Basic Summary Of Transfer Prices Essay

929 words - 4 pages

Objectives of Transfer Prices-For profit centers to share in the revenue generate when product is sold-Transfer price is the mechanism for distributing this revenue-GoalsoShould provide unit with relevant information to determine trade off of costs and revenuesoInduce goal congruent decisions (improve company and unit profits)oMeasure economic performance of the unitoSimple to understand, easy to administerTransfer pricing methods-Traditional: amount used in accounting for any transfer of goods and services between responsibility centers-Book: Value placed on a transfer of good or services in transactions in which at least one of the two parties involved is a profit centerFundamental Principle-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 vendorsoIssues with pricing - should it be so that MC = MP etc?Profit centers have two decisions when purchasing-Sourcing Decision - should the company produce the product inside the company or purchase it from an outside vendor?-Transfer Price Decision - If produce inside, at what price should the product be transferred between profit centers?The Ideal SituationA market price based transfer price will induce goal congruence if all the following conditions exist:-Competent people - mangers interested in LT and ST-Good atmosphere - managers perceive that the transfer price is just-Market price - price based on well-established, normal market price for identical product (adjust market price downward for savings incurred)-Freedom to source - managers choose their best place to purchase it/sell it-Full information - managers know of all information of other choices-Negotiation - smooth mechanism for negotiatingConstraints on Sourcing-Limited MarketsoInternal capacity may limit external salesoIf firm sole produce of a differentiated product, no outside source existsoCompany invest in facilities, unlikely use outside sourcesCompetitive Price-Measure the contribution of each profit center to the total company profitoPublished market prices, if available - used to establish TPoMarket prices set by bidsoProduction profit center sells similar products in outside marketsoBuying profit center purchases similar products from outside marketCost-Based Transfer Prices-If competitive prices are not available use COST PLUIST A PROFIT-Two considerations when doing so-How to define cost-Usual basis is standard costoIncentive to set tight standards and improve standards-Actual costs are not used because production inefficiencies will be passed on to buying profit center-How to calculate the profit markup-What the profit markup is based onoPercentage of costsoPercentage of investments-Level of profit allowedoShould be about the rate of return that would be earned if the business unit were externalUpstream Fixed Costs and Profits-Sometimes a business unit will sell outside; it ignores the upstream fixed costs and profit included in...

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