Transfer Pricing

Hi Hams,
Thanks for your question although I do think we have covered this in our online lecture.

In summary -factors to be considered are whether the selling company has spare capacity ( i.e. will they lose out on external sales by selling internally – in which case they should be compensated for this lost contribution)

Another factor is whether the buying company can buy from elsewhere ( buy in from an external company) in which case if the internal transfer price is too high, in comparison to the external price, then the buying company might shop outside the group ( sometimes this can be in the interest of all companies – sometimes it is not).

A big factor is motivation of the division managers, if a transfer pricing policy is forced by group/ head-office onto the internal company – or if negotiations between internal companies are felt to be unfair ( benefiting one division more than the other) then the managers will feel demotivated due to their divisional profits being affected by transfer prices being too low or too high.

Isses are similar to factors – but I suppose you could say an issue was taxation for international companies. That transfer pricing may be used to move profits to a lower tax regime – by charging high costs in a high tax country – meaning more profits (via those selling prices) are earned in the other lower tax country. There is also an ethical element to this ( tax avoidance – even if its legally ok can be thought badly of when large global corporations reduce their tax bill using this and other tax-planning methods.).

Hope that helps.
Thanks
Cath