Transfer Pricing

Description

In multidivisional companies, it is common to transfer products among divisions. For example, some divisions specialize in manufacturing intermediate products, which are then transferred to other divisions specialized in finished products. The price the manufacturing division charges other divisions for the intermediate product is called the "transfer price." Although internal transfers may seem irrelevant because they do not directly affect corporate profit, transfer prices determine divisional profits and thus can have important consequences for divisional managers' behavior. This is why transfer pricing policies are part of a firm's internal accounting system and thus should be designed to align the interests of employees with those of the company as a whole. This technical note describes the most commonly used methods to set transfer prices in organizations.

Learning Objective

To understand transfer pricing policies and to describe the most commonly used methods to set transfer prices in organizations.

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Keywords

Cost systems Costs Transfer pricing