Transfer Price

A transfer price is an internal charge established for the exchange of goods or services between organizational units of the same company.
General rules to set price for internal use:
The maximum price should be no greater than the lowest market price at which the buying segment can acquire the goods or services externally. The minimum price should be no less than the sum of the selling segments incremental production costs plus the opportunity cost of the facilities used.

Cost-Based Transfer Prices

Absorption cost
Does not produce same amount of income that would be generated if transferring division sold goods externally From Exhibit 14-11: DM + DL + VOH + FOH = $160 + $48 + $72 +$78 = $358

Continuing . . . Cost-Based Transfer Prices

Variable cost production or total?
May have motivation problem for selling department From Exhibit 14-11: Production: DM + DL + VOH = $160 + $48 + $72 = $280

Total: Variable Production Cost + Variable S & A = $280 + $8 = $288

Cost-Based Transfer Prices

Actual cost
Inefficiencies in production may not be corrected

Standard cost
Buyer could pay more than actual cost for goods

Market-Based Transfer Prices

Advantages
Both seller and buyer should accept

Problems
Product may not be sold in open market Internal cost savings may exist External market may temporarily be high or low Determination of right market price may be difficult

Negotiated Transfer Prices

Normally below external sales price Above units incremental costs, including opportunity cost Managers must have authority to go outside the company if negotiations fail

Dual Pricing
Different prices for seller and for buyer Profit for seller and minimal cost to buyer Managers to have most relevant information for decision making and performance evaluation

Transfer Pricing in Multinational Settings

Extremely difficult to set
Tax systems Customs duties Freight and insurance costs Import/export regulations Foreign exchange controls Internal and external objectives of transfer differ

May use different transfer prices for different countries; make certain of legality.