Transfer Pricing Definition Value placed on transfers within an organization,Value placed on transfers within an organization,used as a means of allocating costs

to various profitused as a means of allocating costs to various profitcenters is transfer pricing.centers is transfer pricing. The price at which divisions of a company transactThe price at which divisions of a company transactwith each other. Transactions may include the trade of with each other. Transactions may include the trade of supplies or labor between departments.supplies or labor between departments. Transfer prices are used when individual entities of Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured asa larger multi-entity firm are treated and measured asseparately run entities.separately run entities. Objectives of TP 1.1.It should provide each business unit with theIt should provide each business unit with therelevant information.relevant information. 2.2. It needs to determine optimum trade off It needs to determine optimum trade off between companies cost and revenue.between companies cost and revenue. 3.3. It should induce the goal congruenceIt should induce the goal congruencedecision to improve units profit.decision to improve units profit. 4.4. It should help to measure the economicIt should help to measure the economicperformance of individual business unit.performance of individual business unit. 5.5. The system should beThe system should be simplesimple to understandto understandandand easy easy to administer.to administ Criteria for validity & acceptability of TPTP 1.1. TP should be objectively determined.TP should be objectively determined. 2.2. TP should be equal to the value of theTP should be equal to the value of theintermediate product being transferred.intermediate product being transferred. 3.3. TP should be compatible with a policy thatTP should be compatible with a policy thatmaximises attainment of the companies goal andmaximises attainment of the companies goal andevaluation of segments performance.evaluation of segments performance.

Factors affecting TP Performance measurement.Performance measurement. Capability of accounting system.Capability of accounting system.

Inport quotas.Inport quotas. Custom duties.Custom duties. V A . T Taxes on profitTaxes on profit

Uses of TP 1)1) Price setting for services performed byPrice setting for services performed bybusiness unit.business unit. 2)2) A mean of evaluating financial performance of A mean of evaluating financial performance of business unit.business unit. 3)3) Determining the contribution to net profit byDetermining the contribution to net profit byprofit centers in org.profit centers in org. 4)4) Reduce in corporate taxes paid.Reduce in corporate taxes paid. 5)5) Reduce in VAT , excise, tariffs.Reduce in VAT , excise, tariffs.

Fundamental Principle 1.1. The transfer price should be similar toThe transfer price should be similar tothe price that would be charged if-the price that would be charged ifThe product were sold to outsideThe product were sold to outsidecustomers or customers or Purchased from vendorsPurcha

TP policies

That refers to selection of policies thatThat refers to selection of policies thatwould govern the calculations of suchwould govern the calculations of suchprices under various circumstances.prices under various circumstances. The concern of TP policies are withThe concern of TP policies are withdeveloping a TP system that allows-developing a TP system that allows-1)Performance measurement1)Performance measurement2)Decision optimization2)Decision optimizationa) Optimal utilization of resourcesa) Optimal utilization of resourcesb) Cost of goodsb) Cost of goodsc) Services transferred between unitc) Services transferred between unitd) Opportunity cost, mkt. priced) Opportunity cost, mkt. price

Fundamental decisions Should the company produce the productShould the company produce the productinside the company or purchase from outinside the company or purchase from outside vendor ?side vendor ? This is sourcing decision.This is sourcing decision. If produced inside at what price should theIf produced inside at what price should the product be transferred between profit product be transferred between profit centers? centers? This is transfer pricing decision.

Transfer Pricing A transfer price is the price one subunit chargesfor a product or service supplied to another subunit of the same organization. Intermediate products are the productstransferred between subunits of an organization.

Transfer-Pricing Methods Market-based transfer prices Cost-based transfer prices Negotiated transfer prices

Transfer-PricingMethods ExampleMethods Example Lomas & Co. has two divisions:Transportation and Refining. Transportation purchasescrude oil in Alaska andsends it to Seattle. Refining processescrude oilinto gasoline.

Market-Based Transfer Prices By using market-based transfer pricesin a perfectly competitive market, acompany can achieve the following:Goal congruenceManagement effortSubunit performance evaluationSubunit autonomy