Cost-Plus Method for Transfer Pricing

 

The Cost-Plus method is suitable to used by manufacturing companies or those performing production functions and can also be used for service providers. The Cost Plus method determines the transfer price by adding a reasonable cost-plus markup to the production costs of the product or service. Thus, the indicator used is the gross profit margin, but the gross profit margin of the manufacturing company, differ with the Resale Price Method which takes the gross profit margin from the sales company.

 

For example, PT Q Manufacture (a company in Indonesia) produces the Q-Light brand Car Lights, and this product has a production cost of USD 25 per unit, the cost-plus markup used is 20% so the selling price of the lamp is USD 30 for sales to Q. Sales Co (a company in Singapore), Q Sales Indonesia is a sales agent for lamps. Automotive light manufacturing has a cost-plus markup of 30%. Thus, using the cost-plus method, the arm’s length price for transfer pricing carried out by PT Q Manufacture should be USD 32.5 instead of USD 30.

 

The difficulty faced in applying the cost-plus method is because of the difference in function between the tested company and its comparable, especially if there are elements of the use of intangible assets that might affect the price set. Another thing that adds to the difficulty in applying the cost-plus method is the consistency of accounting practice. There is a possibility of accounting for cost components, for example research costs are recorded as part of the cost of goods sold, while in other companies these costs are recorded as general company operating costs.

 

In situations where there are operating costs that need to be considered for comparability, the Transactional Net Profit method, in general, will be more reliable than the Cost-Plus Method.

 

Pros of the Cost-Plus Method

 

The advantage of the Cost-Plus Method is that it is based on internal costs, where the information is available to multinational companies.

 

Disadvantages of the Cost-Plus Method

 

The disadvantages of the Cost-Plus Method include the following:

  1. There is possibility that profit margin from the cost with market price is not very related;

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  2. Gross profit margin data may not be comparable due to accounting inconsistencies and other factors;

  3. It requires accounting consistency between affiliated transactions and transactions between independent parties;

  4. The analysis only focuses on manufacturer company that carry out transfer pricing.

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