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

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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.
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Concepts of transfer pricing
 Transfer mechanism work in different ways:
If all divisions are made completely independent

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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.

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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.

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ideal situation for operation of transfer
pricing mechanism
Goal congruence
Some of the pre-requisite are:

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 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

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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

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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

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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

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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,

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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

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negotiation.

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 Transfer pricing under constraints on
sourcing

The implications of constraints on

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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

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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:

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 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.

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Arbitration and conflict resolution.
Product classification.

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