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If Transfer price is set at market price , would there be a risk that divisions would not take optimal decision ? ( which would be in the best interest of company as a whole)
Yes.
A sells to B. A’s own costs = 10, B’s = 20.
Intermediate products market price (A can sell at this) = 14
Transfer price = 14
B’s normal selling price = 50, so makes a contribution of 50 – 20 – 14 = 16
B saturates market at 50 and is offered a price of $32 for remaining sales.
B sees a negative contribution of 32 – 20 – 14 = -2, so rejects the deal.
However, for the group the contribution would be 32 – 10 – 20 = 2 positive, so would want the deal to be accepted.
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