Page 216 - DCOM302_MANAGEMENT_ACCOUNTING

Unit 10: Responsibility Accounting and Transfer Pricing

Transfer price in simple words is the price that one sub-unit (segment, department, division and Notes
so on) of an organization charges for a product or service supplied to another subunit of the same
organization. It is different from the normal price in that both divisions are a part of the same
organisation and therefore it is only an internal transfer and not sale. The pricing of these flows
is likely to have an impact on the performance evaluation of the divisions. Setting of transfer
pricing policies within the company is of great significance. The important issue now is at what
price should such transfers be made.

Did u know? Why do transfer-pricing systems exist?

1. To communicate data that will lead to goal-congruent decisions.
2. To evaluate segment performance and thus motivate managers toward goal-
congruent decisions.
3. Multinational companies use transfer pricing to minimize their worldwide taxes,
duties, and tariffs. Ideally, the chosen transfer-pricing method should lead each
subunit manager to make optimal decisions for the organization as a whole. The
three specific criteria that can help in choosing a transfer-pricing method are:
(a) Promotion of Goal Congruence: Goal congruence exists when each divisional
or sub-unit manager acting in his or her own best interest takes actions that
automatically result in achieving the organisation goals established by top
management.
(b) Promotion of a Sustained High Level of Management Effort: Effort is defined as
exertion towards a goal, for example, sellers are motivated to hold down costs
of supplying product or service, and buyers are motivated to acquire and use
inputs efficiently. The environment in the organisation should be such that a
sustained high level of management effort is promised.
(c) Promotion of a High Level of Subunit Autonomy in Decision-making: Autonomy is
the degree of freedom a division manager can exercise in decisions making. If
top management favours a high degree of decentralization, this criterion is of
particular importance.
Transfer pricing is a critical issue in the organisation. This is because the transfer
price decides:
4. The revenue of the supplying division thus influences divisional profit; and
5. The cost of the receiving division thus influences divisional profit.

10.5.1 Objectives of Transfer Pricing

Some of the more important objectives of transfer pricing are as follows:

1. Evaluating Divisional Performance: Prices can be set in order to arrive at a valid measure
of divisional profit for performance evaluation purposes. This should be of value to central
management in allocating resources between divisions.
2. Improving the Quality of Decisions: Transfer pricing may help divisional managers to
take better decisions. Prices can be used to determine how much of a product or service a
particular division is prepared to sell and how much a division is prepared to buy. This can
help in the efficient use of resources within a division.
3. Promoting Autonomy: Transfer pricing can help in promoting the autonomy of division.
Divisional managers can make independent decisions concerning whether or not they wish

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