Transfer pricing refers to the prices charged for goods and services transferred between divisions within the same company. There are several approaches to setting transfer prices, including using market prices, cost-based prices, negotiated prices, or administered prices set by a rule. The objectives of transfer pricing are to provide accurate performance measurement for each division, encourage goal congruence between divisions, and mimic external market prices. Key considerations include using transfer prices that motivate optimal sourcing and production decisions for the entire company.

1. Transfer Pricing
Chapter 6

2. A transfer price is the price one subunit charges
for a product or service supplied to another
subunit of the same organization.
Transfer price is a value at which goods and
Services are Transferred between divisions in a
decentralized organizations .
Intermediate products are the products
transferred between subunits of an organization.

3. Transfer Pricing
• What is transfer pricing?
• It is a set of tools and methods used to
attribute revenues earned by the organization
to organization sub-units.

4. Objectives of Transfer Prices
• It should provide each Business Unit with
relevant information so that Trade-off
between company cost and revenue
• Decision that improve business unit profit will
improve company profit so It should induce Goal
Congruence decision
• Measure the economic performance of
business unit
• Simple to understand, easy to administer

5. 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 must be made periodically
– Sourcing decision
– Transfer price decision

6. Approaches to Transfer Pricing
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There are four approaches to transfer pricing:
Market-Based
Cost-Based
Negotiated
Administered

7. Approaches to Transfer Pricing
Market-Based Transfer Pricing
If a good external market exists
for the transferred product or service,
then market prices are the most
appropriate basis for pricing.
Unfortunately, these markets
with well-defined prices seldom exist.

8. Approaches to Transfer Pricing
Cost-Based
Transfer Prices
Variable cost plus a markup
Full cost
Full cost plus a markup

9. The Ideal Situation
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Competent people
Good Atmosphere
A Market price
Freedom to Source
Full information
Negotiation

10. Constraints on Sourcing
• Limited Markets
– Existence of Internal capacity
– Sole producer of Differentiated products
– Company’s investment in Fixed cost
Excess or shortage of Industry capacity

11. Cost based Transfer price
• Two decision must be made
– How to define cost
– How to calculate Profit Markup

12. Cost based Transfer price
1. The Cost Basis
•
Standard cost is the base
2.The Profit Markup
•What the profit markup is based on
•The level of profit allowed

13. •Agreement among Business Unit
• Two Step Pricing
– Transfer price includes two charges
• Standard variable cost per unit
• Fixed cost associated with unit
“Take or pay” pricing

14. • Profit sharing
– The product is transferred to the Marketing Unit
at Unit Variable cost
– After the product is sold, the Business units share
the contribution
• Two sets of pricing
– Manufacturing unit’s revenue is credited at
outside sales price and buying unit is charged total
standard cost
– The difference is charged to head quarters
account and eliminated when Business unit
statements are consolidated

15. Approaches to Transfer Pricing
Negotiated
Transfer Prices
Supplying and receiving responsibility
centers negotiate prices.
Prices reflect both negotiating skills
and economic considerations.
Optimal transfer price is the
the net realizable value of the last unit
supplied for all units supplied.

16. Approaches to Transfer Pricing
Negotiated
Transfer Prices
Reflect the accountability and controllability
principles underlying responsibility centers
Can easily lead to decisions that
do not provide the greatest economic benefits

17. Approaches to Transfer Pricing
Administered
Transfer Prices
Prices set by a rule, policy, or an arbitrator
Easy to administer
Arbitrary
Tend to violate the spirit of
the responsibility approach

18. How does company set TP
•PUBLISHED MARKET PRICE
•BIDS
•SIMILAR PRODUCT OUT SIDE MARKET