Page 128 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 5: Transfer Pricing

Notes
Questions:
1. Using each of the transfer price of ` 80, ` 88, ` 95 and ` 100 show with supporting
calculations, the financial results as projected by the:
(a) Manager of division X
(b) Manager of Division Y
(c) Company

2. Comment on the effect of each transfer price of the performance of the Managers of
Division X and division Y.
3. If you were to make a decision in the matter without regard to the views of the
individual divisional manager, where should Division X obtain its materials from
and at what price?
5.5 Summary

 Delegating authority depends on the ability to delegate responsibility for profits Profit
responsibility cannot be delegated unless two conditions exist: the delegate has all the
relevant information needed to make optimum profit decisions and the delegatee’s
performance is measured on how well he or she has made cost/revenue trade-offs.

 Where segments of a company share responsibility for product development,
manufacturing, and marketing, a transfer price system is required if these segments are to
be delegated profit responsibility.
 This transfer price system must result in the two conditions described above. In complex
organizations, devising a transfer price system that assures the necessary knowledge and
motivation for optimum decision making can be difficult.
 Two decisions are involved in designing a transfer system. First, is the sourcing decision:
should the company produce the product inside the company or purchase it from an
outside vendor? Second is the transfer prices decisions: At what price should the product
be transferred between profit centres?
 Ideally, the transfer price should approximate the normal outside market price, with
adjustments for costs not incurred in intra-company transfers. Even when sourcing decisions
are constrained, the market price is the best transfer price.
 If competitive prices are not available, transfer prices may be set on the basis of cost plus
a profit, even though such transfer price may be complex to calculate and the results less
satisfactory than a market-based price. Cost-based transfer prices can be made at standard
cost plus profit margin, or by the use of the two-step pricing system.
 A method of negotiating transfer prices should be in place and there should be an arbitration
mechanism for settling transfer price disputes, but these arrangements should not be so
complicated that management devotes an undue amount of time to transfer pricing.

5.6 Keywords

Capital Charge: The rate used to calculate capital charge is set by corporate office
Corporate Services: Provision of a service by one part of an organization where that service had
previously been found in more than one part of the organization

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