Transfer Prices

Reasons for Transferring Prices

• Divisional performance
• To get right to right decisions
• Move Profits/ Tax reasons

Transfer Price issue

Div A sells for $150 (Cost is $100). Div B Conversion Costs $50. SP is $200. Div B will decide not to buy from A

Market prices

• Good for competitive mkts
• Should deduct for Selling expenses

Marginal Cost / Mraginal Cost plus Markup

• Good if no mkt for Intermediate product or non-perfect mkt or plant operating below capacity. Will maximize profits

e.g. net MR> MC So if 1000units *10 = MR 100,000 less Div B MC 7,000 = NMR is 93,000 2000 * 9 MR is 180,000-100,000=80,000-7,000 = NMR 73,000 6000*5 MR is 0 - VC =-7,000

Div A profit is highest at 6000 and Div B 3,000 but together 5,000 was optimal Div A performance is misleading unless their costs had a markup

Full Cost Derived for absorption systems that can be misleading. Div A performance will be misleading Cost Plus Mark Up If there are multiple transfers between Div's then final Cost could be too high Suboptimal for firm Ni incentive for supplying division to keep costs down

Negotiated

• too drawn out
• could be suboptimal
• depends on the skill of the negotiator
• Good where there is an external mkt for the goods
• can cause conflict

Marginal Cost plus lump sum

Marginal Cost plus Opportunity Cost If DIV A sells to DIV B then it can sell at MC plus the lost profit form selling to Cust C other wise it has spare capacity then sell just at MC

• can lead to diverse TP's that change frequently

Evidence

Most companies adopt Full Cost where a Market price does not exist