Transfer Pricing Concept

Transfer Pricing Concept

Transfer pricing is a concept related to internal sales i.e. sales is made by one department to another department. The prices at which these transfer are made are known as transfer price. Transfer price does not affect the overall profit, because profit on division is cost of another division.

Transfer Pricing Objective

1.    Full autonomy

Transfer pricing is source of full autonomy of decision making to the divisional manager. It means divisional manager enjoys full authority of decision making and therefore is total responsible for investment center performance.

2.    Fair Performance Valuation

Transfer pricing ensures fair performance evaluations. Transfer pricing allows selling department to charge a fair price for its goods. Thus performance of selling department would not be negatively affected by such transfer.

Types of Transfer Price

Transfer can be made on cost and above cost (adding some profit) and market price.

1.    Transfer at Cost

Selling department may transfer the goods to purchasing department either on marginal cost or full cost. It means that transfer cost may be categorized into full cost and marginal cost method.

2.    Transfer at Cost Plus

Selling department may charge some profit to the purchasing department. Management will decide about the profit margin on the transfer.

3.    Transfer at Market Price

Selling department may transfer the goods to purchasing department at market price. This method can only be used where external market for good exists.