transfer pricing

T.P. is the internal charge used between 2 divisions when internal products / services are transferred . i.e. Division A transfer componets to Division B.

lets say that Division A making components and Division B the final product:

Division A (variable cost $45)
Div. B (variable cost $25)

---

Division A ‘sells’ for $40 (notional charge) components to Division B (TP) and Div. B sells the final product for $90.

**OVERALL COMPANY**
sales revenue $90
VC of Div. B ($25)
VC f Div.A ($45)

---

Contribution $ 20 *****

**Division A**
sales $40
VC ($45)
contr. (5)

**Division B**
sales $90
VC ( $25)
TP ( $40)
Contr. $25

Sum: DivA ($5) + DivB $25 = $20**

$20 was also the number that we found when we calculate the Overall Company Contribution.
So, what TP does is to take the contribution of $20 and SLIP it between the 2 divisions.

If we increase the TR of $40, we will make Div. A happy . ( now it has a loss of $5) , but we must ensure that Div.B still makes a profit..

I hope that it helps you !