Explain the Methods of pricing
The following methods are used for intra company transfer pricing:
1) Total cost method: transfer is made at absorption cost which is the total or full cost. It is a simple method the valuation of stock can be done at cost easily. However if the cost of production is high, the transferee division has to bear the cost of inefficiencies of the transferor division.
2) Marginal cost method: this method is good for short term pricing purpose. The transfer is made at the marginal cost. The fixed costs are not recovered at the division level and the stocks are valued at the marginal cost.
3) Total cost plus profit method: known as full cost plus method a reasonable percentage of profit is added to absorption cost or to the marginal cost. In the latter case, percentage is higher so as to recover the fixed cost. If the cost of the transferor division is already high the addition of profit makes it more costly to the transferee division. Difficulty arises also in the valuation of stocks as the cost includes element of profit.
4) Market price method: transfer is made at the price which would have to be paid if purchased from the market. Difficulty arises in valuation of closing stock by the transferee as it includes element of the profit. So adjustment has to be made. Secondly, market price includes selling and distribution expenses which have little to do with the transfer pricing.
5) Negotiated price method: price is faxed by negation or bargaining between the transferor and the transferee division as if both are independent seller the buyer. The transferee division calls quotations from outside and then decides from whom to buy. In this method, much time is wasted in negotiation and calling for quotations.
6) Artistry price method: price is fixed by top management without seeking ant interference from any division. This method defeats the very purpose of decentralizing profit responsibility of the divisions.