Management Accounting Flashcards
Cost Based Transfer Pricing : Pros and Cons
Pros
• It’s simple.
• It can be readily calculated using available accounting data.
Cons
• It may encourage decisions that do not benefit the company as a whole.
• The distribution of profit may be unfair to the seller or buyer.
• It may encourage production inefficiencies because costs are passed on to the buyer.
Market based pricing: Conditions for optimal pricing
- Immediate market should be perfectly competitive
- Interdependencies between buyer and seller should be minimal
- No additional benefits to the org. in using external vs. internal supplier
Market based Pricing: Pros and Cons
Pros:
- Simple, if external market is readily available
- If selling division is working at full capacity, it would encourage transfers if it would be beneficial to the company as a whole
- Adaptable to changing market conditions
Cons:
- External market may not be readily available (product too specific)
- Sub-optimal decisions if the seller/buyer has excess capacity
- May not motivate divisions to buy internally
Negotiated Transfer Price: Ranges
Operating at full capacity
Seller: Variable cost + opportunity cost (market price)
Buyer: Market Price
Operating at Excess Capacity
Seller: Variable Cost
Relevent costs for short term decision making
- Opportunity costs when there is not idle capacity
- Incremental costs
- Decision maker’s bias
Irrelevant costs for short term decision making
Opportunity costs when there is no idle capacity
Fixed Costs
Sunk costs
Writing a transfer pricing strategy answer
Do both qual and quant
tie back to relevant stake holders and their strategic objectives
consider how managers are evaluated (there may be a bias)
Managers should be evaluated on factors they can control
Make or buy decision - When should you outsource?
A company should outsource when the cost to purchase is less than the incremental cost to source internally
