Multinational transfer pricing, effect of alternative transfer pricing methods, global income tax minimization. User Friendly Computer, Inc., with headquarters in Regina, manufactures and sells desktop computers. User Friendly has three divisions, each ofwhich is located in a different country:

a. China Division—manufactures memory devices and keyboards

b. South Korea Division—assembles desktop computers, using internally manufactured parts and memory devices and keyboards from the China Division

c. Canadian Division—packages and distributes desktop computers Each division is run as a profit centre. The costs for the work done in each division that are associated with a single desktop computer unit are as follows:

China Division: Variable costs = 1,200 yuan Fixed costs = 2,160 yuan South Korea Division: Variable costs = 288,000 won Fixed costs — 384,000 won Canadian Division: Variable costs = $120 Fixed costs = $240 Chinese income tax rate on China Division’s operating income 40%

South Korean income tax rate on South Korea Division’s operating income 20%

Canadian income tax rate on Canadian Division’s operating income 30%

Each desktop computer is sold to retail outlets in Canada for $3,840. Assume that the current foreign exchange rates are:

8 yuan = $1 Cdn.

800 won = $1 Cdn.

Both the China and the South Korea Division sell part of their production under a private label. The China Division sells the comparable memory/keyboard package used in each User Friendly desktop computer to a Chinese manufacturer for 4,320 yuan. The South Korea division sells the comparable desktop computer to a South Korean distributor for 1,248,000 won.

Required 1. Calculate the after-tax operating income per unit earned by each division under each of the following transfer pricing methods:

(a) market price,

(b) 200% offull costs, and

(c) 300% of variable costs. (Income taxes are not included in the computation of the cost-based transfer prices.)

2. Which transfer pricing method(s) will maximize the net income per unit of User Friendly Computer, Inc.?

Excel Apphcation For students who wish to practise their spreadsheet skills, the following is a step-by-step approach to creating an Excel spreadsheet to work this problem.

9101 CHAPTER 23 Step-by-Step 1. Open a new spreadsheet. At the top, create an “Original Data” section for the data provided by User Friendly Computer. Create rows for the exchange-rate data labelled

“Yuan per Dollar” and “Won per Dollar.” Skip two rows. Under the heading “China Division,” create rows for “Price per Unit, Variable Cost per Unit, Fixed Cost per Unit, and Income Tax Rate.” Create two more sets of the same rows under the headings “South Korea Division” and “Canadian Division.” Enter price and cost data in the division coun¬

try’s currency.

(Program your spreadsheet to perform all necessary calculations. Do not “hard-code” any amounts, such as net income per unit, requiring addition, subtraction, multiplication, or division operations.)

2. Skip two rows, and create a “Problem 1” section in a similar format to Exhibit 23-2

(p. 891).

Create columns for each of the three transfer-pricing methods. Under the heading “China Division,” create rows for “Division Revenues per Unit, Division Variable Cost per Unit, Division Fixed Cost per Unit, Division Operating Income per Unit, Income Tax, and Division Net Income per Unit.” Under the headings “South Korea Division” and

“Canadian Division,” create rows for “Division Revenues per Unit, Transferred-In Cost per Unit, Division Variable Cost per Unit, Division Fixed Cost per Unit, Division Operating Income per Unit, Income Tax, and Division Net Income per Unit.” When entering calculations in this section, use the exchange rate data from your Original Data section to convert to Cdn. dollars.
3. Skip two rows, and create a “Problem 2” section. Create columns for each of the three transfer-pricing methods. Create rows for “China Division, South Korea Division, Cdn. Division,” and “User Friendly Computer.” Enter the division net income under each of the transfer-pricing methods that you calculated in step 2 in this section. In the User Friendly Computer row, enter total net income under each of the transfer-pricing methods.
4. Check the accuracy of your spreadsheet: Go to your Original Data section and change the income tax rate for the South Korea Division from 20% to 35%. Ifyou programmed your spreadsheet correctly, total net income for User Friendly Computer under the market / price method should change to $1,533.