| What is a transfer price? | Transfer price: Price, which one subunit pays to another one for receiving an intermediate product from this subunit. |
| What is the market-based transfer price method? | Market-based transfer prices is transfer pricing based on the value the good would have on the market. This can be based of similar items on the market.
The optimal conditions for this are:
• Perfectly competitive market
• Minimal interdependencies between the subunits
• No additional benefits or costs for internal trade vs. external market.
However, market-prices are often not available. |
| What is the cost-based transfer price method? | An easy substitute to market-based transfer prices, where the price is equal to the full cost of the product. However, this can lead to suboptimal decisions due to fixed costs being treated as a variable cost in the short term. |
| What is the negotiated transfer price method | The price can also be agreed upon between the subunits. Cost and market prices are good starting points for negotiation. Final transfer price is determined by the bargaining strengths of the divisional managers. |
| How are transfer prices and taxes related? | Transfer prices determine the operating profit of subunits (They sort of gain a revenue based of the product they sell, and costs related to this).
If subunits are based in different tax jurisdictions, transfer prices can be designed to minimize total tax payments (benefiting the whole organization):
• If selling division is in a lower tax-rate area: Higher transfer price is optimal.
• If buying division is in a lower tax-rate area: Lower transfer price is optimal.
However, tax laws are in place to constrain firms’ attempts to shift profits to low tax-rate areas by guidelines for the proper design of tax-related transfer prices. |
