Transfer Pricing – The Concept

Division A ABC Co Ltd.

Division C

Division B

* Div A’s Output is Div B’s Input,

and A supplies the product to B
* It is a transfer transaction and not a sale
transaction in its pure sense.
* Value charged by Div A to Div B is called
Transfer Price.
* And method followed to arrive at TP is called
Transfer Pricing
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 How am I concerned with TP?
● Objective of MCS is to measure and evaluate
and if needed control the managerial actions/decisions.
● Usually the profit is the best measure of the
performance of any business unit &
is a prime function of Price
● Inappropriate/discretionary pricing for
inter-divisional transfer of good/services draws
a wrong performance picture.
● Hence appropriate pricing policy helps in
ASSESSING THE REALISTIC PERFORMANCE of the division.

● Hence a well-established TP acts as a tool of

Managerial Control in itself.

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 Significance of TP
● To measure the Real Performance and
Profitability of the division.
● To allow Autonomy to divisional functioning
without subverting the firm’s goal.

● To Achieve Goal Congruence .

● To keep up motivation of all concerned
divisions.
● To ensure the cost control at every division.

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 Methods of TP
I) Market Price Based TP: -

A) Market Price as TP:

● Essentials -
* Div A’s product having open market.
* Market forces determine the PRICE.
* Then MP is best TP.

● Advantages -
* Div A can not pass its inefficiencies to Div B
* Acceptable to Div A and Div B.
* It is opportunity cost for Div A.
* Creates competitive environment.
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 Methods of TP
I) Market Price Based TP: -

B) Modified Market Price (MMP): -

● TP lower than MP may be set to compensate

various factors such as –
* Saving on selling and transportation costs.
* Guaranteed take off by Div B.
* Quantity, Quality and Delivery aspects
of transfer.
An unbiased negotiation may lead to acceptable
TP by both divisions.
Thus TP becomes an agreed upon price between them.
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 Methods of TP
I) Market Price Based TP: -

C) TP Lower than MP: -

WHEN - ● Div A is not able to sale its product at MP.
Div B is able to get it below MP.
Establishment of TP in such situation depends on the amount of
IDLE capacity Div A is having…..
If Div A operating at its full capacity- No question of reducing MP.
If Div A running with idle capacity – Opportunity cost of Div
A is zero, and whatever it can earn over and above its VC is
well and good. (Below BEP it FC recovery and above BEP it
is profit)
& Non reduction of MP in such situation leads to reduction
of firms profits.
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hmahesh45@yahoo.com
 ● I) Market Price Based TP: -
A) Advantages -
1. True representation of opportunity cost.
2. MP are easily available.
erformance of both the divisions is continuously harnessed.
4. Sales price variance gives a better control data.
A) Limitations of MP as TP –
1. Div A has no outside market.
competitive market for Div A’s product. (Div A is price leader)
3. Wide fluctuations in MP. ( leads to inconsistent results)
4. What is right MP? Ex-factory/ Wholesalers/Customers
P includes selling and distribution cost. (which is absent in TP.)
. Quantity discounts/special discount plays important role in MP.
7. After sales service do matters in MP.
Dumping price can be anything (when Div A builds idle stock)
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 Thanks….

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