Multinational transfer pricing, effect of alternative transfer-pricing methods, global income tax minimization. User Friendly Computer, Inc., with headquarters in San Francisco, manufactures and sells a desktop computer. User Friendly has three divisions, each of which 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. U.S. Division - packages and distributes desktop computers
Each division is run as a profit center. The costs for the work done in each division for a single desktop computer are as follows:
China Division: Variable cost = 1,000 yuan
Fixed cost = 1,800 yuan
South Korea Division: Variable cost = 360,000 won
Fixed cost = 480,000
won U.S. Division: Variable cost = $100
Fixed cost = $200
■ Chinese income tax rate on China Division's operating income: 40%
■ South Korean income tax rate on South Korea Division's operating income: 20%
■ U.S. income tax rate on U.S. Division's operating income: 30%
Each desktop computer is sold to retail outlets in the United States for $3,200. Assume that the current foreign exchange rates are:
8 yuan = $1U.S
1,200 won = $1U.S
Both the China and the South Korea divisions 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 3,600 yuan. The South Korea Division sells the comparable desktop computer to a South Korean distributor for 1,560,000 won.
1. Calculate the after-tax operating income per unit earned by each division under the following transfer- Required pricing methods: (a) market price, (b) 200% of full cost, and (c) 300% of variable cost. (Income taxes are not included in the computation of the cost-based transfer prices.)
2. Which transfer-pricing method(s) will maximize the after-tax operating income per unit of User Friendly Computer?