Objective of Transfer Pricing :

A sound transfer price system should accomplish the following objectives.

1) Divisional Autonomy :
When the unit is being declared as an independent profit centre, then it
must be given autonomy to carry out its functions. It should motivate the
division manager to make sound decisions. The transfer prices should
communicate information to the managers to take such decisions. Such
information must be reliable information. The manager takes certain
actions to improve the reported profit of his division. This also improves
the profit of the company as a whole.

2) Divisional Performance Appraisal :

The transfer price should result in a report of divisional profits that is a
reasonable measure of the managerial performance of the division. When
goods are transferred from one division to another, a portion of the revenue
of the supplying division becomes a portion of the cost of the receiving
division. Consequently, the prices at which goods are transferred can
influence each division's reported profits and there is a danger that an
unsound transfer price will result in a misleading performance measure
that may cause divisional managers to believe that the transfer price is
affecting their performance rating unfairly. This may lead to differences
amongst the managers and result in negative motivation.

3) Goal Congruence :
The prices should be set so that the divisional management's desire to
maximize divisional earnings is consistent with the objectives of the
company as a whole. The transfer prices should not encourage sub-optimal
decision-making.

Objectives of Transfer Pricing

1. Goal congruence:   The prices should be set so that the divisional management
desire to maximize divisional earnings is consistent with the objectives of the
company as a whole. The transfer prices should not encourage sub-optimal decision-
making. The system should be so designed that decisions that improve business unit
profits will also improve company profits.
2. Performance appraisal: The prices should enable reliable assessments to be
made of divisional performance. The prices form part of information, which should:

1. Guide decision making

2. Appraise managerial performance
3. Evaluate the contribution made by the division to overall company profits.
4. Assess the worth of the division as an economic unit.

The transfer prices should be designed such that they help in measuring the
economic performance

3. Divisional autonomy:   The prices should seek to maintain the maximum

divisional autonomy so that the benefits of decentralization (motivation, better
decision-making, initiatives, etc.) are maintained. The profits of one division should
not be dependent on the actions of other divisions.

4. Simple and easy: The system should be simple to understand and easy to

administer.

5. The transfer price should provide each segment with the relevant information
required to determine the optimum trade-off between company costs and revenues.

The objectives of transfer pricing are as follows:

ADVERTISEMENTS:

1) Maximizing overall after-tax profits.

2) Reducing incident of customs duty payments

3) Circumventing the quota restrictions (in value terms) on imports.

ADVERTISEMENTS:

4) Reducing exchange exposure, circumventing exchange controls

and restricting profit repatriation so that transfer firms affiliates to
the parent can be maximized.
5) Transferring of funds in locations so as to suit corporate working
capital policies.

6) ‘Window dressing’ operations to improve the apparent (i.e.,

reported) financial position of an affiliate so as to enhance its credit
ratings.

What are the Objectives of Transfer Pricing?

1) Profitability

The transfer pricing should pay close attention to the profitability of both the
divisions of the organizations. Since both, the divisions belong to the same
firm. Thus the items, goods, and services can be configured at any arbitrary
price.

But, if you want to the profit margins of both the divisions to stay

unaffected, it would be a great idea to keep the prices as close to the
market prices as possible.

2) Taxation
The transfer price will also have a bearing on taxation. A proper transfer
pricing will help you offset the tax liability of one division with an equivalent
one on the other. One of the major objectives of the transfer pricing is to
maximize the overall tax profits of your organization. The transactions are
not governed by open market considerations. This helps you improve upon
the taxation options.

3) Goal Congruence

The transfer pricing should be configured in such a manner that the

divisional earnings of each of the divisions are quite consistent with
the goals of the parent company. The focus should be such that the profit
margins of the subdivisions increase while it will not affect the total
profitability of the parent organization.

Transfer pricing needs to be configured in a way where the company profits

as a whole also improve.

4) Performance evaluation of individual units

Transfer pricing can be one of the best options to arrive at the best possible
appraisal of the individual divisions. This can help guide efficient decision
making.

Some of the areas that transfer pricing can assist the performance

appraisal, and performance management includes appraising the
managerial performance of the divisions, evaluation of the contributions of
the individual entities for the overall profits of the company, and
assessment of the worth of each division as an individual unit.
5) Taking a good look at international trade

Another prime objective that transfer pricing aims to achieve is to measure

the international trade scenario. The pricing should be in tune with the
import and export standards and should be accurately measured.

Too low a price can distort the international trade figures to a greater
extent. The transfer pricing prices should be such that they will not distort
the international trade figures.

6) Shifting of profits

Profit shifting is aimed at reducing the tax liabilities in a particular country

can be reduced. This can be achieved by reducing profits artificially. It is
also aimed at decentralization of the production so that the profits
are concentrated enough in the region where the production of the goods is
undertaken.

Some other objectives of transfer pricing

While the transfer pricing needs to take care of the major objectives as
outlined in the above discussion, it also has a few other essential objectives
to fulfill. A few of the other objectives laid out in a simple to understand
language include-

 Reduce the customs duty payments since the transfer is

between the two division of the same parent organization. This
will help reduce the pricing so that your products will stay in tune
with the market prices.
  Transfer pricing assists you in circumventing the restrictions on
the import quota restrictions. This helps you import the items
without any restrictions.
 Letting you transfer the funds to locations to aid in corporate
funding standards.

The major aim of the concept of transfer pricing is to allocate the profits
between the parent organization and its subsidiaries. But, if the two units or
divisions are located in two different countries, there will be different
taxation patterns, and this will make the proper calculation and fixing of the
transfer price a complex situation.

In any case, the major objective of opting for a proper transfer price is to
avoid or reduce the taxation and thus to increase the profit. The
international objectives of transfer pricing will involve lesser foreign
exchange risks, better competitive advantage, and enhanced governmental
relations.