Set Transfer Price at Market Price:
Some form of the competitive marketed price (i.e., the price charged for an item on the open market) is often regarded as the best approach to the transfer pricing problem. Particularly if transfer prices negotiations routinely become bogged down.
The market price approach is designed for situations in which there is an outside market for the transferred product or service; the product or service is sold in its present form to outside customers. If the selling division has no idle capacity, the market price in the outside market is the perfect choice for the transfer price. The reason for this is that if the selling division can sell a transferred item on the outside market instead, then the real cost of the transfer as for as the company is concerned is the opportunity cost of the lost revenue on the outside sale. Whether the item is transferred internally or sold on the outside market, the production costs are exactly the same. If the market price is used as the transfer price, the selling division manager will not lose anything by making the transfer, and the buying division manager will get the correct signal about how much it really costs the company for the transfer to take place. While the market price works beautifully when the selling division has no idle capacity, difficulties occur when the selling division has idle capacity.
You may also be interested in other articles from “decentralization, segment reporting and transfer pricing” chapter:
- Decentralization in organizations
- Traceable and common fixed costs
- Segment reporting and profitability analysis-segmented income statements
- Hindrances/Problems to Proper Cost Assignment in Segmented Reporting
- Segmented Financial Information on External Reports
- Return on Investment (ROI) for Measuring Managerial Performance
- Controlling and Improving Rate of Return on Investment
- Return on Investment (ROI) and Balanced Scorecard
- Criticism, Disadvantages or Limitations of Return on Investment (ROI)
- Residual Income-Another Method to Measure Managerial Performance
- Limitations, Criticism or Disadvantage of Residual Income Method
- Allow the managers involved in the transfer to negotiate their own transfer price (negotiated transfer pricing).
- Set transfer prices at cost using variable or full (absorption) cost
- Set transfer prices at the market price
- Divisional Autonomy and Sub optimization
- International Aspects of Transfer Pricing
Other Related Accounting Articles: