1. What do you understand by transfer pricing. Does it help a company in setting its profit maximization objectives?

Is there any down side?

Transfer price is the price that one division of a company charges another division of the same company for a product transferred between the two divisions. The basic purpose of transfer pricing is to induce optimal decision making in a decentralized organization i.e. in most cases, to maximize the prot of the organization as a whole. Transfer pricing is a method for distributing revenue between different divisions which jointly develop, manufacture and market products and services. Transfer pricing systems are designed to accomplish the following objectives: To provide each division with relevant information required to make optimal decisions for the organization as a whole. To promote goal congruence that is, actions by divisional managers to optimize divisional performance should automatically optimize the firm's performance. To facilitate measurement of each divisions performance.

Transfer pricing does help a company in setting its profit maximization objectives. Downside to transfer pricing is as follows: Lack of goal congruence among managers in different parts of the organization. Individual divisions profit maximization objective may lead to deviation from the goals set by the parent organization. Increased costs of obtaining goods or services internally will lead to unpredictable price changes which will reflect in the final selling price of the product. Lack of coordination among managers in different parts of the organization. Finally, if the different divisions of a company are in different geographical regions, it might lead to double taxation of the goods and commodities that are part of the transaction.