Challenges Of Setting Adequate Transfer Prices - Common Pricing Methods And Their Pros And Cons

The use of profit center accounting to measure the performance of business units

or departments requires the selection of ways to cover the cost allocation and pricing of internal or appropriate fees for products and services provided by internal service to another.

Most common form of internal pricing is the allocation of public expenditures that are distributed normally with observing the rules of static allocation, such as the number of employees or floor office space movie territory.

And there is the question more difficult and sensitivity is the internal pricing of services or products that are created by a single department, and is used by other departments within the value chain.

Among the most common methods for determining transfer prices in the price of the foreign market as a basis for internal loads. The advantage of this approach is that exposed shortcomings in the provision and delivery of services, and to report to the decision to buy is supported. It should be if the production department is not profitable by the "sale" component to the market price of the company considering the purchase of this external component. If the receiving department is not profitable through the sale of the final product because of the costs associated with the acquisition of a company should consider stopping the production line and sales of an external component.

While this pricing method seems to approach the most economical, it can not be used in the absence of an external market, and it does not take into account factors such as strategic importance for the production of product in the home with the synergy between quality, high ministries or timely delivery.

Another approach is the variable costs such as transfer pricing. In this alternative fixed costs or sunk in the production department is not the responsibility of the reception. This method seems to benefit the Ministry of purchasing power, but also helps the production department to use excess energy. Limit of this method is that the production department can not recover the fixed costs. Therefore limited to the amount of profit from this service. Another disadvantage is that the production department can be biased decisions on the classification of costs with variable costs to reduce fixed costs remaining.

Use the full cost of transfer pricing, which is another alternative which is a delight in its simplicity, but hides the inefficiencies in the management of production, and is likely to prevent the receiver to get the required amount due to the high costs.

As mentioned methods do not seem in favor of the concerned ministries as well, and the negotiation of transport rates between departments to maximize the profits collected seems to be the best solution. However, this can be a time and effort may have been influenced by technical trading individuals.

It could be argued that the impact of applying different methods of transfer pricing does not affect the overall profitability of the company since the offset reduced profitability of the service by improved profitability from another department. However, this perspective ignores the organizational aspects such as organizational structures, performance measurement standards, wages and benefits or impact and influence on decision-making process. Indirectly affected by all of these areas through the development of methods of distribution of internal costs.

And must be in the design of performance measures of the performance measurement system are analyzed carefully to prevent adverse effects. If the manager is measured only on the profitability of the unity and this can lead to poor or low investment quality. Can be in the context of transfer pricing manager determine the transfer price to the level of support to best achieve its goal of profitability by ignoring the consequences of this may be to other departments or business. In this case, the definition of financial management intentionally or unconsciously affected by the personal interest of the individual. The financial measures are also used to make future investment decisions that can affect the long-term success of the company. Could be that the organizational structure of the company and identify profit centers also have a negative impact on business results. If you have not been evaluated dependencies between departments and discussions on transfer pricing leads to conflicts long and that may affect the productivity and staff morale and affect the cooperation between the two teams. The silo will be encouraged to think instead of teamwork and support business goals. Possible solutions to reduce the arguments on transfer pricing and the restructuring of organizational units and combine the previously separate units into a profit center or spinning of the business units in separate legal entities.

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by: Ahmed Zain

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