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Unit 5: Transfer Pricing

assigned to a single executive who can talk to the business unit managers and arrive at an Notes
agreement over the price. Alternatively, a committee may be formed with the responsibilities
to settle transfer price disputes to review sourcing charges and to change the transfer price rules
whenever necessary.
Organizations can have a formal or informal system of arbitration to administer the transfer
price mechanism and to resolve the conflict. In a formal system of arbitration, both the parties
submit their arguments in writing to the arbitrary and the arbitrator reviews then and decides
transfer price. In an informal system, all the presentations are oral.
Irrespective of the formality of arbitration and the process of conflict resolution, the goal is to
make the transfer pricing system effective. There are four ways to resolve conflicts: forcing,
smoothing, bargaining and problem-solving. The conflict resolutions mechanisms range from
conflict avoidance through forcing and smoothening to conflict resolutions through bargaining
and problem-solving.

5.4.3 Product Classification

Sourcing and transfer pricing are greatly affected by the number of intra-company transfers and
the availability of markets and market prices. The larger the number of intra-company transfers
and the less the availability of market prices, the greater the need for more formal transfer
pricing rules. If market prices are readily available, the headquarters can play a vital role in
making sourcing decisions. In some companies, products are classified into various categories
to help in determining transfer prices.

Example: A company can divide its product portfolio into two classes before taking
transfer pricing decisions. Class I products may include all those products whose transfer price
the senior management at the headquarters would like to control. These would normally be
large volume products; products for which no outside source exists and the products over which
manufacturing is important, for quality or secrecy reasons.
Class II is all other products. In general, these are products that can be produced outside the
company without any significant disruption to present operations and products of relatively
small volume, produced with general purpose equipment.

Self Assessment

Multiple Choice Questions:
10. Which method of intercompany buying pricing is schematically represented as Transfer
price-price paid in comparable uncontrolled sales +/- Adjustments
(a) Resale price method (b) Cost plus method
(c) Comparable uncontrolled price method
(d) Comparable controlled price method

11. Transfer price = Applicable resale price-Appropriate mark up +/- adjustments? The above
equation represents
(a) Resale price method

(b) Cost plus method
(c) Comparable uncontrolled price method
(d) None of the above

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