7 Flashcards
What is transfer pricing
Amounts charged when one business unit sells goods or services to another business unit – effectively, internal selling prices
Its revenue for supplying unit and cost of buying unit
In decentralised organisations, how are goods and services transferred
Between different responsibilities centres
What is the rationale for transfer prices
When subunit managers evaluate decisions, focus is on how their actions will affect subunit performance without evaluating their impact on company wide performance
Why do organisations use transfer prices
It allows selling units to record revenue to recognise a profit on transfer, to reflect effort that it has expanded in producing that product, and allows buying units to record cost of transfer of product which will be matched against revenue when it eventually sells product to external markets
When there is a series of transfers of product between units, what do transfer prices allow each unit to show
Profits for their efforts
What does transfer pricing encourage
Each unit to generate profits and managers of units to manage their own unit as if it was a standalone business
What are the key characteristics of transfer pricing
System should operate in a way that doesn’t undermine goal congruence or the decentralised managers autonomy
Therefore it should result in unit profits that are a reliable and accurate measure of unit performance, preserve and encourage autonomy within business units, and encourage goal congruent behaviour
Who sets transfer prices
In a decentralised organisation, managers of profit centres and investment centres usually have considerable autonomy over setting and accepting transfer prices
Direct intervention by corporate management is usually considered to be inconsistent with philosophy of decentralisation
Corporate management may be reluctant to interfere in transfer pricing transactions as this may undermine autonomy of business to unit managers
What are the types of transfer pricing policies
Because of potential for goal incongruence, corporate management often develop general policies to guide transfer pricing practice. For example, they may develop rules regarding minimum and maximum transfer prices rather than external sales
What are the types of transfer prices
Market based prices
Cost plus prices
Negotiated prices
What are market-based prices
In determining transfer prices, management may choose to use price of a similar product or service publicly listed
If there are competitive external markets for products, the market prices are generally recommended transfer price
Consistent with responsibility accounting and decentralisation philosophies
Leads to calculation of realistic divisional profits that can be compared to competitive industry benchmarks
However, will not always encourage goal congruent behaviour
When are cost plus prices used
When transferred goods don’t have reliable external market prices and when supplying unit has spare capacity
What are negotiated prices
In some cases, subunits of a company are free to negotiate transfer price between themselves and then decide whether to buy and sell internally or deal with outside parties.
Managers negotiate price at which transfers will be made
External market prices may form starting point for negotiations and incremental cost of producing and supplying products may form lower bounds of transfer price
What is the general transfer pricing rule
Specifies minimum transfer price as sum of two cost components
Costs incurred by supplying unit to produce and supply goods or services to be transferred
Opportunity cost – any profit forgone by supplying unit to produce and supply product for internal transfer
Allows supplying unit to be as well off as if it’s good or services were sold to external customers
Results in transfer prices that promote goal congruent behaviour – managers will make decisions that enhances their own profit but also enhances profits of company as a whole
