Transfer pricing is a practice which is usually connected to international operations. It’s related to non-market approach in defining prices of products and services, which are being delivered from one division of the organisation to another. Despite of the administrative pricing, the operations can be conducted on the basis of market principles whereas through the price base there are implemented typical features of the competition pricing.
The definition of the transfer prices can be troubled from the fact that every division sells a part of its production to clients from outside the organization. The price, which one division received as in income is actually an expense for the other division. This is why, transfer pricing inevitably brings the conflict between the economic interests of the different divisions of the organization. In the basis of the transfer pricing, there are company’s priorities, not market realities. The way of defining transfer prices depends more than anything from the management’s purposes, which can be:
• The transfer prices to serve as an assessment of the effectiveness of the divisions’ work;
• The transfer prices to be used for minimization of the taxable basis;
• Through the transfer prices a control to be exercised over the rate of return within the organization;
• Transfer of profits between the divisions.
Depending on the specific purposes, transfer prices are being developed on different price basis and are different than the prices which the organization is selling its production on the foreign markets. The transfer pricing can be also considered as a mechanism for internal distribution of financial resources between the different divisions. There are 3 basic methods of transfer pricing, each of them with a specific purpose and application.
1) Method of market-oriented transfer price
It’s being applied as a price basis for the internal company’s exchange in companies with a high level of decentralization and for the transitional products (object of the transfer) there are alternative external markets. In case when the transfer price reflects the real market conditions, then it is the most objective criterion of the exchange between the structural departments. For the application of the market type transfer prices there should be some conditions met:
– The corporation to be heavily decentralized
– The separate divisions to be autonomous when making decisions
– The structural units to be as less dependent to each other as possible
– A competitive market to exist for the transfer products
– There to be a reliable, access free information for the competitive market prices (to be continued)
