What is Transfer Pricing | Transfer Pricing Methods | CMA | CIMA | CA | ACCA | Commerce Specialist |

Summary

This video script delves into the concept of transfer pricing, using a car manufacturing company as an example to illustrate how departments within the same company can set prices for goods transferred between them. It discusses the importance of autonomy in decision-making, factors influencing transfer pricing such as capacity, outside demand, and market price, and provides tips for determining minimum and optimal transfer prices. The script also covers different types of transfer pricing strategies, including variable cost, full cost, cost plus, market price, and negotiated pricing, offering valuable insights for those studying or working in commerce.

Takeaways

• 😀 Transfer pricing is a concept that allows departments within the same company to negotiate prices for goods and services they exchange with each other.
• 🏢 The purpose of transfer pricing is to give autonomy to different departments, allowing them to decide whether to buy internally or from an external supplier.
• 🔄 An example is given where Department A makes tires for Department B's cars, and the quality and cost of the tires affect the final product's marketability.
• 💰 The transfer price should ideally be set considering the market price, capacity, and external demand for the product.
• 📈 If there's unlimited external demand and capacity to meet it, the transfer price should reflect the market price to ensure both departments are satisfied.
• 🚫 If there's no external demand, the minimum transfer price should cover at least the variable costs to avoid losses.
• 📉 In situations where external demand exceeds capacity, the transfer price should account for the lost contribution from not selling to external customers.
• 📚 The script suggests that for exam purposes, remember that the minimum transfer price is the variable cost, and the most reasonable price is the market price.
• 📉 The concept of contribution margin is introduced, which is the difference between the selling price and the variable cost, and it's important when setting transfer prices.
• 🛍 Different types of transfer pricing methods are mentioned, such as variable cost, full cost, cost plus, market price, and negotiated transfer pricing.
• ⚠️ The video ends with a caution to subscribe to the channel for timely updates and a reminder that transfer pricing has various methods and considerations.

Q & A

What is transfer pricing?

Transfer pricing is the method by which the price of goods or services is set when they are exchanged between different departments or divisions within the same company.

Why is transfer pricing important for a company?

Transfer pricing is important as it gives autonomy to different departments within a company to decide whether to buy from an internal source or an external supplier, based on quality and cost considerations.

What is the example given in the script to explain transfer pricing?

The script uses the example of a company with two departments, A and B, where department A manufactures tires and department B assembles cars. Transfer pricing is used to determine how much department B should pay for the tires made by department A.

What are the two main factors to consider when setting a transfer price?

The two main factors to consider when setting a transfer price are the capacity of the producing department and the outside market demand for the product.

What is the minimum transfer price that should be charged according to the script?

The minimum transfer price to charge is the variable cost of production, which is the cost that varies with the level of output.

What is the best transfer price according to the script?

The best transfer price, which keeps both department managers happy, is usually the market price of the product.

What happens if there is unlimited outside demand for the product?

If there is unlimited outside demand, the transfer price should ideally be set at the market price, as the producing department could sell the product to external customers at that price.

What should be the transfer price if there is no outside demand for the product?

If there is no outside demand, the transfer price should at least cover the total cost of production, and ideally, it should be set at the market price if the product was being sold externally.

What is the impact of distribution costs on the transfer price?

Distribution costs should be considered in the transfer price. If selling internally saves on distribution costs, this saving can be factored into the transfer price to make it more favorable for the internal customer.

What is the contribution lost if internal supply leads to forgoing external sales?

The contribution lost is the difference between the market selling price and the variable cost per unit of the product that is not sold externally due to the internal transfer.

What are the different types of transfer pricing methods mentioned in the script?

The script mentions several types of transfer pricing methods including variable cost, full cost or absorption cost, cost plus, market price, negotiated transfer pricing, and arbitrary transfer pricing.