2. There are several situations in which goods are bought and
sold among various divisions and departments of an
organization.
3. T.P. is defined as the value placed on transfer of goods or
services among two or more profit centers.
It is a behavioral tool and not accounting tool.
4. For profit center selling the goods, T.P. will be the major
determinant of its revenue.
For buying profit center it will be major determinant of the
expenses incurred.
The price of inter-divisional sales affects the selling division’s
sales and the buying division’s costs.
5. Objectives of transfer prices
Should provide each segment with relevant information
required to determine the optimum trade off between costs
and revenue.
Should induce goal congruence
Should help measure economic performance
Should be simple and easy to operate.
6. Fixation of Transfer price
A division may operate in two distinct situations:
Completely independent of each other
Divisions are inter dependent
7. Independent division
Market price of the products manufactured are available
T.P. is the current market price and divisional profitability is
measured as if the division is an independent company.
Decision making autonomy
Co-ordination among divisions and conflicts are minimum.
8. Inter dependent divisions
There may not be any outside source for the product.
If the product is a key component, top management may not
allow outsourcing.
9. Try to get information about market price
If exact prices are not available, approximate market price
should be estimated through appropriate market intelligence.
M.P. is not available cost based transfer prices are used.
10. Selling divisions are allowed a profit margin over and above
the cost of the product.
A standard cost is developed and T.P. is based on it.
This may be adjusted for price level changes in the prices of
materials etc.
11. Idea of using standard costs is that the inefficiencies of the
selling division should not be passed on to the buying
divisions.
12. Cost based T.P.
Increase in actual cost will not be considered for standard
cost.
There is no incentive for the selling division to reduce
standard costs
13. How much profit margin should be
allowed
Selling division may be allowed a mark up % related to the
assets employed in making the product.
14. In case if the division is selling exclusively to other divisions
and outside customer does not exist, the divisional manager
principal responsibilities will be for control of costs, control
of quality and production schedules.
15. The divisional manager has hardly any marketing
responsibility and his revenue is determined by the
marketing decisions of the buying division.
Since the volume of sales and hence pricing decisions are not
within the control of the selling division, the profits of the
selling division are not a true indicatior
16. Methods of calculating T.P.
Fixed monthly charges (two-step pricing)
Profit sharing system
Two sets of prices
17. Profit sharing system
Product is transferred to marketing unit at standard variable
cost
After the product is sold, business units share the
contribution margin earned.
18. How to divide contribution margin
Since the contribution is not allocated until after the sale has
been made, the manufacturing unit’s contribution depends
on the marketing unit’s ability to sell and on the actual selling
price.
19. Two sets of prices
The manufacturing unit’s revenue is credited at the outside
sales price.
Buying unit is charged the total standard costs.
Difference is charged to headquarters' account and
eliminated when the business unit statements are
consolidated.
21. This method motivate business units to concentrate on
internal transfer
Sum of the business unit profit is greater than overall
company profits.
It creates an illusive feelings that business is making profit.
Additional bookkeeping involved in debiting headquarters'
account
23. If control of pricing is left to the head quarters’ staff, line
management’s ability to affect profitability is reduced.
A negotiated T.P. often is the result of compromises made
by both buyer and seller
If headquarters establish T.P. business units managers can
argue that their low profits are due to arbitrariness.
24. Business units have the best information on markets and costs
and so are best able to arrive at reasonable prices.
They should know the ground rules within which these T.P.
negotiations are to be conducted.
25. In a few co H.O. informs business units that they are free to
deal with each other or with outsiders as they think fit, but if
there is a tie the business must be kept inside.
26. Arbitration and conflict management
No matter how specific the pricing rules are there may be
instances in which business units will not be able to agree on
a price.
Such disagreements are resolved by referring the decision to
headquarters and seeking its arbitratrion.
27. Arbitration can be done in two ways
Assigning a single executive
To set up a committee
