Week 4, DQ2 - • Market-based transfer pricing •...

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Week 4, DQ 2 What factors must be considered when setting internal transfer pricing between divisions of a company? Which method of internal transfer pricing is the most effective? Why? Give an example of a company that you think is using transfer pricing in their accounting practices today. Transfer pricing is a term that refers to: analysis, setting, adjustment and documentation of charges made between related parties for services or goods. An internal transfer price is the price assessed when a division of a company sells services or goods to another division of the same company. Internal transfer price does not affect the overall profit of a company. Factors that must be considered when setting internal transfer pricing are: • The company must consider maximizing the return for the whole company. • Divisional performance must be consired. • The price must not be set too high or too low that it benefits one division, while hurting the other division. Some internal pricing methods are:
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Unformatted text preview: • Market-based transfer pricing • Marginal cost transfer pricing • Full cost transfer pricing • Cost-plus mark-up transfer pricing • Negotiated transfer pricing The best method depends on the current divisional situation. Factors to consider when using the above methods can be: excess capacity or availability of an external market for the product that is being internally transferred. When selecting a transfer pricing method, the autonomy of the division must not be placed into jeopardy. Having said the above, the most advisable method is market-based transfer pricing when possible. Market-based is based on the existing external market price. In using this method, the selling division bases its transfer price on the existing market rate. Manufacturing companies use internal transfer pricing when moving parts from one division to another. Another example is oil companies like BP, when they transfer crude oil to their refineries....
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