Chapter 11 International Transfer Pricing: Multiple Choice Questions

Chapter 11 International Transfer Pricing
Multiple Choice Questions

1. The monetary amount used to record intercompany transactions is called:
A) exchange rate
B) transfer price
C) conversion rate
D) incremental cost
Answer: B Level: Easy LO: 1
2. What is the term used for intercompany transactions from a parent to a subsidiary?
A) upstream transfer
B) downstream transfer
C) international transfer
D) none of the above
Answer: B Level: Easy LO: 1
3. What is the term used for intercompany transactions from a subsidiary to a parent?
A) upstream transfer
B) downstream transfer
C) international transfer
D) none of the above
Answer: A Level: Easy LO: 1
4. In 2006, what portion of total U.S. goods trade was made up of intercompany
transactions?
A) 20%
B) 82%
C) 41%
D) 11%
Answer: C Level: Medium LO: 1
5. What is the primary characteristic of a decentralized organization?
A) size of divisions
B) number of divisions
C) delegation of decision making authority
D) diversity of foreign operations
Doupnik, International Accounting 2e

6. While there are many advantages of decentralization, what is the major disadvantage
of decentralized organizations?
A) manageability of multiple divisions in both domestic and international operations
B) possible conflict between division managers' decisions and goals of the
organization
C) making timely operating decisions
D) All of the above
Answer: B Level: Medium LO: 1
7. What is goal congruence?
A) making the goals of individual managers the same as corporate goals
B) equating managerial goals to corporate goals
C) aligning managerial goals with corporate goals
D) giving managers complete autonomy to make decisions
Answer: C Level: Hard LO: 1
8. How is goal congruence achieved in decentralized organizations?
A) forcing managers to take on corporate goals as their personal goals
B) creating incentives for managers to make decisions that are consistent with
corporate goals
C) setting policies that direct managers in the way decisions should be made
D) eliminating the authority for divisional managers to make operating decisions
9. Which of the following is a limitation of cost-based transfer pricing?
A) determining which cost to use
B) lack of incentive for selling division to control cost
C) inefficiencies in one unit may be transferred to another unit
D) All of the above
Answer: D Level: Medium LO: 5

10. A multinational corporation may attempt to minimize the taxes it pays in a country
with a high effective tax rate by setting a very high transfer price on goods transferred
to a subsidiary in a high-tax country. Why is this often not successful?
A) Laws in the foreign country may prohibit such a scheme.
B) The high transfer price would actually increase taxes.
C) Foreign exchange losses will eliminate any tax savings.
D) None of the above.
Answer: A Level: Medium LO: 1
11. In a 2007-2008 survey by Ernst &Young, what issue did 39% percent of respondents
identify as the most important international tax issue they face?
A) foreign currency translation of taxable income
B) double taxation
C) transfer pricing
D) withholding taxes
12. What is the primary difficulty of using market-based transfer prices for intercompany
transactions?
A) markets that are too complex
B) lack of a well-developed market
C) lack of objectivity
D) operating inefficiencies are transferred from one subsidiary to another
13. What is the primary advantage of a negotiated transfer price?
A) It is objectively determined.
B) It reflects managers' ability to control cost.
C) It is based on arms-length transactions with unrelated parties.
D) It preserves managerial autonomy to make decisions.

14. When a transfer price is set by the management of a parent company rather than by the
subsidiary managers, what kind of transfer price is being used?
A) market-based transfer price
B) negotiated transfer price
C) discretionary transfer price
D) cost-based transfer price
15. Subsidiary X, located in a country with a 25% corporate income tax rate, and
Subsidiary Y, located in a country with a 35% corporate income tax rate are part of a
decentralized organization. They have been engaged in trade with one another using a
negotiated transfer price of $50 per unit for sales by Subsidiary X to Subsidiary Y.
Pipko, the parent company of both Subsidiary X and Subsidiary Y recently set a
discretionary transfer price of $80 per unit for the transfers between X and Y. What is
advantage of this decision?
A) Net income for Subsidiary X will increase by $30 per unit.
B) Net income for the corporation as a whole will increase by $30 per unit.
C) Net income for the corporation as a whole will increase by $3 per unit.
D) Net income for Subsidiary Y will decrease by $30 per unit.
16. Subsidiary X, located in a country with a 25% corporate income tax rate, and
Subsidiary Y, located in a country with a 35% corporate income tax rate are part of a
decentralized organization. They have been engaged in trade with one another using a
negotiated transfer price of $50 per unit for sales by Subsidiary X to Subsidiary Y.
Pipko, the parent company of both Subsidiary X and Subsidiary Y recently set a
discretionary transfer price of $80 per unit for the transfers between X and Y. How
will subsidiary managers in the decentralized organization view this decision by parent
company management?
A) They will embrace it whole-heartedly because corporate profits will increase.
B) The manager of Subsidiary Y will be concerned about the decline in Y's profit and
the effect this will have on his/her bonus.
C) They won't mind because the intercompany transaction will still occur.
D) They won't notice because all decisions in the decentralized organization are made
by the parent.

