Here are a few guidelines when asked about inventory pricing and transfers between related companies, especially when one is a foreign related entity:
1. The first issue is the notion of transfer pricing between related companies. These should be constructed as if they were arm length transactions between unrelated buyers. Often times there is a temptation to load or unload costs between entities for tax benefits. This is a highly scrutinized area and whatever the pricing scheme is used it should be highly documented. When two countries are involved there more than likely will need to be disclosure on a reporting form .
2. The second point is the allocation of overhead to inventory. If you were a manufacturer you are required to allocate manufacturing overhead to the product. If you are a reseller, then this is not required and to do so should be done in line with a common sense approach. Part of the costs should include samples, bad product, additional rework, etc. and this can be a flat percentage based on experience. Whatever is used should be consistently applied so there is no variation from year to year.
3. Then there is the ordering of costs. There are two approaches. FIFO which stand for first in first out so the first purchases are assumed to be the first sold and LIFO which assumes the last purchases to be the first out. During inflationary times LIFO results in a more representative cost. Both are legitimate but need to be consistently applied.
Written by John M Matras CPA
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