Johnson produce electronic component in China, has very strong local market for integrated circuit. The variable production cost is $40, & company can sell its entire supply domestically for $110. Tax rate in China is 30%. Alternatively, Johnson can ship electronic component to division that is in Korea, to be used in product that Korea division will distribute throughout South Korea. Info about Korean product & division's operating environment are as follows:
Selling price of final product: $400
Shipping fees to import integrated circuits: $20
Labor, overhead, and additional material costs of final product: $230
Import duty levied on integrated circuits (to be paid by the South Korean division): 10% of transfer price
Korea tax rate: 40%
Based on China & South Korean tax law, company establish transfer price for integrated circuit equal to China market price. Assume South Korean division can obtain integrated circuit in South Korea for $125.
(a) Johnson's acc department has figured that company will generate $66.40 for each unit transferred & used in South Korea division's product. Rather than proceed with transfer, would Johnson be better off to sell its goods domestically & allow the South Korean division to acquire integrated circuits in South Korea? Show computation for both China & South Korea operation to support your answer.
(b) Generally speaking, when tax rates differ between country, what income strategy should company use in set its transfer prices? If seller is in low tax-rate country, what type of price should it set? Why?
(c) What is transfer pricing? This question is not related to the previous questions.
(d) One element of general transfer-pricing rule is opportunity cost. Briefly define term "opportunity cost" & then explain how it is computed for (1) company that has excess capacity & (2) company that has no excess capacity. This question is not related to the previous questions.
