Basic Summary of Transfer Prices

Essay by betobertoUniversity, Bachelor's February 2007

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Objectives of Transfer Prices

-For profit centers to share in the revenue generate when product is sold

-Transfer price is the mechanism for distributing this revenue


oShould provide unit with relevant information to determine trade off of costs and revenues

oInduce goal congruent decisions (improve company and unit profits)

oMeasure economic performance of the unit

oSimple to understand, easy to administer

Transfer pricing methods

-Traditional: amount used in accounting for any transfer of goods and services between responsibility centers

-Book: Value placed on a transfer of good or services in transactions in which at least one of the two parties involved is a profit center

Fundamental Principle

-The transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendors

oIssues with pricing - should it be so that MC = MP etc?

Profit centers have two decisions when purchasing

-Sourcing Decision - should the company produce the product inside the company or purchase it from an outside vendor?

-Transfer Price Decision - If produce inside, at what price should the product be transferred between profit centers?

The Ideal Situation

A market price based transfer price will induce goal congruence if all the following conditions exist:

-Competent people - mangers interested in LT and ST

-Good atmosphere - managers perceive that the transfer price is just

-Market price - price based on well-established, normal market price for identical product (adjust market price downward for savings incurred)

-Freedom to source - managers choose their best place to purchase it/sell it

-Full information - managers know of all information of other choices

-Negotiation - smooth mechanism for negotiating

Constraints on Sourcing

-Limited Markets

oInternal capacity may limit external sales

oIf firm sole produce of a differentiated product, no...