PM – Nov 2018 – L2 – Q2c – Transfer Pricing

Explains two key attributes of a good transfer pricing policy.

Question

Explain TWO attributes of a good transfer pricing policy.

Answer

Goal Congruence:
A good transfer pricing policy should ensure that the objectives of the individual divisions align with the overall goals of the company. This avoids situations where divisions make decisions that benefit themselves but harm the overall company profitability.
Performance Evaluation:
The transfer price should allow for accurate and fair evaluation of the performance of each division. A clear and transparent pricing mechanism ensures that each division is properly assessed based on its contribution to the company’s profits, leading to better managerial accountability.
Divisional autonomy: The prices should seek to maintain the maximum divisional
autonomy so that the benefits of decentralisation (motivation, better decision making,
initiative, etc.) are maintained. The profit of one division should not be dependent on
the action of other divisions
Tax minimisation: In multinational companies, the prices should lead to the
minimisation of tariffs and income taxes and observance of legal restrictions.
Motivation: The transfer price should be such that will encourage the
divisions to transact business with one another