The task of handling the cost of shared services or transfer pricing brings with it several accounting and administrative challenges. These include:

The determination of a fair price: The transfer price can be determined on any full absorption costing basis, a market price basis, a dual-pricing basis or simply an agreed price based on specific capacity levels or a required return on investment.

General ledger implications: The transfer pricing system may have a serious impact on the operation of the organisation's general ledger. For proper divisional profitability reporting, business units may require that transfers of costs be accounted for in the general ledger(s). Transfer prices for shared services may be defined between hundreds or thousands of entities and cost centres, and for hundreds or thousands of products and services. The sheer number of entries this entails makes it an accounting nightmare.

If there is a single general ledger, the problem is not as serious as it is when the various business units use different and, sometimes, completely independent general ledgers because they are separate legal entities or are physically segregated. The financial manager must, therefore, devise a method whereby costs are entered into the various general ledger systems, taking into consideration appropriate inter-company loan accounts.

Implications for taxation: Tax authorities worldwide cast a critical eye on transfer pricing regimes where the aim might be to minimise tax liabilities between entities. This is particularly relevant where one party may be subjected to a higher or lower tax rate than the other as a result of the existence of accumulated tax losses. In this case the transfer price must be defendable.

Consolidations and unearned profits: The issue of unearned profits on inter-company transactions may also arise in the case of shared services, but is less likely than in the case of goods transferred but unsold. "Work in progress" is often raised by entities, and some transfer of cost can be construed as unearned and may therefore be written back. Obviously, the internal turnovers should not be duplicated in the consolidated accounts.

A shared services transfer pricing system gives effect to the SILA. It determines periodically (normally every month) what the right charge between the entities should be. This is based on the volume of service rendered for a specific period and is multiplied by the appropriate price in terms of the SIA (it may even be a fixed amount). The same service may be delivered to several business units but not necessarily at the same price. If a penalty clause is invoked, this must be taken into consideration in the chargeable amount.

Internal invoices may, therefore, be issued between the parties as evidence of the `transaction', as in any conventional accounting system. If the parties wish this transaction to be recorded in the general ledger, the provider's relevant internal revenue accounts and the purchaser's relevant expense accounts must be updated. In some instances, the transaction is concluded with a cash payment. A full debtor/creditor relationship therefore exists and must be accounted for.

For external reporting purposes these internal transactions must be eliminated. This is done by selecting pre-defined accounts for the purpose and ensuring that they contra out for later reversal if necessary.

Administering a transfer pricing system for shared services without the help of the appropriate technology can be a problem. The sheer administrative effort required can foil the best intentions, but a properly designed system will reduce this burden and allow accounting interfaces to be provided with ease. A system that sets up the SLA with appropriate interfaces to the various general ledgers and source systems for service volumes is required.

The transfer pricing system contains all current information on the SJA and pulls volumetric data from source systems. It then performs the cost calculation in terms of the SLA and produces an internal invoice for the parties. When approved, invoices are posted to the appropriate general ledger for updating. Internal invoicing is an important part of the transfer pricing solution. Using conventional invoicing systems this is a laborious job, so a system that automatically creates invoices based on the parameters defined in the SLN will save on administrative effort here. This is structured to provide for VAT automatically where applicable.

The technological solution could also play an important part in the integration of the internal invoicing system with the general ledger. If relevant accounts to be updated are identified and an automated interface to the general ledgers is developed, the administrative effort needed to operate the system can be reduced dramatically. Often purchasers are in different legal entities, meaning that the integration has to span several general ledger systems, but this too can easily be achieved with the appropriate IT.

Accounting for shared services is a new concept making an important contribution in managing support costs and providing transparency. Support costs are the last major component of cost that has not been subjected to intense scrutiny, but accounting for shared services offers exactly this opportunity.

(Edited extracts from Financial Management, a journal of CIMA, London. www.cimaglobal.com.)

Article E-Mail :: Comment :: Syndication