Management Accounting chapter 15

Transfer price

The amount charged when one division of an organization sells goods or services to another division. The exhange is internal and does not affect total sales or profit

Calculating transfer price

Additional outlay cost per unit + opportunity cost per unit

Excess capacity

When a division can produce more than its selling, even after meeting all external demand (opportunity cost = 0, transfer price = outlay cost)

No excess capacity

When a division is operating at full capacity and can sell everything it produces externally. Producing internally means giving up external sale (transfer price = outlay cost + opportunity cost)

Calculating opportunity cost for transfer pricing

External price - outlay cost

Distress market prices

Occasionally, an industry experiences a period of significant excess capacity and extremely low prices

Cost-based transfer pricing

Based upon unit-level cost or absorption cost. Used when a company does not use market prices or negotiated prices to determine transfer price

Absorption cost

Equal to the product’s unit-level cost plus an assigned portion of the higher-level costs

Negotiated transfer price

Negotiations between divisions to set transfer prices

Dual transfer-pricing system

Charges the buying division for the cost of the transferred product and credits the selling division with the cost plus some profit allowance

International transfer pricing

Transfer prices can differ per country since tax rates differ

Why do transfer prices exist in highly centralized organizations?

To record the transfer of goods and services from one unit to another for the same reasons such organizations allocate costs

Four methods by which transfer prices may be set:

Equal to the additional outlay cost, external market price, negotiations among divisions, production costs

What is the optimal method for transfer pricing?

Market-based transfer pricing, because it preserves divisional autonomy and encourages division managers to make economically optimal decisions

Why would companies use other strategies than the market-based method?

Market prices are not available or market prices lead to suboptimal behaviour

What is the general transfer pricing rule?

The minimal transfer price is equal to the transferring division’s outlay cost plus the opportunity cost incurred by the organization in making the transfer

What impact do import duties or tariffs have on the transfer prices of multinational companies?

They might set a low transfer price to minimize the duty charged on the transferred goods