Transfer Pricing for Derwent Limited’s Product B12
| 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 |
Certain methods are inherent for proceeding; however, the most important thing to be taken into consideration is that the transfer price, which would reduce the overall import duties of Derwent Limited would be either the overall manufacturing cost or the market price related to comparable imports. Hence, a scenario is considered, in which the transfer price increases by $1 each time, in which the overall manufacturing cost is $800 per unit. This would lead to certain changes illustrated in the form of a table 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 |
For verifying the above solution, another consideration is made by changing the transfer price from $800 to $950. This would result in certain changes for each unit as follows:
| Particulars | Units |
| Transfer price | $ 800 |
| Change in tranfer 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 |
From the above table, it is evident that the decrease in total profit is exactly the difference in after-tax operating incomes obtained in the first section. Therefore, Derwent Limited would reduce income taxes and import duties through settlement if the transfer price at the minimal level of $800, which is the overall manufacturing cost.
| Particulars | If Transferred to USA | If sold in Australia only | ||
| Australia | USA | Australia | USA | |
| Units | 10,000 | 10,000 | 10,000 | 10,000 |
| Cost per unit | $ 900 | $ 1,150 | $ 900 | $ – |
| Sales | $ 9,000,000 | $ 11,500,000 | $ 9,000,000 | $ – |
| Less: Import cost | $ – | $ 9,000,000.00 | $ – | $ – |
| Less: Import duty @15% | $ – | $ 1,350,000.00 | $ – | $ – |
| Less: Full manufacturing cost @$800 | 8,000,000 | 0 | 8,000,000 | |
| Profit | $ 1,000,000 | $ 1,150,000 | $ 1,000,000 | $ – |
| Tax rate | 35% | 40% | 35% | 40% |
| Taxable amount | $ 350,000 | $ 460,000 | $ 350,000 | $ – |
| Profit after tax | $ 650,000 | $ 690,000 | $ 650,000 | $ – |
| Total divisional profit: | ||||
| If transferred to USA | $ 1,340,000 | |||
| If sold locally | $ 650,000 |
It has been evaluated the transfer of product at full manufacturing cost of the Australian department reduces import duties. However, in such situation, there is no operating income for the Australian division. However, the division intends to raise its profit level by acting anonymously through sale of the product B12 in Australia (Fullerton, Kennedy and Widener 2014). This would lead to a profit of $650,000, if the product is sold locally, instead of transferring the product at full manufacturing cost to the US division. Hence, the transfer price computed in the first part would not lead to actions, which would be optimum for Derwent Limited (Hopper and Bui 2016).
| 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 |
The minimal transfer price, which the manager of the Australian division of Derwent Limited could agree would lead to payment of additional $40,000 in import duties and taxes.
To,
The Directors of Eastcoast Airways,
Date: 20/05/2018
Subject: Airline pricing strategy
In order to determine the best pricing strategy for Eastcoast Airways, the following calculations are made based on the provided data:
| 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 |
According to the above table, it could be evaluated that the maximisation of contribution margin of Eastcoast Airways by charging $1,350 from each business traveller and $1,350 from each pleasure traveller. Hence, price differentiation strategy is suitable for the airline, as it would help in maximising its profit level (Otley 2016). However, to choose between the alternative prices, the other provided costs like allocated yearly lease costs, fuel costs, ground service costs and crew salaries of the flight are not taken into consideration, since they are not relevant. This is because these prices would remain the same regardless of the pricing strategy of Eastcoast Airways.
It has been observed that the business travellers intend to return in the same week, while the pleasure travellers prefer to stay in the weekends. Hence, if the passengers choose a night stay on Saturdays, they would be eligible for the S600 discount fare and thus, this would act in the form of discrimination between the categories of the passengers. Such price discrimination is legal, since airlines are service firms instead of manufacturing firms and these practices are not followed to eradicate competition from the sector (Quattrone 2016).
References:
Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2014. Lean manufacturing and firm performance: The incremental contribution of lean management accounting practices. Journal of Operations Management, 32(7-8), pp.414-428.
Hopper, T. and Bui, B., 2016. Has management accounting research been critical?. Management Accounting Research, 31, pp.10-30.
Otley, D., 2016. The contingency theory of management accounting and control: 1980–2014. Management accounting research, 31, pp.45-62.
Quattrone, P., 2016. Management accounting goes digital: Will the move make it wiser?. Management Accounting Research, 31, pp.118-122.
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