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  Transfer Pricing

Introduction and Meaning of Transfer Pricing

Transfer pricing has supposed lot of significance today. For performance evaluation of a division or department it is one of the significant tools in the hands of management. Transfer pricing has become essential in extremely decentralized companies in which number of divisions/departments are formed like a part and parcel of the decentralized organization. In the current days, production is on the mass scale because of technological up gradation and improvement. Organizations raise in course of time and for such type of growing organizations, decentralization becomes very essential. It becomes inevitable for such types of organizations to establish separate divisions and departments to make sure smooth working. Though, it is also essential to calculate the performance of these departments/divisions. Transfer pricing is one of the best tools within the hands of management for measuring the performance.

A 'Transfer Price' is that notional value on which goods and services are transferred among divisions in a decentralized organization. Transfer prices are generally set for intermediate products that are goods, and services which are supplied through the selling division to the buying division. As described in the above paragraph, within large organizations, every division is treated like a 'profit center' as a part and parcel of decentralization. Their profitability is measured through fixation of 'transfer price' for inter divisional transfers.

A question comes into mind as to how the transfer of goods and services among divisions should be priced. The transfer price can contain influence on the divisions performance and therefore lot of care is to be taken in fixation of the same. The following issues should be taken into consideration before fixing the transfer prices.

Ø   Transfer price should assist in the correct measurement of divisional performance.

Ø   It should inspire the divisional managers to maximize the profitability of their divisions.

Ø   Authority and autonomy of a division should be assured.

Transfer Price should permit 'Goal Congruence' that means that the objectives of divisional managers match along with those of the organization.

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