Notes 4.

5: Transfer Pricing
Created @July 22, 2021 5:36 PM

Class ACYMAG1

Type Class Lecture

Reviewed

How different is Transfer Pricing with the Pricing discussed in Unit3?

Transfer Pricing: Involves the same organization

2 units within the same Organization

Notes 4.5: Transfer Pricing 1

 Internal Pricing: Price charged for another unit within the same
organization and not an external customer

Example: You have a Producing Department 1 producing the Finished

Goods used as a Direct Material of Producing Department 3. In this case.
Producing Department 3 has the option whether to buy from Producing
Department 1 or outside the organization

Producing Department 3 does not automatically use Producing

Department 1's products due to coordination and may be in different
locations, thus may not know they are producing it

Managers might not opt to buy from the organization since lowest
price possible is desired, which is why it is an issue regarding Goal
Congruence

Pricing discussed in Unit3: Involves the company and external customer

Transfer Price

Selling or Transferring Division: Records Income

Buying or Receiving Division: Records Cost

Both division want to increase their Profits, thus Selling Division makes
sure they sell at the highest possible price, while the Buying Division
makes sure to buy at the lowest possible price, thus have to come up with

Notes 4.5: Transfer Pricing 2

 a win-win situation or the Transfer Price to assure transfer (internal sale) to
take place

Objectives of Transfer Price

Since managers ant to make sure that they will be able to achieve the overall
company objective, of earning more income profit

Notes 4.5: Transfer Pricing 3

 Decision whether to purchase or sell internally or externally is automatically a
decision made by the division manager, thus performance evaluation is
accurate

Since division managers are allowed to set their prices and negotiate them, we
maintain division authority within divisions, thus autonomy is preserved

General Rule

Transfer Price = Minimum Price + Opportunity Cost per Unit

Minimum Price: The lowest price possible, which is not below the Cost or
savings from Cost

Transfer will not happen if selling externally is better

Maximum Price: Transfer will not happen if buying externally is better

Buying Division: Amount to pay if purchased externally

Opportunity Cost: Amount of division margin to be sacrificed because of the

choice to purchase externally rather than internally

Notes 4.5: Transfer Pricing 4

 Cost-based

Similar to Cost plus Pricing wherein you can base it to costs

Market-based

Used when there is no excess capacity or when we operate in a Perfect

Environment without excess capacity

Whatever is charged to the external customers is also the Transfer Price

However, sometimes there is no Selling Price available in the market

If there is information about this, we use this as the Transfer Price

Negotiated

Used in order to preserve or maintain autonomy

If Selling Division has better bargaining skills: Expect that the Transfer Price
will lean towards the Market Price or the Maximum Price

If Buying Division has better bargaining skills: Expect the Transfer Price to be
near the Minimum Price, which is the Cost

If no Transfer Price is achieved: Company can come in and arbitrate or

mediate the argument

Notes 4.5: Transfer Pricing 5

Notes 4.5: Transfer Pricing 6