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:
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.