Profit and Investment Centres

Transfer Pricing

Transfer Pricing
The fundamental principle is that the transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendors.

Transfer Pricing: Important Decisions

Should the company produce the product inside the company or purchase it from an outside vendor? This is the sourcing decision. If produced inside. At what price should the product be transferred between profit centres? This is the pricing decision.

Market Based Pricing

Market Price Information Freedom to source Full Information Negotiation Constraints

Cost Based Pricing

How to define cost?
Actual cost Standard cost

How to calculate profit mark-up?

Percentage of cost Percentage of investment

Transfer Pricing and Upstream Fixed Cost and Profits

The profit center that finally sells to the outside customer may not be aware of the amount of upstream fixed costs and profit included in the price. Even if they are aware: They may be reluctant to reduce the profits. How to mitigate this problem?

Transfer Pricing and Upstream Fixed Cost and Profits

Agreement among the business units Two-step pricing Profit sharing

Two-step pricing
Establish a TP that include two charges: Product Charge: Standard variable cost of production Periodic charge:Fixed costs associated with the facilities reserved for the buying unit. Profit may be included in the above.

Find Transfer Price Expected monthly sales to A (units) 5,000 Variable cost per unit 5 Monthly ficed cost assigned to the product 20,000 Investment in Wcapital 1,200,000 Normal ROI 10%

Transfer Price VC FC Profit per unit

5 4 2 11

Ttwo- Step Transfer Price VC Fixed Cost Profit

5 20,000 10,000

Ttwo- Step Transfer Price VC Fixed Cost Profit

5000 5 25000 20,000 20000 10,000 10,000 55000 11

3000 15000 20000 10,000 45000 15

6000 30000 20000 10,000 60000 10