A transfer price is that which is charged between two or more related parties in an intercompany transaction. It involves allocating profits and losses among the various parts of a multinational corporation for the purpose of tax. Negotiated transfer prices usually work well under the right conditions to the benefit of all the businesses involved. If the managers of the different arms in the multi-national cooperation understand their businesses exceptionally well and are cooperative then this method of transfer pricing would be very successful.
If the transfer serves the best interests of the entire company, then the profits are bound to increase. In such a scenario, it is always possible to find the right price at which each division’s profits can increase. A pie analogy can be used to explain the situation. When the managers of the different facets of a multi-national company become cooperative towards one another, then there is an opportunity for each manager to make a bigger profit through the transfer prices. However, if the managers are uncooperative then negotiated transfer pricing will not be effective. To avoid this problem, the company needs to educate the managers of the different divisions on the importance of cooperation and its benefits to the entire company (Caplan, 2006).
Often enough, a multi-national company will use market-based transfer prices to determine the allocation of profits and losses throughout the company. This happens when there is a competitive external market for the goods or services being transferred across the company. The multi-national company will use the market price of the commodity in question to determine the ultimate transfer prices. It is relatively easy to administer and is considered the correct price if the condition of no idle capacity is satisfied. However, when there is idle capacity, the buying party might consider the purchasing price too high and opt to purchase from an external supplier to avoid the high costs/transfer price.
Caplan, D. (2006). Management accounting concepts and techniques. Retrieved on 8/11/2015 from http://denniscaplan.fatcow.com/Chapter23.htm