2. Objectives of Transfer Pricing
Provide relevant information to
determine the optimum trade-off
between company costs & revenues.
Induce goal congruent decisions.
Help measure the economic
performance.
Simple & easy.
3. Transfer Pricing Methods
Transfer price is the value placed on a
transfer goods or services in transactions
in which at least one of the two parties
involved is a profit center.
4. The Fundamental Principle
The transfer price should be similar to the price that
would be charged if the product were sold to outside
customers or purchased from outside vendors.
Two decisions are involved in designing a transfer
price system:
1. The sourcing decision: Should the company
produce the product inside the company or
purchase it from the outside vendor?
2. The transfer price decision: At what price should a
product be transferred between profit centers?
5. The Ideal Situation
Competent People
Good Atmosphere
A Market Price
Freedom to Source
Full Information
Negotiation
6. Constraints on Sourcing
Limited Markets
1. The existence of internal capacity might limit the
development of external sales.
2. If the company is the sole producer of a
differentiated product, no outside source exists.
3. If a company has invested significantly in
facilities.
Excess or Shortage of Industry Capacity
7. Cost-Based Transfer Prices
If competitive price not available,
transfer prices may be set on the basis
of cost plus a profit.
Two decisions must be made:
1. How to define cost.
2. How to calculate the profit markup.
8. The Cost Basis
The usual basis is standard cost.
The Profit Markup
Two decisions:
1. What the profit markup is based on.
2. The level of profit allowed.
The profit markup base on:
Percentage of costs
Percentage of investment
Base the profit allowance on the investment required
to meet the volume needed by the buying profit
centers.
Cost-Based Transfer Prices
9. Upstream Fixed Costs & Profits
Agreement among business units.
Two-Step Pricing
Profit Sharing
Two Sets of Prices
10. Pricing Corporate Services
Exclude the cost of central service staff units
over which business units have no control
(e.g., central accounting, public relation,
administration).
Control over amount of Service:
1. Standard variable cost.
2. Full cost: standard variable cost plus a fair share of
the standard fixed costs.
3. Market price: standard full cost plus a profit margin.
Optional use of services.
Simplicity of the price mechanism.
11. Administration of Transfer Prices
Negotiation
If headquarters control pricing, line’s
management’s ability to affect profitability is
reduced.
Line management usually have the best
information on markets & costs.
Arbitration & Conflict Resolution
Assign to single executive
Set up a committee