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1) Cost-plus Transfer Pricing:
We include fixed costs in the calculation of total costs (on the assumption that the company is making this product only and FC is caused by this product). This means that profit is calculated by taking transfer price and subtracting all costs (including variable and fixed costs).Profit = Transfer Price – all costs (VC + FC)
2) Sensible Transfer Pricing:
We ignore fixed costs in the calculation of total costs (on the assumption that the company is making different products). This means that profit is calculated by taking transfer price and subtracting variable costs only (not fixed costs).Profit = Transfer Price – variable costs (not FC)
Since transfer price is set by the selling division (ie transferring division) so the fixed costs whether it should be included or not is done by the selling division only (not by the buying division).
Is that all correct?
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