Transfer Pricing

Definition
Value placed on transfers within an organization,

used as a means of allocating costs to various profit centers is transfer pricing.

The price at which divisions of a company transact

with each other. Transactions may include the trade of supplies or labor between departments.

 Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as multiseparately run entities.

Objectives of TP
1. It should provide each business unit with the relevant information. 2. It needs to determine optimum trade off between companies cost and revenue. 3. It should induce the goal congruence decision to improve units profit. 4. It should help to measure the economic performance of individual business unit. 5. The system should be simple to understand and easy to administer.

Criteria for validity & acceptability of TP

1. TP should be objectively determined.

2. TP should be equal to the value of the

intermediate product being transferred.

3. TP should be compatible with a policy that

maximises attainment of the companies goal and evaluation of segments performance.

TransferTransfer-Pricing Methods

Market-based transfer prices Cost-based transfer prices Negotiated transfer prices

MarketMarket-Based Transfer Prices

By using market-based transfer prices in a perfectly competitive market, a company can achieve the following: Goal congruence Management effort Subunit performance evaluation Subunit autonomy

MarketMarket-Based Transfer Prices

Market prices also serve to evaluate the economic viability and profitability of divisions individually.

CostCost-Based Transfer Prices

competitive prices are not available transfer prices may be set on the basis of Cost-Plus a profit. Two decisions must be made in a cost based TP sys. 1)How to define cost. 2)How to compute the profit markup. The usual basis is standard costs. Actual cost should not be used because production inefficiencies will be passed on to the buying profit center.
If

TP & profit share system

This system operates as follows:1)The product is transferred to marketing unit at Standard variable cost. 2)After selling of product the business unit Shares the contribution earned which is Selling price-VC& marketing cost.

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