Global Finance 407shipped. There are, of course, some potential offsetting disadvantages from
this practice:
- Charging higher transfer prices will increase ad valorem tariffs.
- Charging higher transfer prices will lower profits of the transferee firm
and potentially present problems in evaluating the profit performance of
the unit and its management. - Charging higher transfer prices might impair the competitive position of
the transferee firm. - Charging higher transfer prices lowers profits of the transferee firm and
could reduce its apparent financial strength in the eyes of lenders and
other users of its financial statements.
This enumeration of factors bearing on the setting of transfer prices is not
exhaustive. However, it should be sufficient to highlight the inherent complex-
ity of setting transfer prices. This complexity is magnified as the global reach
of multinational firms extends into a greater numbers of countries with wide
variations in taxes, competitive conditions, business practices, types of govern-
mental control, variability in exchange rates, and rates of inf lation. This last
factor, rates of inf lation, is discussed next in terms of its impact on measuring
the financial performance of domestic firms as well as foreign subsidiaries.
IMPLICATIONS OF INFLATION FOR
FINANCIAL PERFORMANCE
As Fashionhouse continued its evolution as a global firm, it considered locating
manufacturing capacity in countries with low labor costs. However, in many
cases high rates of inf lation were linked to low labor costs. Judging perfor-
mance in highly inf lationary environments presents special problems. At some
point, financial statements prepared from unadjusted (historical) cost data lose
their ability to provide reasonable indicators of either the financial perfor-
mance or status of firms. Several different approaches have been developed to
adjust historical cost financial statements. The principal methods can be clas-
sified as involving either (1) general price level or (2) current cost adjustments.
These two methods are illustrated below and contrasted with historical-cost
statements as the baseline. To provide some useful background, current man-
agement commentary on the impact of inf lation on financial performance
is presented.
Management Commentary on the Impact of and
Response to Inf lation
Management’s Discussion and Analysis, a section of the annual report required
by the SEC, often includes commentary on the implications of inf lation for finan-
cial performance. This commentary provides useful insight into management’s