Divisionalisation- transfer pricing Flashcards
(15 cards)
What is transfer pricing?
The price one subunit charges for a product or service to another subunit.
What to look out for when setting transfer prices
1) The ability to motivate managers to make good economic decisions for the performance of the company as a whole
2) The ability to provide information which can be used to evaluate the managerial and economic performance of division
3) To ensure divisional autonomy is not undermined
4) To intentionally move profit between divisions for tax efficiency
Potential conflicts in transfer prices
1) Decision making vs performance evaluation- for buying division lower price is better but for selling division higher price is better.
2) Imposition vs Autonomy- supplying manager has no say if HQ makes transfer price undermining decentralisation.
3) Organsiational vs managerial performance- a transfer price which will be satisfactory for divisional performance mta be suboptimal when viewed form overall company perspective.
Alternative transfer pricing methods
1) Market based transfer prices
2) Cost plus a profit mark up transfer prices
3) Negotiated transfer prices
4) Administered
What is the minimum transfer price
Looking at the selling division we find marginal cost + opportunity cost
What is the maximum transfer price?
We look at the buying division and find market price - cost savings from internal transfer
Requirement for market-based transfer price
A perfectly competitive market
Benefits of market price
Divisional performance is more likely to represent the real economic contribution of the division to total company profits.
If they save on packaging costs what are the effects on the market?
1) Market unlikely to be perfectly competitive
2) Distress prices may cause incorrect decisions (high supply, lower demand)
3) Can make adjustments to reflect imperfections
Benefits of using marginal cost TP
- Motivates profit maximising output where market is imperfect or non-existent
- In the absence of capacity constraints, this is more optimal
Issues with marginal cost TP
- Short-term perspective
- Problem of categorising cost
Benefits of full cost TP
- More widely used in practice
- Long-term approach
- Preferable with regards to performance evaluation as it’s less skewed
Issues with full cost TP
Same problems as traditional costing system
When is negotiated TP used
Used when market imperfections exist
Issues with negotiated TP
- Outcome dependent on negotiating skills
- Potential for conflict
- Impact on divisions’ profitability
- Time-consuming
