Transfer Pricing
The pricing methodology for goods and services exchanged between divisions of the same company, balancing divisional autonomy with overall corporate optimization.
Transfer Pricing
The pricing methodology for goods and services exchanged between divisions, subsidiaries, or related entities within the same organization, balancing divisional performance measurement with overall corporate optimization.
For example, when an automotive manufacturer’s engine division supplies engines to its assembly division, transfer pricing determines the internal charge—whether based on market price ($5,000 per engine), full production cost ($4,200), variable cost plus markup ($3,600 plus 20%), or negotiated terms—affecting both divisions’ profitability and decision-making.
Effective transfer pricing serves multiple purposes: measuring divisional performance fairly, promoting goal congruence between divisional and corporate objectives, preserving divisional autonomy while encouraging optimal resource allocation, and fulfilling tax compliance requirements for international transfers. Common methods include market-based pricing (using external market prices when available), cost-based approaches (variable, full, or cost-plus), and negotiated prices determined through internal bargaining. The optimal approach depends on corporate structure, divisional interdependence, market conditions, and strategic objectives. For multinational entities, transfer pricing carries significant tax implications, requiring careful documentation to demonstrate that intercompany transactions follow arm’s-length principles satisfying various jurisdictions’ regulatory requirements.