Transfer pricing: inter-company charges/ inter-company sales or purchases/ management fees/

Transfer pricing is a hot topic among accountant in almost every countries. Transfer pricing become a significant topic following the globalization foot-step, where cross-border transactions become more and more common. Your audit client may have a head office in Singapore, a packaging plant in Malaysia, while a main manufacturing plant in China. The supply chain of the audit client can span accross different countries.

Of course, when a inter-company / related company rendered service for other inter-companies / related companies, a price will be charged. The question is: how much to be charged? on what basis should the audit client determine the pricing / gross margin ( in circumstances of cost plus company) on inter-company transactions.

It is important for us to highlight to client to have a basis on determining the inter-company charges (including: sales transaction, purchase transaction). The inter-company transactions should be conducted on an arms length basis (i.e. the pricing should not differ materially from the market price). This is because local tax authority is concern on potential tax manipulation to record higher margin at lower tax rate country / region.

Hence, a proper documentation on transfer pricing is important to support all inter-company transaction. Management should always make reference to market price to assess if transfer pricing is conducted on an arms length basis.

In addition, it is common for holding company / other entities within the Group to charge managment fee to other inter-companies for certain centralised function  (e.g. shared service centre)/ corporate service. Likewise, a proper documentation and computation is required to support the basis of determining the management fee.

As auditor , we need to understand the basis of management in coming up the transfer pricing documentation and  to reivew for high level reasonableness.

IFRS 7: Financial Instruments- Disclosure: Receivables that are past due but not impaired

IFRS 7 set out certain disclosure requirements relating to financial instrument of the entity. One of the key requirements is: our audit client is require to disclose the analysis of the age of the financial assests that are past due but not impaired.

In general, this relates to trade receivables / other receiables from custoemrs or other third parties. This disclosure allowed financial statement users to have more information relating to the aging profile of the Company, especially those debts that are past due, but not impaired.

A general things to highlight to audit client is to emphasize that the aging table should be prepared based on the due date of the debts, instead of the age of the invoice. Auditor is required to perform testing ot the aging profile, as well as performing high level review on the aging profile prepared by client. This shall be cross checked against the debtors' turnover of the Company.

To illustrate, if our audit client has a debtors' turnover of 90 days, we will then expect the aging profile to have certain debts that are more than 90 / 120 days.

Please feel free to contact us at myauditing@gmail.com if you need more insight on this.

Internaitonal Standard on Auditing: Communication with those charged with governance

International Standard on Auditing ("ISA") 260 deals with the "Communication with those charged with governance".

For the purpsoe of ISA 260, the standard has defined the following:


10. For purposes of the ISAs, the following terms have the meanings attributed below:

(a) Those charged with governance – The person(s) or organization(s) (for

example, a corporate trustee) with responsibility for overseeing the

strategic direction of the entity and obligations related to the

accountability of the entity. This includes overseeing the financial

reporting process. For some entities in some jurisdictions, those charged

with governance may include management personnel, for example,

executive members of a governance board of a private or public sector

entity, or an owner-manager. For discussion of the diversity of

governance structures, see paragraphs A1-A8.

(b) Management – The person(s) with executive responsibility for the conduct

of the entity’s operations. For some entities in some jurisdictions,

management includes some or all of those charged with governance, for

example, executive members of a governance board, or an owner-manager.   ISA 260 has stated the matters required to be communicated to those charged with governance, as below: - Auditor's responsbilities in relation to the financial statement audit; - planned scope and timing of the audit; - significant findings from the audit; - Auditor independence   This is a very important auditing standard, whereby all the audit team members, especially audit executive need to master. This standard clearly defines on the audit matters to be communicated, to whom to be communicated, and the communication process. Hence, we suggest all audit executives to read through this ISA 260 to ensure that the audit team has complied with the standard.

Purchase Price Allocation Review- Intangible Assets- A Cross Check

Meger & acquisition activities never disappear, even when the economy appears to be slowed down. Entity with strong balance sheet and with huge cash on hand will acquire certain companies when the valuation is relatively cheaper.

When your audit client acquire a company. They are required to perform Purchase Price Allocation review, which allocates the consideration to the relative fair value of the tangible and intangible assets / liabilities acquired, with the remaining amounts recorded as goodwill/ bargain purchase.

Usually, an audit client will engage an external valuer to value the tangible assets / liabilities and intangible assets acquired. In general, intangible assets (such as: brand name/ customer list) is not recorded on acquiree' balance sheet.

We will talk more about the details of purchase price allocation review in our future posts. A very way to understand the business rationale of acquiring the target is to compare the net asset of the target company to total consideration paid by your audit client.

To illustrate, audit client has paid US$10mil to acquire a target company with a net asset value of US$1mil. It appears to you that the Company has paid US$9mil to acquire certain intangible assets or certain items not recorded at fair value on target's balance. There is a number of possible reason:

- target company has strong brand name;
- target company has comprehensive list of customer relationship;
- land & building was recorded at cost and not at fair value (note: this is allowed under accounting standard);
- a goodwill the Company is willing to pay for; etc etc

By comparing the total consideration against the net asset of the target company, you will be able to find out the business rationale of acquiring the target company and assess if the acquisition fits into the client's long term business objective. Please, never fail to understand the business rationale while you perform the auditing.

Value of engaging Big 4 accounting firms

In previous post, we invited opinions/ comments from our reader to discuss the value of engaging Big 4 accounting firms. After considering the opinions/ comments received from Accounting & Auditing blog's reader, we would like to share with you our thought:

- established reputation / recognition by the financial markets ( majority of the Blue Chip companies appointed Big 4 as their auditor);
- established audit methodology developed by respective firms (i.e. existence of technical department, etc);
- stronger support from administrative department;
- integrated support from member firms globally to ensure that audit of foreign subsidiaries are carried out smoothly;
- internal quality review policy carried out to review that quality of the audit meet the firm standard

Of course, while there is a value of engaging Big 4, there is a premium need to be paid for. Fee charged by Big 4 accounting firms is, on average, higher than those medium tier audit firm (e.g. BDO, Horwath, etc). Please feel free to drop us an email at myauditing@gmail.com if you woud like to find out more from us.