Transfer pricing is one single area of managerial accounting that has been generating heat and still generates more heat. The existence of interdependencies in divisional-ised companies creates a problem of determining at what price goods needs to be transferred within a business. Transfer pricing exist because of the existence of interdependent activities within a company. Three kinds of interdependencies exist in a modern business, they are:
TYPES OF INTERDEPENDENCIES WITHIN A COMPANY
- 1. Pooled interdependencies
- 2. Reciprocal interdependencies
- 3. Sequential interdependencies
METHODS OF TRANSFER PRICING
Various approaches of fixing the right transfer prices have been put forward by researchers promising to help solve the problem of managers acting sub optimally as a result of having the feeling that he or she has not had a fair bargain in fixing the price at which goods/services comes into or go out of his or her division. Some of the methods of fixing transfer prices put forward by scholars and qualified accountants in the study of management accounting and transfer pricing are as follows:
- Cost based transfer price
- Market based transfer price
- Negotiated transfer price
- Administered transfer price
PURPOSES OF SETTING TRANSFER PRICES IN A COMPANY
One may at this point be wondering what benefit accrue to a business entity for going through the stress of determining the right transfer price for goods and services that moves around the company. Well, if you are in this category of people, wait a minute until you finish reading this section. Is just like questioning the importance of accounting! The reasons and benefits of establishing a transfer price for a company is to meet the following needs of the company as a whole:
- To supply information adequate enough to motivate the divisional managers into making good economic decisions or capital budgeting. Good decision in this context is; when the summation of results from divisional managers improves the reported profit of a division and the profit of the company as a whole.
- To give useful and transparent information that will aid the evaluation of managerial and economic performance of the divisions. This is sometimes call business valuation or business analysis.
- To redistribute wealth/ economic resources within a company, i.e. between divisions or locations.
- To make sure that divisional autonomy is protected and respected.
Considering the above benefits that a company will enjoy by figuring out what transfer price will motivate managers, it is obvious that the transfer pricing exercise is after all not a mere waste of time. This does not apply to only transfer pricing but other accounting information generating tools like variance analysis and budgeting process.
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