Transfer pricing refers to a process where one division of a company charges price for selling good or service from another division even though they both are part of a same company. Since transfer pricing involves divisions of the same company the price is not easy to establish. Let’s look at methods which are used for establishing the transfer prices –
- Market Based Transfer Price – In this method of transfer pricing a division charges the market rate from another division that is the rate at which company sells the products to outside parties.
- Cost Based Transfer Price – Under this method of transfer pricing, company follows the policy where one division will sell goods or services to another division at a price which is equal to the actual cost of good or service, therefore in this method a division forgoes its profit percentage. In this method the price at which division of a company sells goods to outsiders is different from the price at which other division buys.
- Negotiated Transfer price – Under this method of transfer price the top management of the various divisions are given freedom to decide the price at which goods should be sold between divisions. Hence in this method the transfer price is the price which is mutually agreed by both the divisions.