TRANSFER PRICING

1. TRANSFER PRICING
 THE AMOUNT CHARGED WHEN ONE DIVISION
SELLS GOODS OR SERVICES TO ANOTHER
DIVISION IS CALLED TRANSFER PRICE.
 THE TRANSFER PRICE ASSUMES IMPORTANCE IN
THE CONTEXT OF MEASUREMENT OF
PERFORMANCE IN THE PROFIT CENTRES OR
INVESTMENT CENTRES.

5. GOAL CONGRUENCE
 THE GOAL IN SETTING TRANSFER PRICES IS TO
ESTABLISH INCENTIVES FOR AUTONOMOUS
DIVISION MANAGERS TO MAKE DECISIONS
THAT SUPPORT THE OVERALL GOAL OF THE
ORGANISATION.
 THE TRANSFER PRICE SHOULD BE CHOSEN SO
THAT EACH DIVISION MANAGER, WHEN
STRIVING TO MAXIMIZE HIS OWN DIVISION’S
PROFIT, MAKE THE DECISION THAT MAXIMIZE
THE COMPANY’S PROFIT.

6. THE GENERAL TRANSFER –PRICING
RULE
 MANAGEMENT’S OBJECTIVE IN SETTING A
TRANSFER PRICE IS TO ENCOURAGE GOAD
CONGRUENCE AMONG THE DIVISION
MANAGERS INVOLVED IN THE TRANSFER.
 A GENERAL RULE THAT WILL ENSURE GOAL
CONGRUENCE IS GIVEN BELOW:
 T.P = VARIABLE COST OF + OPPORTUNITY
PRODUCT PLUS COST TO THE
ANY SPL OUTLAY COMPANY
DUE TO TRANSFER DUE TO TRANSF.

7. GENERAL TRANSFER PRICE RULE
 IN APPLYING THE GENERAL TRANSFER PRICING
RULE, WE WILL DISTINGUISH BETWEEN TWO
DIFFERENT SCENARIOS.
 SCENARIO 1: NO EXCESS CAPACITY.
 SCENARIO 2: EXCESS CAPACITY.

8. DIFFICULTIES IN APPLYING
GENERAL TRANSFER-PRICING RULE
 THE GENERAL TRANSFER-PRICING RULE WILL ALWAYS
PROMOTE GOAL CONGRUENCE DECISION MAKING, IF IT
CAN BE IMPLEMENTED.
 THE RULE IS DIFFICULT TO IMPLEMENT IN CASE IT IS
DIFFICULT TO MEASURE OPPORTUNITY COST.
 ONE REASON WHY OPPORTUNITY COST MAY BE
DIFFICULT TO MEASURE IS THAT THE EXTERNAL
MARKET MAY NOT BE PERFECTLY COMPETITIVE.
 SECOND REASON COULD BE THAT THE PRODUCT
TRANSFERRED TO UNIQUE, NOT HAVING EXTERNAL
MARKET.
 THIRDLY THE PRODUCT TRANSFERRED MAY BE MADE
UP OF MORE THAN ONE PRODUCT/SERVICES MAKING IT
DIFFICULT TO KNOW THE OPPORTUNITY COST OF
EACH.

9. TRANSFERS BASED ON EXTERNAL
MARKET PRICE
 A COMMON APPROACH IS TO SET THE TRANSFER PRICE
EQUAL TO THE PRICE IN THE EXTERNAL MARKET.
 WHEN THE PRODUCTION DIVISION HAS NO EXCESS
CAPACITY AND PERFECT COMPETITION PREVAILS, THE
GENERAL TRANSFER PRICE RULE AND EXTERNAL
MARKET PRICE WILL YIELD THE SAME TRANSFER PRICE.
 IF THE PRODUCTING DIVISION HAS EXCESS CAPACITY
AND PERFECT COMPETITION DOES NOT PREVAIL, THEN
THE TWO METHODS WILL GIVEN DIFFERENT TRANSFER
PRICES.
 IN CASE THIS SYSTEM IS FOLLOWING, BOTH THE
PRODUCING AS WELL AS BUYING DIVISIONS SHOULD BE
FREE TO SELL/BUY TO/FROM EXTERNAL MARKET.

10. NEGOTIATED TRANSFER PRICE
 DIVISION MANAGERS ACTUALLY NEGOTIATE THE
PRICE AT WHICH THE TRANSFER WILL BE MADE.
 SOMETIMES THEY START WITH MARKET PRICE AND
MAKE ADJUSTMENTS FOR VARIOUS REASONS.
 THIS METHOD IS USED SOMETIMES WHEN NO
EXTERNAL MARKET EXISTS FOR THE PRODUCT.
 TWO DRAWBACKS OF THIS METHOD ARE -
DIVISIVENESS AND COMPETITION BETWEEN
DIVISION MANAGERS AND UNDUE WEIGHTAGE TO
NEGOTIATING SKILLS OF A MANAGER IN
APPRAISING HIS PERFORMANCE.

11. COST-BASED TRANSFER PRICE
 VARIABLE COST: UNDER THIS APPROACH
VARIABLE COST IS SET AS THE TRANSFER PRICE.
 THE PROBLEM WITH THIS APPROACH IS THAT
THE PRODUCING DIVISION IS NOT ALLOWED TO
SHOW AND CONTRIBUTION ON THE
TRANSFERRED GOODS, EVEN IF IT HAS EXCESS
CAPACITY

12. FULL COST BASED TRANSFER PRICE
 UNDER THIS METHOD TRANSFER PRICE IS
EQUAL TO VARIABLE COST OF THE PRODUCT
PLUS AN ALLOCATED PORTION OF THE FIXED
OVERHEADS.
 TRANSFER PRICE BASED ON FULL COST RUN
THE RISK OF CAUSING DYSFUNCTIONAL
DECISION MAKING BEHAVIOUR.
 THIS HAPPENS BECAUSE THE BUYING DIVISION
PERCEIVES THE FIXED COST TO THE COMPANY
AS A WHOLE AS VARIABLE COST TO THE
BUYING DIVISION.

13. AN INTERNATIONAL PERSPECTIVE
 INCOME TAX RATES: MULTINATIONAL
COMPANIES OFTEN CONSIDER DOMESTIC AND
FOREIGN INCOME TAX RATES WHEN SETTING
TRANSFER PRICES.
 IMPORT DUTIES: THESE DUTIES ALSO PLAY A
ROLE IN SETTING TRANSFER PRICES IN CASE OF
GOODS BEING TRANSFERRED TO OTHER
DIVISIONS LOCATED IN DIFFERENT COUNTRIES.