17. What is the primary problem with using discretionary transfer prices to minimize costs
in a decentralized organization?
A) They don't really minimize tax costs.
B) The appropriate transfer price to minimize costs cannot be determined by the
parent company.
C) The benefits of decentralization may be lost.
D) They are extremely difficult to administer.
18. How can the conflict between cost minimization and performance evaluation be
overcome in a decentralized organization?
A) dual transfer pricing systems
B) market-based transfer pricing systems
C) cost-based transfer pricing systems
D) negotiated transfer pricing systems
Answer: A Level: Easy LO: 3
19. Withholding taxes on dividends paid by a foreign subsidiary to a parent can be
reduced by:
A) raising prices paid by the parent for goods it acquires from the subsidiary.
B) raising prices paid by the subsidiary for goods it acquires from the parent.
C) negotiated transfer pricing.
D) reducing prices charged by the parent for good transferred to the subsidiary.
Answer: B Level: Hard LO: 3
20. What is an ad valorem import duty?
A) a requirement that a parent buy the output of a foreign subsidiary
B) a tariff charged by a government on the invoice price of goods coming into its
country
C) a requirement that a subsidiary acquire its material inputs from a foreign parent
D) a tax charged on intercompany transactions

21. Which of the following is a reason for a parent to use discretionary transfer prices?
A) improve competitive position of foreign operation
B) minimize import duties
C) avoid restrictions on repatriation of funds
D) All of the above
22. What is the general rule for international transfer pricing advocated by the
Organization for Economic Cooperation and Development (OECD)?
A) cost-based prices
B) negotiated prices
C) arm's length prices
D) discretionary prices
23. What power is given to the Internal Revenue Service (IRS) under code section 482?
A) power to eliminate intercompany transactions
B) authority to audit international transfer prices
C) authority to impose tariffs on foreign imports
D) All of the above
24. Which of the following is NOT within the power of the Internal Revenue Service
(IRS) under code Section 482?
A) authority to audit international transfer prices
B) authority to adjust international transfer prices
C) authority to levy addition taxes if a transfer price is deemed inappropriate
D) authority to stop intercompany transactions
25. According to IRS code Section 482, what is the standard used by the IRS for
international transfer pricing?
A) cost-based prices
B) discretionary prices
C) negotiated prices
D) arm's length prices

26. IRS code Section 482 describes appropriate transfer prices as the prices which would
have been agreed upon between unrelated parties engaged in the same or similar
transactions under the same or similar conditions in the open market. How does it
refer to such prices?
A) arm's length prices
B) market prices
C) international prices
D) comparable prices
27. According to the Internal Revenue Service, the most reliable measure of an arm's
length prices for sales of tangible property in intercompany transactions is:
A) cost-plus method
B) comparable profits method
C) comparable uncontrolled price method
D) resale price method
28. In keeping with Internal Revenue Code, Clarence Company transfers goods to
Marguerite Corporation, its foreign subsidiary, at the price Marguerite will sell the
product to its customers, less the industry's average gross profit margin of 30%. What
method of transfer pricing is Clarence using?
A) cost-plus method
B) comparable uncontrolled price method
C) comparable profits method
D) resale price method
29. Under what condition does the IRS consider the resale price method acceptable as a
transfer price?
A) The subsidiary is a foreign controlled corporation.
B) The related party is primarily a sales subsidiary.
C) The divisions are part of a decentralized organization.
D) There is no market price upon which to base the transfer price.

30. A cost-plus transfer pricing scheme is allowed by the Internal Revenue Service when:
A) it is easiest for the taxpayer to calculate.
B) the related party is primarily a sales subsidiary.
C) there is no readily comparable market price and the related buyer is more than just
a distributor.
D) the average industry mark-up is greater than the taxpayer's standard markup.
31. Using the comparable profits method of transfer pricing, the transfer price is
determined by:
A) backing into it based on objective measures of sales, operating expenses, and a
reasonable profit margin on sales.
B) adding a standard profit margin to the operating expenses of the buying division.
C) dividing a reasonable amount of profit between the selling and buying divisions.
D) comparing the normal profits of the selling and buying divisions and basing the
price on the highest margin.
32. In addition to regulating the transfer prices on tangible property, the Internal Revenue
Service also provides guidance on:
A) interest charged on intercompany loans.
B) transfer prices for intangible property.
C) charges for intercompany services.
D) All of the above
33. Correlative relief is a component of the U.S. Model Income Tax Treaty. What is
correlative relief?
A) Additional tax imposed by the IRS related to a transfer pricing audit is offset with
a foreign tax credit in the same amount.
B) When the IRS adjusts an international transfer price, the tax authority in the
foreign country makes a corresponding adjustment.
C) The burden of revising transfer pricing schemes is offset by reduction of the
corporate tax rate on foreign source income.
D) IRS and foreign taxing authorities will collaborate in determining the appropriate
international transfer price.

