Transfer Pricing

2712 WordsFeb 20, 201311 Pages
Transfer Pricing An Overview Transfer pricing is a popular topic in management accounting. It is concerned with the price when one department (the selling department) provides goods or services to another department (the buying department). That is, one department generates revenue from the sales of goods or services and the other department incurs expenses from the purchases of goods or services. Transfer pricing is closely related to responsibility accounting in which each department is responsible for its cost, revenue, expense or investment return depending on the type of centre it is. Thus, transfer pricing effectiveness is essential to the success of the overall company. The related key issue is the determination of a transfer…show more content…
Even in a situation where the sub-unit B has no excess capacity, that is, it can sell its total output to outsiders at Rs 100 per unit, the decision of the sub-unit A to restrict its output at a level lower than its achievable capacity might be sub-optimal for the firm as a whole. Assume that the firm earns a contribution of Rs 100 per unit on the final product, the output of the sub-unit A. The contribution is higher than the contribution of Rs 60 per unit on the intermediate product. The firm loses the opportunity to earn higher profit by using the intermediate product internally in the sub-unit A instead of selling the same to outsiders. In summary, the main advantage of market-based transfer prices is that they are objective and unbiased measures, although they might fluctuate because of market conditions over time. Further, they are difficult to manipulate. A disadvantage of a market-based transfer price is that the prices for some commodities can fluctuate widely and quickly. Companies sometimes attempt to protect divisional managers from these large unpredictable price changes. Cost-based Transfer Prices: Cost-based transfer prices can also align managerial incentives with corporate goals, if various factors are properly considered, including the outside market opportunities for both divisions, and possible capacity constraints of the selling division. First
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