Q. Common aims of transfer pricing systems?
The common aims of transfer pricing systems
- Motivate mangers: A transfer price ensures an internal cost is recognised by an internal buyer and an internal price recognised by an internal seller. Often when profit centres exist, divisional or department managers are held accountable for earning profit, a seller would simply not be motivated to supply to an internal customer at zero price (or zero cost to the buyer).
- Fair performance evaluation Transfer pricing allows a better understanding of the financial performance of each profit centre because a price and cost is recognised within management accounts.
- Promote autonomy. Allows divisions or departments to work independently as profit centres, commercially each internal buyer or seller can negotiate on commercial grounds.
- Goal congruence. Transfer pricing can ensure all departments or divisions in the same group, act in the best interests of the group as a whole, not just for their own self-interest. If it is cheaper for a group to make a product or service internally, rather than buy outside the group, then to ensure goal congruence the transfer price must ensure both seller and buyer will trade. If it is cheaper to buy outside the group then a transfer price should discourage internal trade from taking place.
- To ensure optimal allocation of resources: a transfer price can ensure a certain volume is sold internally to ensure the minimisation of cost or maximisation of contribution or profit. Often spare capacity is another factor to consider e.g. lower pricing to sell more internally and ensure that the seller is utilising efficiency to its greatest extent.