Transfer Pricing
The Fuqua School of Business Duke University
International Strategy: WBA 434 Professors Heath, Huddart, & Slotta
Transfer Pricing 1. Overview
An essential feature of decentralized firms is responsibility centers (e.g., cost-, profit-, revenue-, or investment-centers). The performance of these responsibility centers is evaluated on the basis of various accounting numbers, such as standard cost, divisional profit, or return on investment (as well as on the basis of other non-accounting measures, like market share). One function of the management accounting system therefore is to attach a dollar figure to transactions between different responsibility centers. The transfer price is the price that one division of a company charges another division of the same company for a product transferred between the two divisions. The basic purpose of transfer pricing is to induce optimal decision making in a decentralized organization (i.e., in most cases, to maximize the profit of the organization as a whole). Profit Center : Any sub-unit of an organization that is assigned both revenues and expenses. In a profit center, a manager is treated as an entrepreneur. Typically, a profit center manager is given decision-making power and is held responsible for the profits generated by her center.
2.
2.1
Advantages and Disadvantages of Decentralization
Advantages
• Decisions are better and more timely because of the manager’s proximity to local conditions. • Top managers are not distracted by routine, local decision problems. • Managers’ motivation increases because they have more control over results.
Based on a note by Nahum Melumad.
c Heath, Huddart & Slotta, 2009. All rights reserved.
www.personal.psu.edu/sjh11
WBA 434: International Strategy
Transfer Pricing
• Increased decision making provides better training for managers for higher level positions in the future. 2.2 Disadvantages
• Lack of goal congruence among managers in different parts of the organization. • Insufficient
International Strategy: WBA 434 Professors Heath, Huddart, & Slotta
Transfer Pricing 1. Overview
An essential feature of decentralized firms is responsibility centers (e.g., cost-, profit-, revenue-, or investment-centers). The performance of these responsibility centers is evaluated on the basis of various accounting numbers, such as standard cost, divisional profit, or return on investment (as well as on the basis of other non-accounting measures, like market share). One function of the management accounting system therefore is to attach a dollar figure to transactions between different responsibility centers. The transfer price is the price that one division of a company charges another division of the same company for a product transferred between the two divisions. The basic purpose of transfer pricing is to induce optimal decision making in a decentralized organization (i.e., in most cases, to maximize the profit of the organization as a whole). Profit Center : Any sub-unit of an organization that is assigned both revenues and expenses. In a profit center, a manager is treated as an entrepreneur. Typically, a profit center manager is given decision-making power and is held responsible for the profits generated by her center.
2.
2.1
Advantages and Disadvantages of Decentralization
Advantages
• Decisions are better and more timely because of the manager’s proximity to local conditions. • Top managers are not distracted by routine, local decision problems. • Managers’ motivation increases because they have more control over results.
Based on a note by Nahum Melumad.
c Heath, Huddart & Slotta, 2009. All rights reserved.
www.personal.psu.edu/sjh11
WBA 434: International Strategy
Transfer Pricing
• Increased decision making provides better training for managers for higher level positions in the future. 2.2 Disadvantages
• Lack of goal congruence among managers in different parts of the organization. • Insufficient