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Transfer Pricing

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Transfer Pricing

A transfer price is a price on goods and services sold by one member of a corporate family to another, such as from a parent to its subsidiary in a foreign country, it creates revenue for the selling subunit and a purchase cost for a buying subunit, affecting operating income numbers for both subunits. This article is an attempt to highlight the various evaluation methods of transfer pricing which are useful for multinational and domestic business organizations. Advantages of transfer pricing, its impacts on income and general rules of transfer pricing have also been discussed.

Individual subunits of an organization act as separate units. In these settings, the management control system often uses transfer prices to coordinate actions and to evaluate performances. Because the price is in between related companies, it is not necessarily an arm’s length price; that is, a price between two companies that do not have an ownership interest in each other. The assumption is that an arm’s length price is more likely than a transfer price to reflect the market accurately.

The transfer price creates revenue for the selling subunit and a purchase cost for a buying subunit, affecting operating incomes can be used to evaluate the performance of each subunit and to motivate the managers.

Guiding Principles in Fixing Transfer Prices

It is important that, so far as possible, transfer prices shall be set in such a way as to provide:

Autonomy for divisional managers

Incentive to the manager of the supplier division

Goal congruence between divisional and organizational objectives

Advantages of the Transfer Price policy

It will develop healthy inter-divisional competitive spirit

Management by exception is possible

Helps in coordination of divisional objectives in achieving organizational goals

Transfer price will act as check on supplier’s price

It fosters economic entity and free enterprise system As a consequence, transfer pricing has become an appropriate theory of the multinational business organizations. A final note regarding corporate use of transfer price is that many corporations are moving towards the use of benchmarking and outsourcing. Both reduce the need for internal pricing by typing divisional behavior to the outside market.

Benchmarking involves tracking the most effective and efficient provider of a particular activity. The above mentioned methods of transfer pricing are useful for multinational corporations and domestic companies.


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