Transfer Pricing
Chapter 19
Transfer price
 Amount charged by one division selling
goods/services to another division
 Intra-organization transfer
 Overall organization profit is unaffected
 Transfer price will affect the profit of the
divisions involved
 Revenue to seller, cost to buyer
Transfer price
If seller/buyer have no other options
 Transfer price is irrelevant to the
organization
 What is good for seller is bad for buyer and
vice-versa
 Seller’s revenue will equal buyer’s cost
Transfer price
If seller/buyer have options
 Seller will sell to outsider if transfer price is
below market price
 Buyer will buy from outsider if transfer price
is above market price
Overall organization’s profit will be
affected
General rule
Transfer price calculated as
Additional outlay cost per unit
+ Opportunity cost per unit if transferred
Transfer price
General rule
No excess capacity
Producing Division
$80 cost per unit
100 unit capacity
Assembly Division
Transfer price?
External wholesale customers
100 unit demand
$100 price
$20 per unit
profit
External retail customers
$130 price
80 unit demand
$50 per unit
profit
Would the Assembly Division sell to an
external customer offering $95 per unit?
General rule
Excess capacity
Producing Division
$80 cost per unit
500 unit capacity
Assembly Division
Transfer price?
External wholesale customers
100 unit demand
$100 price
$20 per unit
profit
External retail customers
$130 price
80 unit demand
$50 per unit
profit
Would the Assembly Division sell to an
external customer offering $95 per unit?
Transfer based on external
market price
Same result as the general rule if no
excess capacity exists
If excess capacity exists
 General rule results in a lower transfer price
 Producing Division can sell to either internal
or external customers
 Assembly Division should purchase from
Producing Division
Cost-based transfer price
If based on incremental cost
 Producing Division has no contribution
margin
If based on full-absorption cost
 Assembly Division may buy from external
source because of higher transfer price
 May be bad decision because the fixed
portion of the transfer price will be incurred
regardless
Multinational transfer pricing
Multinational companies may operate in
countries with different tax rates, import
duties, etc.
Transfer prices should be set to minimize
profits in high-tax countries and maximize
them in low-tax countries
 High transfer price if buyer is in a higher-tax
country than the seller
Multinational transfer pricing
Seller in hightax country
Buyer in lowtax country
Revenue
Third-party costs
Transferred goods cost
Taxable income
Tax rate
Tax liability
$
5,000,000
(300,000)
$
4,700,000
75%
3,525,000
$ 30,000,000
(1,400,000)
(5,000,000)
$ 23,600,000
30%
$ 7,080,000
$ 35,000,000
(1,700,000)
(5,000,000)
$ 28,300,000
Revenue
Third-party costs
Transferred goods cost
Taxable income
Tax rate
Tax liability
$
2,000,000
(300,000)
$
1,700,000
75%
1,275,000
$ 30,000,000
(1,400,000)
(2,000,000)
$ 26,600,000
30%
$ 7,980,000
$ 32,000,000
(1,700,000)
(2,000,000)
$ 28,300,000
$
$
Combined
$ 10,605,000
$
9,255,000