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Transfer Pricing

Transfer Pricing Lester M. Legette Trident University International

ACC501- Accounting for Decision Making Dr. Ralph Wayne Ezelle 19 March 2012

Transfer Pricing

Evaluate and discuss the implications of the following transfer pricing policies: a. Transfer price = cost plus a mark-up for the selling division. The pricing policy here is the transfer price between the departments is decided by adding the mark up to the actual cost. If the costs incurred by the selling division are more because of the inefficiency of the manager of the selling division, then inefficiency is transferred to other divisions and finally it will increase the cost of the final product. Further, cost can be unduly affected by the increase and decrease in the prices of various materials and parts used by the selling department. However, the transfer is in the interest of the shareholders as the real cost is reflected in the records. Here, the divisional manager will be tempted to buy the product from outside if the transfer price of the product from the selling division is high compared to the market price. b. Transfer price = standard cost plus a mark-up for the selling division. In this policy, standard cost plus specified margin on the standard cost is fixed and since the cost is standard, then there is no chance that the cost of purchasing division product is affected by the efficiency or inefficiency of the management of selling division and also price fluctuations do not affect the purchasing division. c. Transfer price = incremental cost If the division A has idle capacity, then selling division can sell the product to the purchasing division at the price which is equivalent to variable cost of manufacturing the product. Sometimes, the top management in order to encourage the manager of the selling division decide to add some profit percentage to the variable cost of manufacture of selling division. However, if the selling division has no spare capacity and it is selling the products to

Transfer Pricing

external supplier, then the selling divisional manager will not accept the transfer price as equivalent to incremental cost of manufacturing. Rather, he would expect the transfer price which should be equivalent to the current market price. d. Transfer price = price negotiated by the managers. In this method, the transfer price is fixed by mutual agreement between the managers of the purchasing and selling division. The major advantage of this method is that the transfer is being made at arms length. It creates the amicability between the managers of the divisional heads. However, it is not possible to infer that this transfer price will serve the interests of the company or shareholders of the company and rather it will be decided upon the negotiating ability of the particular divisional head. If the divisional manager fails to agree on the transfer price, then the top management will interfere and decide the transfer price and then the main purpose of negotiated transfer price will fail.

Transfer Pricing

Reference Background reading