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Hello sir, in the lecture video you mentioned and even in the notes you’ve mentioned repeatedly the reason for transfer pricing is to make profit accountable. I’m not sure what you mean by it. also in the lecture notes it says The problem would be compounded if Division A was selling the same product externally as well as transferring to Division B. how would the problem be compounded? Thank you in advance
If Division A makes goods and sends them to Division B who has some extra costs and then sells them, then the total profit of the company as a whole is the revenue earned by Division B less all of the costs of both divisions.
However if A does not charge B (i.e. there is no transfer price) then A only has costs and B has all of the revenue and only their own costs. So then it is impossible to measure the profits of each of the two divisions separately. By letting A charge B for the goods (i.e. a transfer price) then we can calculate profit for each division separately and measure their performance on their profit (i.e. make them accountable for the profit they make).
If there is no transfer price but A sells some of their costs externally, then if there is no transfer price for goods sent to B, it only serves to make the problem of measuring the profitability of each division worse.
Thank you for the response sir, when A sells externally and there is no transfer price then A would just sell externally is the reason why it would be worse?
If there was no transfer price (so that transfers to B were not charged for) then the manager of A would prefer to sell externally, which is unlikely to be goal congruent for the company as a whole.
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