Transfer Pricing

• BY,
• KARAN WADHERA
MBA 4TH SEM
RT1803A16
 TRANSFER PRICING

Transfer Price is the price one subunit charges for

a product or service supplied to another subunit
Of the same Organization
 Transfer Pricing

Profit Centre Input are related to Output

Input Output
EC RC
Money Cost Money Profit

Production Marketing Business Unit

Buying cost Selling cost

Selling cost Buying cost
Variable cost Variable cost
Fixed cost Fixed cost
Profit margin

3
TRANSFER PRICING CYCLE
 TRANSFER PRICE REGULATIONS

• The Finance Act 2001 introduced the detailed

TPR w.e.f. 1st April 2001
• The Income Tax Act
• AS-18
 FACTORS AFFECTING TRANSFER
PRICE
• INTERNAL • EXTERNAL
FACTORS: FACTORS:
 PERFORMANCE  ACCOUNTING
 MEASUREMENT STANDARDS
 EVALUATION  INCOME TAX
AUTHORITY
 CUSTOM DUTY
 CURRENCY
FLUCTUATIONS
 METHODS FOR TRANSFER PRICING
COST BASE
MARKET BASE
MARKET
TREANFER
PRICING
PRICING

N
E
G
O
TI
A
T
E
D
T
R
A
N
SF
E
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P
RI
CI
N
G
 MARKET BASE TRANSFER PRICING

TRANSFERRING AT MARKET PRICE

IS BEST IF:-

• PERFECTLY COMPETITIVE MARKET

• INTERDEPENDENCE OF SUBUNIT IS MINIMAL
• NO ADDITIONAL COST-BENEFITS TO COMPANY
 ADVANTAGES
– Forces selling division to be competitive
with market conditions
– Does not penalize buying division by
charging a price greater than it would have
to pay on the market
 DISADVANTAGES
May lead selling division to ignore negotiation
attempts from buying division and sell directly to
outside customers
• Could cause an internal shortage of materials
• Forces buying division to purchase materials from the
outside
• Overall company profits may fall even though selling
division makes a profit
 DRAWBACKS
• The major drawback to market-based prices is
that market prices are not always available for
items transferred internally
 COST BASE TRANSFER PRICING

• About half of the major companies in the

world transfer items at cost.
 COST BASE TRANSFER PRICING

• SOMETIMES THE MARKETS ARE

UNAVAILABLE ,INAPPROPIATE OR TOO
COSTLY TO BE USED AS TRANSFER
PRICE.
• IN SUCH CASE WE SHALL FOLLOW THE
COST BASE TRANSFER PRICING
 COST BASE TRANSFER PRICING

VARIOUS METHODS ARE:-

 FULL COST
 COST + MAKE UP
 MARGENAL COST
 MARGENAL COST +ROI
 PROBLEM
• XYZ CO. HAS TWO SUB UNITS A&B. DIVISION A PURCHASES
CERTAIN UNITS FROM B @ RS. 7500/UNIT.
• DIVISION B PLANS TO RASE TO RAISE THE PRICES FROM
RS.7,500 TO 10,000.
• VARIABLE COST FOR DIVISION B IS RS. 7000/ UNIT & FIXED
COST IS RS.15,00,000 AND ITS OUTPUT IS 1,00,000 UNITS.
• IF DIV. A BUYS FROM OUTSIDE DIV. B WILL RERMAIN IDEAL
AND A CAN PURCHASE THESE @ RS. 7500 / UNIT FROM
OUTSIDERS
SO FRIENDS SHALL THE CO. ALLOW TO MAKE PURCHASES
FROM OUTSIDERS OR NOT??????????????
 NEGOTIATED TRANSFER PRICING

• Companies heavily committed to segment

autonomy often allow managers to negotiate
transfer prices.
 NEGOTIATED TRANSFER PRICING

Negotiated transfer prices arise from the outcome of a

bargaining process between selling and buying divisions.
• Where subunits of a firm are free to negotiate the transfer
price between themselves and then to decide whether to
buy and sell internally or deal with external parties
• May or may not bear any resemblance to cost or market
data
• Often used when market prices are volatile
• Represent the outcome of a bargaining process between
the selling and buying subunits
DYSFUNCTIONAL BEHAVIOR
Virtually any type of transfer pricing policy
can lead to dysfunctional behavior – actions
taken in conflict with organizational goals.
 ADVANTAGES
• Decentralisation
• Better information about costs and benefits
• Most appropriate where there are market
imperfections for the intermediate product
and when managers have equal bargaining
power.
• To be effective, managers must understand
how to use cost and revenue information.
 DISADVANTAGES
• Can lead to dysfunctional behavior
• Time - consuming
• Divisional profitability may be strongly
influenced by the bargaining skills and powers
of the divisional managers.
BENEFITS OF TRANSFER PRICING

• COST CONTROL
• MAXIMISING PROFITS
• HELPS TO MEASURE THE
PERFORMANCE OF RESPONSIBILITY
CENTER
• GOAL CONGRUANCE
QUESTIONS
THANKS