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Transfer PricingTransfer Pricing
• Definition: Transfer price is the Definition: Transfer price is the price charged for goods and price charged for goods and services in intra company services in intra company transfers.transfers.
• Transfer Price and selling priceTransfer Price and selling price
Objectives of Transfer PricingObjectives of Transfer Pricing
It provides each unit with the It provides each unit with the relevant information required for relevant information required for making cost-benefit trade-off.making cost-benefit trade-off.
It induces the goal congruence It induces the goal congruence among business units and among business units and corporation.corporation.
It helps in measuring the It helps in measuring the performance of individual profit performance of individual profit centers.centers.
Methods of Transfer PricingMethods of Transfer Pricing
Fundamental PrincipleFundamental Principle Ideal situationIdeal situation
Competent peopleCompetent people Good atmosphereGood atmosphere Market PriceMarket Price Freedom of choiceFreedom of choice Full informationFull information NegotiationNegotiation
Why Market Prices cannot be Why Market Prices cannot be adopted?adopted?
Limited marketsLimited markets Capacity limitationsCapacity limitations Integrated companiesIntegrated companies Differentiated ProductsDifferentiated Products Investment in facilities Investment in facilities
Short or Excess Capacity in Short or Excess Capacity in the Industrythe Industry
Market Prices for Units that do Market Prices for Units that do not buy or sell outsidenot buy or sell outside
Published Market PricesPublished Market Prices BidsBids Market Prices for similar Market Prices for similar
ProductsProducts
Cost Based PricesCost Based Prices
Standard Variable costStandard Variable cost Mark-upMark-up
Two Step PricingTwo Step Pricing
Standard Variable costStandard Variable cost Fixed Costs on percentage of Fixed Costs on percentage of
facilities usedfacilities used Profit mark-upProfit mark-up
The transfer price for business unit ZBusiness Unit 1 Product
Expected monthly salesto business center z 5000 unitsVariable cost per unit
$ 5Fixed expenses applicable to theFacilities reserved for Z
20 000Investment in assets
1, 200,000Return on investment
10 %The transfer price for business unit ZVariable cost
$ 5Fixed costs applicable 20000/5000
4Return on investment 1200 000/12 X .1
5000$11
If the Business Unit Z orders If the Business Unit Z orders only for 4 000 units,only for 4 000 units,
The transfer price is $ 50,000. The transfer price is $ 50,000. The variable cost 4000 X 5 and The variable cost 4000 X 5 and the fixed costs 20,000 plus the fixed costs 20,000 plus return on investment 10, 000.return on investment 10, 000.
The excess of $ 6000 is penalty The excess of $ 6000 is penalty for Unit Z for not utilizing the for Unit Z for not utilizing the capacity.capacity.
Profit SharingProfit Sharing
The product is transferred to The product is transferred to the marketing unit at the the marketing unit at the Standard cost of products sold.Standard cost of products sold.
After the product is sold, After the product is sold, contribution earned is shared contribution earned is shared among the business units, among the business units, which is the selling price minus which is the selling price minus the variable marketing and the variable marketing and manufacturing costs.manufacturing costs.
Two sets of pricesTwo sets of prices
Under this method, the business unit Under this method, the business unit which manufactures the product will which manufactures the product will be credited with the selling prices be credited with the selling prices minus expenses of marketing unit, minus expenses of marketing unit, and,, the marketing business unit is and,, the marketing business unit is debited with the standard debited with the standard manufacturing cost. This method is manufacturing cost. This method is most desirable for both the business most desirable for both the business units and the conflicts between them units and the conflicts between them can be minimized.can be minimized.
Pricing of Corporate ServicesPricing of Corporate Services
Control over amount of servicesControl over amount of services Optional Use of ServiceOptional Use of Service
The business units may buy these The business units may buy these services from the corporate services from the corporate department ordepartment or
2. They may buy from an outside 2. They may buy from an outside party orparty or
3. They may develop the facilities on 3. They may develop the facilities on their own ortheir own or
4. They may seldom using the service 4. They may seldom using the service at allat all
Administration of Transfer Administration of Transfer PricesPrices
NegotiationNegotiation Arbitration and Conflict Arbitration and Conflict
ResolutionResolution ExecutiveExecutive CommitteeCommittee
