Professional Documents
Culture Documents
Transfer Pricing
• Advantages
– Forces selling division to be competitive with
market conditions
– Does not penalize buying division by charging
a price greater than it would have to pay on the
market
Market-based transfer prices
• Disadvantages
– May lead selling division to ignore negotiation
attempts from buying division and sell directly
to outside customers
• Could cause an internal shortage of materials
• Forces buying division to purchase materials from
the outside
• Overall company profits may fall even though
selling division makes a profit
Cost-Based Pricing Methods
No changes in unit costs are expected this period. Desired profit for
the period is $110,625. The company uses assets in producing the
panels and expects a 14% return on those assets
Gross Margin Pricing
• Gross margin
– The difference between sales and the total production
costs of those sales
• Gross margin pricing
– Cost-based pricing approach
• Price is computed using a markup percentage based on a
product’s total production costs
• Markup percentage
– Designed to include all costs other than those used in
the computation of gross margin
– Composed of selling, general, and administrative
expenses and the desired profit
Gross Margin Pricing (cont’d)
• This method can be easily applied
– An accounting system often provides
management with production cost data
Return on Assets Pricing
Limitations:
• Can lead to sub-optimal decisions
• Time - consuming
• Divisional profitability may be strongly influenced by the
bargaining skills and powers of the divisional managers.
Comparison of
Transfer-Pricing Methods
Criteria Market- Cost- Based Negotiated
Based
Achieves Goal Yes, when Often, but not Yes
Congruence markets are always
competitive
Useful for Yes, when Difficult unless Yes, but transfer
Evaluating markets are transfer price prices are affected
Subunit competitive exceeds full cost by bargaining
Performance and even then is strengths of the
somewhat buying and selling
arbitrary divisions
Comparison of
Transfer-Pricing Methods
Criteria Market- Cost- Based Negotiated
Based
Motivates Yes Yes, when based on Yes
Management Effort budgeted costs; less
incentive to control
costs if transfers are
based on actual
costs