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Transfer Price Definition
Transfer price, which is also known as transfer cost, refers to the amount that is set for the transfer of goods and services from one branch of a company to another. It is the price of trade activities or goods and services transferred between different departments of a company. This pricing method feature in intra-transactions, that is business deals done internally in an organization. This term explains the intra group transfer prices that occur between individuals groups in a multinational firm. These divisions or individual groups are seen as separate entities.
A Little More on What is Transfer Price
Transfer pricing is an accounting practise which permits different departments of a multi-entity company to be in charge of their own profits. This also means they can can set prices when transacting with one another. Despite that profit must be made, transfer prices are also regulated to promote fairness of transaction between the entities.
Although transfer prices are set by individual departments of the same company, they are not too lower than normal market prices. Transfer price is used in determining costs when intra transaction occurs in an industry. The arm’s length transaction rule is one of the regulations of transfer pricing that establish fair and accurate prices that are not too different from general market prices.
Transfer prices are not set without due procedures being followed which also includes the documentation of transfer prices. These prices are put in record when compiling the financial report that a company submits to auditors or financial regulators. The documentation of transfer prices is crucial because these prices are closely monitored by regulators who have the right to sanction excessive prices.
Adequate documentation enable an easy scrutinizing of transfer prices while a inadequate documentation can attract a company to added taxation or restatement fees.
Aside from being the price at which divisions of a company transact with each other, transfer pricing can also serve as means of regulating intercompany tax. Tax authorities or the government place transfer pricing tax on intercompany transactions given that some multi-entity companies use transfer prices to evade taxation.
Through transfer pricing multi-entity companies make significant profits and pay lower tax rates. Also, some companies use transfer prices for international business transactions so as to avoid import or export duties and tariffs. This gave rise to transfer pricing taxes as international tax laws regulated by the Organisation for Economic Cooperation and Development (OECD). Financial auditors and regulators also take note of this when monitoring transfer prices in multi-entity companies.
References for Transfer Price
Academic Research on Transfer Price
Decentralization and the transfer–price problem, Cook, P. W. (1955). The Journal of Business, 28(2), 87-94.
The multinational firm with arm’s length transfer price limits, Samuelson, L. (1982). Journal of International Economics, 13(3-4), 365-374.
Fair transfer price and inventory holding policies in two-enterprise supply chains, Gjerdrum, J., Shah, N., & Papageorgiou, L. G. (2002). European Journal of Operational Research, 143(3), 582-599.
Accounting implications of a mathematical programming approach to the transfer price problem, Dopuch, N., & Drake, D. F. (1964). Journal of Accounting Research, 10-24.
Risk sharing and transfer price systems under uncertainty, Kanodia, C. (1979). Journal of Accounting Research, 74-98.
The role of transfer price for coordination and control within a firm, Yeom, S., & Balachandran, K. R. (2000). Review of quantitative finance and accounting, 14(2), 161-192.
Complementary arrangements of organizational factors and outcomes of negotiated transfer price, Ghosh, D. (2000). Accounting, Organizations and Society, 25(7), 661-682.
Fair profit allocation in supply chain optimization with transfer price and revenue sharing: MINLP model and algorithm for cellulosic biofuel supply chains, Yue, D., & You, F. (2014). AIChE Journal, 60(9), 3211-3229.
Transfer price optimization for option-based airline alliance revenue management, Graf, M., & Kimms, A. (2013). International Journal of Production Economics, 145(1), 281-293.
A market-driven transfer price for distributed products using mathematical programming, Lakhal, S. Y., H’Mida, S., & Venkatadri, U. (2005). European Journal of Operational Research, 162(3), 690-699.
The effect of framing and compensation structure on seller’s negotiated transfer price, Ghosh, D., & Boldt, M. N. (2006). Journal of Managerial Issues, 453-467.