Q1: Transfer Pricing [10 Marks]

Pacific Bicycle Company produces racing bikes in its manufacturing plant in Japan. The bikes are then shipped to the entity's assembly plant on the Gold Coast, Australia, where they are assembled and finished. The manufacturer in Japan never sells these unassembled bikes to any other assembler. However, the market for them is competitive. The market price per unassembled bike is $650.

At the Japan based plant Variable costs to manufacture the bikes are $250 per bike and fixed costs are $2000000 per period. The plant typically manufactures and ships 10000 bikes per period to the Gold Coast. Taxes in Japan amount to 30 per cent, of pre-tax income.

The Gold Coast operations incurs variable costs to assemble and complete the bikes of $80 per bike in addition to the cost of the bike. The Gold Coast manufacturing plant's fixed costs amount to $5000000 per period. The 10000 bikes produced each period are sold for an average of $1 500 each. For the Australian operations, the tax rate is 45 per cent of pre-tax income.

Required:

1. To reduce taxes, will Pacific Bicycle Company prefer a transfer price based on cost or market price? Explain. [3 marks]

1. Will the managers of the Japanese and Australian operations prefer to use cost or market price as the transfer price? Explain. [4 marks]

1. How would you resolve potential conflict over the transfer price policy?[3 marks]