AN PRESENTATION ON THE TOPIC “TRANSFER PRICING”

Presented by:Rakesh T.C

DEFINITION AND MEANING:

A transfer price is defined as “ the price that is assumed to have been charged by one part of a company for products and services it provides to another part of the same company, in order to calculate each division’s profit and loss separately.”

Transfer price doesn’t have any direct impact in the organization’s profits as a whole because its effect on one’s division’s revenue is exactly offset by another division’s cost. 2

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CONCEPTS OF TRANSFER PRICING

Transfer mechanism work in different ways: If all divisions are made completely independent

of each other, then the selling division will set its product to the buying divisions only at the market price. So, the transfer price is the current market price; and divisional profitability is measured as if the division were an independent company.

The use of market price as transfer price establishes the discipline of the market on the divisional managers and allows them to operate their divisions with greater autonomy.

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OBJECTIVES OF TRANSFER PRICING

The main objective is proper distribution of revenue between profit centers.

Some of the other objectives are: Providing relevant information to the profit

centers regarding the trade-off between costs and revenues of the company.

Inducing goal-congruent decisions. Helping to measure the economic

performance of profit centers. Minimizing tax liability. 4

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IDEAL SITUATION FOR OPERATION OF TRANSFER PRICING MECHANISM

Goal congruenceSome of the pre-requisite are:

Competent people. Good organizational atmosphere. Details of market prices. Freedom to source. Availability of information. Scope for negotiation.

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COMPETENT PEOPLE

Organizations need managers who can balance long-term and short-term goals. Managers are often accused of sacrificing long-term gains for short-term profits. The approach can prove disastrous for the organizations. Hence, organizations should have competent people skilled at negotiation and arbitration, who are capable of determining the appropriate transfer prices.

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GOOD ATMOSPHERE

In order to achieve goal congruency, managers of profit centers, especially the buying centers, should ensure that the transfer prices charged by the selling profit centers are just. This will create the atmosphere of trust between selling profit center and buying profit centers.

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DETAILS OF MARKET PRICES

When a product is transferred from one profit center to another, the normal market price for the identical product can be taken as the basis for establishing the transfer prices.

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FREEDOM TO SOURCE

Managers of the selling profit centers should be given freedom to sell their goods in the external market, while managers of buying profit centers should be allowed to buy their goods from the external market. Thus the market becomes the main determinant of the transfer price.

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AVAILABILITY OF INFORMATION

Managers should be fully aware of market conditions and should have all the necessary information available to them, before they take any decision.

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SCOPE FOR NEGOTIATION

There must be a mechanism for negotiating contracts and managers who take transfer pricing decisions should be trained in negotiation.

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TRANSFER PRICING UNDER CONSTRAINTS ON SOURCING

The implications of constraints on sourcing on the appropriate transfer pricing policies are described below:

Limited markets. Excess or shortage of industry capacity. Sourcing constraints.

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METHODS OF CALCULATING TRANSFER PRICES

The following criteria should be used to evaluate the methods for calculating transfer price.

Goal congruence. Rationality. Autonomy. Performance evaluation.

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CONT..

The other common methods of calculating the transfer pricing are:

Market- based pricing method. Cost-based pricing method.

Actual costs approach. Standard costs approach. Variable costs approach. Marginal costs approach.

Negotiated pricing method.

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ADMINISTRATION OF TRANSFER PRICING

Negotiation. Arbitration and conflict resolution. Product classification.

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