Transfer pricing - a brief note

In Bhimani et al. (2008), the topic of transfer pricing is covered in Chapter 18. They use a case study to illustrate the three options used in transfer pricing, namely, (a) market-based transfer prices, (b) cost-based transfer prices, and (c) negotiated transfer prices. This is captured in the following diagram drafted by me:

The general rule they offer for transfer pricing is:

Minimum transfer price = additional incremental costs per unit incurred up to the point of transfer + opportunity costs per unit to the supplying division.

Essentially, this is the market price available to the supplying division. Thus, if the supplying division can sell the product to the marketplace at $40 per unit while its incremental cost per unit is $30 per unit. Then, its opportunity cost per unit is ($40-$30) = $10 per unit. Or, using the formula from them, the minimum transfer price is $30 + $10 = $40 (ie market price per unit).

The formulation of transfer pricing needs to also take into considerations of taxation, treasury management, distress price factor and divisional performance measurement.



References

1. Asia Briefing Ltd. (2009) Transfer Pricing in China, published by Asia Briefing Ltd.
2. Bhimani, A., Horngren,C.T., Datar, S.M. and Foster, G. (2008) Management and Cost Accounting, FT Prentice Hall.
3. Emmanuel, C.R. and Mehafdi, M. (1994) Transfer Pricing, Academic Press, published in association with CIMA.