34. What is an advance pricing agreement?
A) a transfer price that is negotiated between two divisions of a decentralized
organization
B) a transfer pricing method accepted by the IRS before an intercompany transaction
is completed
C) a contract between a parent company and a foreign subsidiary to complete a
transaction at a specified future price
D) a foreign currency firm commitment with payment before delivery of the product
35. What is the advantage of an advance pricing agreement?
A) IRS will not challenge the transfer price after the tax return is filed if the
agreement is followed.
B) World-wide taxes will be minimized.
C) The brief form explaining the transfer price to be used can be completed with
minimal effort by the taxpayer, but will reduce a tremendous amount of work later.
D) All of the above are advantages of APA.
36. Which of the following is true about advance pricing agreements?
A) They are only granted for intercompany transactions between a U.S. parent and a
foreign subsidiary.
B) They are only granted for intercompany transactions between a foreign parent and
a U.S. corporation.
C) In 2003, the IRS approved several thousand advance pricing agreements for U.S.
taxpayers.
D) None of the above is true.
37. According to a U.S. General Accounting Office report, what percent of foreigncontrolled corporations paid $0 of federal income tax in the period 1996-2000?
A) 22%-27%
B) 35%-45%
C) 67%-73%
D) 80%-92%

38. In a 2007 Ernst & Young survey, which industry was found most at risk for a transfer
pricing adjustment?
A) consumer packaged goods
B) pharmaceuticals
C) petroleum
D) manufacturing
39. Worldwide, which type of transfer is most likely to be audited?
A) royalties paid for intangible assets
B) r & d conducted for related parties
C) intercompany services
D) interest on intercompany loans
40. Which is NOT a common risk associated with local authorities scrutiny of a
companys transfer prices?
A) potential double taxation
B) uncertainty as to the groups worldwide tax burden
C) problems in relationships with local tax authorities
D) discovery of a tax treaty violation
Answer: D Level: Hard LO: 7
41. For what reason are the transfer prices of imports more closely monitored worldwide
than are exports?
A) political implications
B) effect on local job availability
C) impact on a country's balance of trade
D) All of the above
10

42. Of the signals that may cause a taxing authority to audit a company's transfer price,
which one is the most important?
A) the nature of the business of the multinational corporation
B) unexpectedly low profit
C) profits higher than expected for a specific industry
D) parent company located in an emerging economy
43. According to a 2007 study by Ernst & Young, what percentage of respondents had
experienced a transfer pricing audit somewhere in the world since 2003?
A) 10%
B) 25%
C) 50%
D) 90%
44. Which of the following statements is true about applying the arm's-length standard for
transfer pricing?
A) A unique transfer price will be objectively determined using the arm's-length
concept.
B) Since a range of transfer prices would conform to the arm's-length concept,
taxpayers can minimize taxes by choosing a transfer price at one end of the range.
C) The arm's-length concept is accepted worldwide as the optimal transfer pricing
model.
D) Purchasing divisions prefer the arm's-length standard for transfer pricing over
alternative methods.
45. The comparable uncontrolled transaction (CUT) method is one alternative for
determining an arm's-length transfer price for what kind of intercompany transaction?
A) interest on intercompany loans
B) sale of tangible property
C) licenses of intangible property
D) intercompany services
11

46. The price for using intangible property is called:
A) interest
B) rent
C) royalty
D) service charge
Answer: C Level: Easy LO: 5
47. Which cost will be minimized by setting a low transfer price?
A) withholding taxes on a downstream transfer
B) import duties
C) currency devaluation of foreign cash flows
D) All of the above
48. The Internal Revenue Service determined that Covington Ltd should have been using
a transfer price of $400 for the purchase of goods from its U.S. subsidiary, but had set
the price at $50. What is the rate of penalty that the IRS can impose on the taxpayer?
A) 10% of the amount of taxes underpaid
B) 20% of the amount of taxes underpaid
C) 40% of the amount of taxes underpaid
D) 100% of the amount of taxes underpaid
Answer: C Level: Hard LO: 4
49. What is a prime reason that the IRS has found it difficult to obtain information needed
to examine the transfer pricing scheme of foreign parents with U.S. subsidiaries?
A) The information is held by the foreign parent, which is beyond the jurisdiction of
the U.S. taxing authority.
B) Since transfer pricing is not a significant issue to multinational corporations, little
information about it exists.
C) United States does not have tax treaties with the most important countries
involved in foreign direct investment in this country.
D) Computer systems have not been adapted to receive the data from companies in
foreign countries.
12

50. What is the time frame in which taxpayers must produce documentation to the IRS, in
which it justifies the transfer pricing method which it has selected as being the most
reliable measure of arms-length price?
A) 90 days
B) 60 days
C) immediately upon request
D) 30 days
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Chapter 11 International Transfer Pricing

Multiple Choice Questions

Doupnik, International Accounting 2e