Cost Accounting (14th Edition)

22
Management Control Systems,
Transfer Pricing, and Multinational
Considerations
774
Learning Objectives
1. Describe a management control
system and its three key properties
2. Describe the benefits and costs of
decentralization
3. Explain transfer prices and four criteria
used to evaluate alternative
transfer-pricing methods
4. Illustrate how market-based transfer
prices promote goal congruence
in perfectly competitive markets
5. Understand how to avoid making
suboptimal decisions when transfer
prices are based on full cost
plus a markup
6. Describe the range of feasible
transfer prices when there is
unused capacity
7. Apply a general guideline for determining
a minimum transfer price
8. Incorporate income tax considerations
in multinational transfer pricing
Transfer pricing is the price one subunit of a company
charges for the services it provides another subunit of
the same company.
Top management uses transfer prices (1) to focus managers’ attention
on the performance of their own subunits and (2) to plan and
coordinate the actions of different subunits to maximize the company’s
income as a whole. While transfer pricing is productive, it can also be
contentious, because managers of different subunits often have very
different preferences about how transfer prices should be set. For
example, some managers prefer the prices be based on market
prices. Others prefer the prices be based on costs alone. Controversy
also arises when multinational corporations seek to reduce their overall
income tax burden by charging high transfer prices to units located in
countries with high tax rates. Many countries, including the United
States, attempt to restrict this practice, as the following article shows.
Symantec Wins $545 million Opinion in
Transfer Pricing Dispute with the IRS 1
Symantec Corp., a large U.S. software company, won a significant
court decision in December 2009, potentially saving it $545 million in
contested back taxes. The Internal Revenue Service (IRS) had been
seeking back taxes it alleged were owed by Veritas Software Corp., a
company acquired by Symantec in 2005. The dispute was over the
company’s formula for “transfer pricing,” a complex set of rules
determining how companies set prices, fees, and cost-allocation
arrangements between their operations in different tax jurisdictions.
At issue were the fees and cost-allocation arrangements between
Veritas and its Irish subsidiary. Ireland has emerged as a popular tax
haven for U.S. technology companies. Veritas granted rights to Veritas
Ireland to conduct research and development on various intangibles
(such as computer programs and manufacturing process
technologies) related to data storage software and related devices.
Under the agreement in effect, Veritas Ireland paid $160 million for this
grant of rights from 1999 to 2001. Based on a discounted cash flow
analysis, the IRS contended that the true value of the transferred rights
was closer to $1.675 billion. As a consequence, it claimed that the
transaction artificially increased the income of Veritas Ireland at the
1 Source: Chinnis, Cabell et al. 2009. Tax court upends IRS’s billion dollar buy-in valuation adjustment in
“Veritas.” Mondaq Business Briefing, December 17; Letzing, John. 2009. Symantec wins $545M opinion in
tax case. Dow Jones News Service, December 11.