax rate	35%
Increase in US taxes	$ 0.35
Import duty rate	15%
Increase in import duties paid in Australia	$ 0.15
Australian tax rate	40%
Decrease in Australian tax	$ (0.46)
Increase in import duty and tax payments	$ 0.04

The above table points out that the US tax would rise by $0.35 per unit. Similarly, the Australian import duties would rise by $0.15 per unit; however, the Australian tax expense would fall by $0.46 per unit as well. The overall outcome obtained is the rise in tax payments and import duties by $0.04 per unit.

The change in the transfer price has been made from $800 to $950 and the effects of this change are illustrated as follows:

Particulars	Units
Transfer price	$ 800
Change in transfer price	$ 950
Increase in import duty and tax payments per dollar	$ 0.04
Net increase in import duty and tax payments per unit	$ 6
Production	10,000
Decrease in total profit	$ 60,000

It is evident that the net rise in tax payments and import duties is $6 per unit. Since the production level is 10,000 units, the total profits would fall by $60,000 and the amount could be identified as the difference in the net income of the two divisions. Therefore, minimising import duties and taxes would be a feasible solution for Derwent Limited at the level of overall manufacturing cost, which is $800 (Rugman and Eden 2017).

Scenario 1b: Multinational transfer pricing, goal congruence

Requirement 1:

Requirement 2:

There would be reduction in import duties for the Australian division by transferring B12 at the overall manufacturing cost. However, it would not earn any operating profit in this case. The department aims to raise its divisional profit by increasing the sale of the product in the Australian market. The profit level would be $650,000, if the division decides to sell the product in the local market. However, by transferring the product at the overall manufacturing cost to the US division would not help the organisation in achieving the purpose (Shunko, Debo and Gavirneni 2014). Hence, it could be stated that optimum pricing structure could not be maintained, if the transfer price computed in the above section is taken into consideration.

Requirement 3:

Particulars	If transferred to USA
	Australia	USA
Units	10,000	10,000
Cost per unit	$ 900	$ 1,150
Sales	$ 9,000,000	$ 11,500,000
Less: Import cost	$ 9,000,000
Less: Import duty @15%	$ 1,350,000
Less: Full manufacturing cost @$800	$ 8,000,000	$ -
Profit	$ 1,000,000	$ 1,150,000
Tax rate	35%	40%
Taxable amount	$ 350,000	$ 460,000
Profit after tax	$ 650,000	$ 690,000

Particulars	Transfer price
	$800 per unit	$900 per unit
Australian income taxes	$ -	$ 350,000
US import duties	$ 1,200,000	$ 1,350,000
US income taxes	$ 920,000	$ 460,000
Total	$ 2,120,000	$ 2,160,000

From the above tables, it is clearly inherent that the minimum transfer price, which is feasible to the divisional manager of Derwent Limited in Australia, might result in additional payment of $40,000 in the form of import duties and income tax payments. However, the transfer price would help the organisation in maintaining the desired profit margin (Davies et al. 2018).

2: Airline pricing

To,

The Directors of Eastcoast Airways,

Date: 24/05/2018

Subject: Airline pricing strategy

Based on the critical evaluation of the provided information about Eastcoast Airways, it could be found that the airline is expected to have 150 pleasure travellers and 200 business travellers, if the price per passenger is set as $600. Similarly, if the price is set at $1,350 for each passenger, the airline could expect 180 business travellers and 20 pleasure travellers. However, before recommending any particular pricing strategy, it is necessary to consider their feasibility for Eastcoast Airways and therefore, the following computations are made:

Particulars	Option 1	Option 2
	Units	Units
Sales revenue	$ 600	$ 1,350
Less: Variable cost per ticket	$ 65	$ 150
Contribution per passenger	$ 535	$ 1,200
Total number of business travellers	200	180
Total number of pleasure travellers	100	20
Contribution margin from business travellers	$ 107,000	$ 216,000
Contribution margin from pleasure travellers	$ 53,500	$ 24,000

 From the above table, it is clearly inherent that Eastcoast Airways could expect the contribution margin to be increased, if it decides to charge $600 each from the pleasure travellers and $1.350 each from the business travellers. This implies that the strategy of price discrimination would be immensely beneficial for the airline; as such strategy would help in raising its overall profit level (Escobari, Rupp and Meskey 2016). Some information regarding other costs is provided in the case study, which are not taken into consideration in this case for arriving at the contribution margin. The costs that are excluded in this case include the following:

• Lease cost
• Fuel cost
• Ground service cost
• Salaries of the flight crews

These cost items are considered to be irrelevant, as no change in the pricing strategy would take place, even if they increase or decrease with the passage of time (Chandra and Lederman 2018). The business travellers tend to return within the same week for work purpose, while the pleasure travellers prefer to stay in the destinations during the weekends. Hence, Eastcoast Airways might charge $600 as flight fare from those travellers intending to stay during the weekends. As a result, the price discrimination strategy would come into play between the two groups of passengers. Along with this, the airline could not be accused legally, since it is a service provider and the policy of price discrimination is followed for not eradicating competition from the sector.