1st Take away An intermediate product is an uncompleted product that is transferred from one subunit to another subunit of the same company. Transfer Pricing refers to the prices one part of an organization charges another part for products and services. Transfer pricing creates revenue for the selling division and creates costs for the buying division. Transfer pricing allows companies to evaluate the divisions performance and to help motivate managers to become more profitable.
The intermediate products that are transferred can be sold by the receiving company to external customers or it can be used further in the manufacturing process. The purpose of transfer pricing is to help managers focus on how their choices will impact their division without assessing their influence on companywide performance. The theory is that if they focus more on improving their own divisions performance, it will have a good impact on the whole company.
2nd Take away Alternative Transfer-Pricing Methods The three general methods for determining transfer prices:1) Market-Based transfer prices. Management can choose to set the transfer price based on a comparable product or service that is publicly listed, or what an external customer might pay for that product or service. 2) Cost-based transfer prices. Management can choose to charge a transfer price based on the cost of producing the product. Sometimes, cost-based transfer prices contain a markup or profit margin that represents a return on the subunits investments. 3) Negotiated transfer prices. Sometimes, subunits within companies are allowed to negotiate the transfer price between themselves and then decide if to buy or sell internally or deal with external parties.
3rd Take awayCriteria for Evaluating Transfer Prices1) Transfer prices should promote goal congruence.2) Transfer prices should encourage managers to use a high level of effort. Subunits selling products or services should be motivated to keep their costs low.
3) Transfer prices should help management evaluate performance of individual subunits. 4) Subunit managers seeking to maximize the operating income of the subunit should allowed to make transactions with internal and external parties.