Transfer Pricing

* Transfer price typically includes a profit element because an independent company normally would not transfer goods or services to another independent company at cost or less.

* The fundamental principle is that the transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendors

* Sourcing decision vs. transfer price decision

Constraints on Sourcing

* Limited Markets

* Existence of internal capacity might limit the development of external sales.

* If company is the sole producer of a differentiated product, no outside source exists

* If company invested a lot in facilities, it is unlikely to use outside sources unless the outside selling price approaches the company’s variable cost, which is not usual.

* COMPETITIVE PRICE

* Best satisfies the requirements of a profit center system

* Measures the contribution of each profit center to the total company profits

* Different b/t competitive price and inside cost is the money saved by producing rather than buying

* Measures how well a profit center may be performing against competitors

* Published market prices are available (similar conditions)

* Market prices may be set by bids

* If production profit center sells similar products in outside markets

* If the buying profit center purchases similar products from the outside market

* Excess or Shortage of Industry Capacity

* Arbitration committee

* In every case, the transfer price would be the competitive price. In other words, the profit center is appealing only the sourcing decision. It must accept the product at the competitive price.

* Buying profit centers may prefer to deal with outside sources:

* 1) Perception that outside sources provide better service

* 2) The internal rivalry that sometimes...