TRANSFER PRICING

Definition
It is defined as the amount used in
accounting for transfer of goods and
services between responsibility
centres
 Goal Congruence

An Accounting tool
Motivational tool
- Cost control
- Incentive
Effects
A high transfer price high profit to
seller and low profits to the buyer
A Low transfer price- low profits to
seller and high profits to buyer
 General Transfer Pricing Rule

Transfer Price = Additional Opportunity

outlay cost per unit
cost + To the
per unit organisation
incurred because of the
transfer
With No Excess Capacity at
Division A
Standard Variable Cost Rs.7
Transportation Rs.0.25
Market Price Rs.11
Transfer Price=Outlay cost+Opportunity Cost
Var. Cost + (S.P Var Cost)
(7+0.25) +(11-7.25)
= Rs11
Division B can also buy from outside at Rs.11. Both the
divisions are willing to buy and sell and it promotes
goal congruence
Excess Capacity exists
Transfer Price = Outlay cost + Opportunity Cost
Rs.7.25 + 0
= Rs.7.25

But will Div. A be happy?

Difficulty in implementing
general rule
Difficulty in measuring opportunity cost
Additional cost included like
packaging, design, etc
Methods
Cost based Transfer Price
Market Price
Negotiated Price
Marginal Cost Price
 Market based Transfer Price
Assumption that the markets are highly
competitive that producing division can
sell as much required as they wish and
buying dept. buy as much as they wish
If no profit is made at the market prices
by the seller dept. it is better to close
down the dept. and similarly for the
purchasing dept.
Generally followed practices
Market based prices less a discount
to encourage internal transfers ie a
saving on selling & distribution
Problems in market based
pricing
Special demands of delivery may be made
by the buyer internally,timing,place,packing
Quality may not be up to the mark
Where confidentiality has to be maintained
and prices have to be adjusted
Special quality requirements may be there
and so extra costs
Prices quoted by external may be a
penetration price ie it may be a short run
pricing
 Cost based Transfer Price
Two Decisions
a) How to define costs
b) What should be the profit mark up

Cost- Standard Price at full costs

Profit Mark up- a % on cost or on investment
What is cost?
Full cost based on traditional
accounting methods which assign
overheads arbitrarily are dangerous
Overheads change based on capacity
used
Variable costs plus a mark up profit