MANAGEMENT CONTROL SYSTEM GROUP 11 :

 Abraham Jordy Winarto (12030117190241)

 Rifqi Husein Aldjoeffry (12030117190246)
 Saskia Feby Maharantika (21030117190133)

Chapter 6

Transfer Pricing

In this chapter we discuss various approaches to arriving at transfer prices for transactions
between profit centers and the system of negotiation and arbitration that is essential when
transfer prices are used. We also discuss the pricing of services that corporate staff units furnish
to profit centers.

Objectives of Transfer Prices

 It should provide each business unit with the relevant information it needs to determine
the optimum trade-off between company costs and revenues.
 It should induce goal congruent decisions- that is, the system should be designed so
that decisions that improve business unit profits will also improve company profits.
 It should help measure the economic performance of the individual business units.
 The system should be simple to understand and easy to administer.

Transfer Pricing Method

Transfer pricing is the setting of the price for goods and services sold between controlled (or
related) legal entities within a enterprice.

Fundamental Principle

The fundamental principle is that the transfer price should be similar to the price that would be
charged if the product were sold to outside customers or purchased from outside vendors.

The Ideal Situation

A market price-based transfer price will induce goal congruence if all of the following
conditions exist : Competent people, Good Atmosphere, A Market Price, Freedom to Source,
Full Information, and Negotiation.
Constraint on Sourcing

 Limited Markets.
(1) The existence of internal capacity might limit the development of external sales. (2) If
a company is the sole producer of a differentiated product, no outside source exists. (3)
If a company has investef significantly in facilities, it is unlikely to use outside sources
unless the outside selling price approaches the company’s variable cost.
 Excess or Shortage of Industry Capacity
Suppose the selling profit center cannot sell to the outside market all it can produce-
that is, it has excess capacity. Conversely, suppose the buyinh prift center cannot obtain
the product it requires from the outside while the selling profit center is selling to the
outside.

Cost-Based Transfer Prices

Two decisions must be made in a cost-based tranfer price system : (1) how to define cost and
(2) how to calculate the profit markup.

Upstream Fixed Costs and Profits

 Agreement among Busniess Units

Representatives from the buying and selling units meet periodically to decide on outside
selling prices and the sharing of profits for products wtih significant upstream fixed
costs and profit.
 Two-Step Pricing
(1) For each unit sold, a charge is made that is equal to the the standard variable cost
of production. (2) a periodic charge is made that is equal to the fixed costs associated
with the facilities reserved for the buying unit.
 Profit Sharing
(1) The product is transferred to the marketing unit at standard variable cost. (2) After
the product is sold, the business units share the contribution earned, which is the
selling price minus the variable manufacturing and marketing costs.
 Two Sets of Prices
In this method, the Manufacturing unit’s revenue is credited at the outside sales price
and the buying unit is charged the total standard costs.
Pricing Corporate Services

There remain two types of transfers : (1) For central services that the recieving unit must accept
but can at least partially control the amount used. (2) For central services that the business unit
can decide whether or not to use.

Control over Amount of Service

Busniess unit may be required to use company staffs for services.In these situations, the
business unit manager cannot control the efficiency with which these activities are performed
but can control the amount of the service received.

Optional Use of Services

Management may decide tha business units can choose whether to use central service units.

Simplicity of the Price Mechanism

The prices charged for corporate services will not accomplish their intended result unless the
methods of calculating them are straightforward enough for business unit managers to
understand them.

Administration of Tranfer Prices

Negotiation

Business units negotiate transfer prices with each other,that is, transfer prices are not set by a
central staff group.

Arbitration and Conflict Resolution

Arbitration is a process whereby parties to a contract submit disputes arising between them to
and independent third party for resolution. Litigation refers to the resolution of disputes through
the court system. Alternative dispute resolution refers to ways of settling disputes outside of
formal trials.

Product Classification

 Class I would be large-volume products which no outside source exists and products
whose over manufacturing.
 Class II includes relatively small volume which outside source exists and produced with
general-purpose equipment. Clas II products are transferred at market prices.