APT TECHNICAL CPD - MAF TRANSFER PRICING AND PERFORMANCE EVALUATION - - PowerPoint PPT Presentation

APT TECHNICAL CPD - MAF

TRANSFER PRICING AND PERFORMANCE EVALUATION

Transfer Pricing and performance evaluation

Nicholas Riemer Nicholas.Riemer@firstrand.co.za

Agenda

• Workflow to understanding Transfer pricing and performance evaluation
• What is Performance management? Generic Problem
• What is Transfer pricing? Generic problem
• Industry considerations?
• What is the specific problem?
• How to incorporate into your file

TP and performance Workflow Approach

Generic problem Performance evaluation

• Strategy: Long-term plan of action
• Budgeting: Short-term plan of action
• Performance Evaluation
• Control function
• Historic
• Performance Management
• Planning function
• Future

Performance evaluation

• Central structure vs. Divisionalized/Decentralized
• Can top management control operations?
• Risk of divisionalization that it does not ensure goal concurrence
• Develop performance measure that ensures goal concurrence
• Financial vs. Non financial measures
• Strategy

Divisionalization

• Advantages
• Speed and quality of decisions
• Self – fulfillment
• Strategic planning
• Risks/Disadvantages
• Goal concurrence NB
• Loses control

Divisionalization

• Pre-requisites
• Diversified activities
• Independent (autonomous)
• Relation must be regulated (Transfer Pricing)

Performance evaluation

• Divisional vs. Managerial
• CONTROLABALITY (Profit/cash & Investment)
• Can only measure performance on what manager/division

control!

• Every expense is controlled by someone – include at the

relevant level

• Manager
• Division

Performance evaluation

Performance evaluation

Manager Controllability Division Avoidability Unavoidable Head Office Costs Compare divisions with each other: DON’T TAKE INTO ACCOUNT Compare with external comp: TAKE INTO ACCOUNT

Performance evaluation

• Investment/Asset-base (Controllability)
• 1. Economic value?
• 2. Replacement cost?
• 3. Original cost?
• 4. Written down value?

PERFORMANCE EVALUATION

• Purpose of performance evaluation:
• Checks position / communicate position / confirms position / compels

improvement

• Controllability & choice of basis (method)
• Controllability : though not always fully controllable, the measure should at

least be influence by the person or unit being measured

• Choice of method: “what you measure is what you get”.
• Centre's: cost / profit / investment (mostly required to measure)

PERFORMANCE EVALUATION

• Profit based measures:
• Basis / problems
• ROI
• Controllable profit/controllable assets
• Profit Centre (not investment Centre)
• Residual Income
• Profit and Investment Centre.

PERFORMANCE EVALUATION

• Wealth creation measures:
• EVA = EBIAT – ((Assets – current liabilities) x Cost of capital)
• 173 adjustments to Acc numbers
• Adjustments to bring closer to cash
• (controllable profit) – (a cost for the capital employed) = value added
• Controllable cost of capital: based on risk profile
• ST Assets controllable by manager?
• MVA = PV of all future EVA’s

The components/principles of an ideal performance evaluation system

• Should be based on controllability
• Should look at the short/medium and long term
• Should comprise a basket of measures
• Should ensure goal congruency
• Should consist of financial as well as non-financial measures
• Must ensure execution of strategy

(These principles can be used as a structured means in order to criticise an existing performance evaluation system)

Industry Considerations

• Banks a big user of Divisionalization
• Inter division funding costs or FTP Funding transfer price
• SLA Service level agreements between divisions
• 2018 APT Banking case study
• Big move in financial sector to NIACC neutral charges on loans or other services in

an attempt to bring on the client from a transactional banking point of view.

• Service industries applying Divisionalzation, key issues have been incorrect

performance remuneration. Purely on profits, thus decisions not made in the best interest of the company.

• Move toward correct performance evaluation, managers also rewarded for joint

revenue generated in other divisions.

• Deloitte Report move toward decentralization, Impact on industries and

challenges facing the adoption.

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Specific problems

• Currently a centralized process wants to move to Divisionalization
• Currently incorrect performance management, need to assist.
• Assisting with the different types of management assessments which can be

made as well as divisional performance management.

• Assisting with new strategy of goal congruence by implementing initiatives to

drive the company as a whole forward as opposed to just the division.

Transfer Pricing

Generic issue

Transfer Pricing

Introduction

• Purpose of transfer pricing (criticise or evaluate)
• Goal congruency (good economic decisions)
• Performance evaluation/Managing performance
• Further practical issues
• Taxation; Consolidations, Segmental reporting, International transfer pricing.

Different Transfer Pricing Options

Purpose

• Goal congruency
• Relevancy principals
• Performance Measurement
• Wants to include profit
• Wants to cover fixed costs as well

Transfer Pricing Options

Goal Concurrency Performance

COMPETITIVE MARKET EXISTS

 Market Price P P

NO EXTERNAL MARKET EXISTS

 Variable Cost + Profit Margin x x  Full Cost + Profit Margin x P  Marginal/Variable (without markup) P x  Full Cost (without mark-up) x x  Marginal/Variable cost + Opportunity cost P x

(variable but taking market value into account – refer example above)

NEGOTIATED TRANSTER PROCESS

Module and Working example

Negotiated Transfer Price

• The minimum T/F price
• From the point of view of the transferring division
• Variable cost plus opportunity cost minus internal savings
• BASIC PRINCIPLE
• Relevancy – want to be at least in the same position as before the transfer

Negotiated Transfer Price

• Maximum T/F price
• From the point of view of the receiving division
• BASIC PRINCIPLE
• Relevancy – want to be at least in the same position as before the transfer
• Point where contribution = 0
• Maximum price limited to Market price!

Transfer prices conclusion

• Perfect market exists
• Use market prices
• Imperfect market exists
• Negotiated price method (relevancy principles to determine minimum and maximum)
• No external market exists
• Long run marginal cost
• Variable
• Fixed lump sum
• Treat as Cost Centre
• Use standards

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Other important discussions

• Capital budgeting
• EVA
• EVA and NPV
• ROI and ARR
• Valuations
• EVA
• Budgeting

Building a file

• Coverage!!!!!
• Summarized Theory
• Practical information summarized industry
• Link to previous lectures and develop the same technique for each

trigger.

• Good luck for Assessment 2