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8/13/2019 Transfer Pricing (Inter Divisional)
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8/13/2019 Transfer Pricing (Inter Divisional)
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oWHAT IS TRANSFER PRICING?
A Transfer pricing is the internal price charged by a selling
department, division or subsidiary of a company for a raw
material , component or finished goods or services which is
supplied to a buying department, division or subsidiary of thesame company.
The concept of transfer price is fundamentally aimed at
simulating external market conditions within the organization so
that the managers of individual business unit are motivated to
perform well.
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Transfer pricing is a business tool used by many
companies. This enables companies to keep profits
high, no matter what the economy is doing. Theobjectives of transfer pricing are, therefore, keeping
the profit margin high by over charging or under
charging on goods and services. Usually this is
done when a company has a branches in multiple
companies.
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Broadly there are three objectives of transfer pricing:-
Objective of Transfer Pricing
Performance AppraisalGoal Congruence Division Autonomy
1. Goal Congruence:- While designing the mechanism for transfer
pricing , the interest of individual profit centers should not supersede
those of the organization as a whole. The division manager in
maximizing the profits of his/her division should not engage in
decision making that fails to optimize the organizationsperformance.
2. Performance Appraisal:- Transfer pricing should aid in reliable and
objective assessment of the activities of profit centers. Transfer prices
should provide relevant information to guide decision making , assess
the performance of divisional manager and also assess the value
added by profit center toward the organization as a whole.
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3. Divisional autonomy:- The transfer pricing should aimed at providing
optimum divisional autonomy , thereby allowing the benefits of
decentralization to be retained . Each divisional manager should be
free to satisfy the requirements of his/ her profit center form internal
or external sources. There should be no interference in the process by
which the buying center manager rationally strives to minimize the
costs and the selling center manager strives to maximize revenues.
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Method of calculating transfer prices:-1. Market-Based Pricing Method:-Organization that uses this method
price the goods and services they transfer between their profit centersat a level equal to the prevailing open market price for those goods
and services.
2. Negotiated Pricing Method:- In this method of transfer pricing , the buying and selling division
negotiate a mutually acceptable transfer prices.
Since each division is responsible for its own performance, this will
encourage cost minimization and encourage the parties to seek a
transfer price that yields them an appropriate return.
Tax authorities have reservation about this method because it gives
organization greater scope to manipulate the transfer prices and thus
minimize their tax liability.
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3. Cost Plus Method:-
It is the simplest method of transfer pricing is to use full historical
cost.
The full cost of product is material , labor and overhead cost requiredto produce and ship the product to the buying unit.
Full costs are the most economical transfer prices to develop because
they are routinely prepared for inventory evaluation.
4. Marginal Cost:- the marginal cost of a unit is the additional cost required to produce
it.
If the transfer pricing system is designed to ensure efficient allocation
of resources than the best transfer price to use is marginal cost.
At less than full capacity, marginal cost consist of the variable costs
of producing and shipping goods plus any cost directly associated
with the transfer.