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transfer prices


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The prices at which goods and services are bought and sold between divisions or subsidiaries within a group of companies.

The transfer price is a cost to the receiving division and revenue to the supplying division: therefore the transfer price will affect the profitability of each division. In a complex organization there may be several buying and selling divisions in a group. Transfer prices can also apply between cost centres.

Managers need to consider a complex range of issues when setting a transfer price. This is because transfer pricing can be used for several quite different purposes: to provide information that motivates managers to make good economic decisions; to provide information for evaluating the managerial and economic performance of divisions; to maintain divisional autonomy; to move profits between divisions, which may involve moving profits from one country to another to minimize tax on profits. (In the UK the scope for doing this has been greatly reduced by legislation passed in 2003.)

to provide information that motivates managers to make good economic decisions;

to provide information for evaluating the managerial and economic performance of divisions;

to maintain divisional autonomy;

to move profits between divisions, which may involve moving profits from one country to another to minimize tax on profits. (In the UK the scope for doing this has been greatly reduced by legislation passed in 2003.)

As a result, those setting transfer prices may find that they face a conflict of objectives. For example, senior managers of a group may want to maximize profitability even though this will means reducing the autonomy of divisional managers. This may result in short-term increases in profitability but at the expense of the motivation of divisional managers in the long run.

There are six main transfer-pricing methods: see cost-plus transfer prices; dual-rate transfer prices; full-cost transfer prices; marginal-cost transfer prices; market-based transfer prices; negotiated transfer prices.

Subjects: Accounting.


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