Transfer Pricing
Why have transfer pricing?-There can be significant tax benefits and foreign exchange benefits.
From an organisational perspective benefits can be seen through: * The ability to now calculate profit/loss from each division * Easy and fair to assign responsibility to business units and reward their performance * Easy to see the contribution of each division to whole company profits * Better cost control and quality improvement * Motivate managers/increase managerial autonomy
Overall direct management accounting benefits can be seen through the fact that overall organisational performance improves as performance in each division will be measured and evaluated much better. There will also be better cost control and quality improvement.
Indirectly the management accounting benefits that are most evident is that of motivation and the increase in managerial autonomy.
Two key factors to consider:
Look at the market price and look at the capacity position of the firm. The selling division will not sell at less than market price when they are at full capacity. If there is spare capacity they will sell at Variable cost.
It is only natural for the buying division to want a low transfer price and the selling division to want a high transfer price. An optimal price will lead to division managers making decisions that are in the best interests of the company as a whole. This price should be within the optimal range, this is between VC and Market price. The closer the price is to VC the greater the financial benefits for the buying division the closer it Is to Market price the greater the financial benefits for the selling division.
The Four Pricing Approaches * Variable Cost- Direct Labour + Direct Materials+ Variable Overhead * Full Cost- Variable Cost + Fixed Cost+ Mark Up * Market Price- What price does seller sell to external customers? * Negotiated Prices- Negotiates a range between upper and lower limit, the closer they can both agree on which is in the middle the better they can both profit share. * Administered transfer prices- Group dictates prices depending on circumstances Transfer price = Variable cost+ Total Contribution On lost sales Number of units transferred
VARIABLE COST PRICING
This method is most appropriate when there is no opportunity cost of internal transfer. The selling division has excess capacity and there is no outside market.
FULL COST PRICING
Similar to Variable Costing, appropriate when there is no opportunity cost. Excess capacity in selling division or there is no outside market, can also include a profit mark up. When there is spare capacity however the optimal TP is always Variable!
Transfer price= Variable Cost + Fixed cost + Total contribution margin on lost sales Number of units transferred
Market Price
In general if a competitive market exists for the intermediate product, the current market price may be an appropriate transfer price. Market pricing is very much objective and verifiable. It provides a bench mark to measure efficiency and provides a measure of opportunity cost. If divisions have spare capacity however Market Price is not the economic optimum transfer price. If either division does not agree to the transfer due to unfair price and buying division goes for outside market with higher price the whole company can suffer.
Cost based pricing leads to buying divisions being at an advantage whereas market based pricing leads to selling divisions been at an advantage, there must be a win- win solution?????
NEGOTIATED TRANSFER PRICES
Allowing managers to negotiate prices improves goal congruence between divisions. It is however time consuming and requires frequent price revision. Requires top management supervision and information is also asymmetry.
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