Transfer pricing relates to the cost incurred by a division of one company to transfer goods or services to a division of the same company. Transfer pricing is primarily a mode for distributing the revenues among all constituent divisions in an organization symbiotically working towards the development processing and marketing of finished goods or services (Terpstra & Sarathy, 2011).
As a mechanism designed to cater for the relay of related information with the primary aim of optimizing the decision making processes of an organization as a unit. This implies that transfer pricing helps each divisional head to sustain ably reach for the point at which enhanced performance automatically enhances the organizations performance (Terpstra & Sarathy, 2011). Transfer pricing shows the overall picture of an organizations performing or underperforming divisions.
Market based transfer pricing is a situation in which an in-between products are in a perfectly competitive market environment. A division within an organization can sell its products or services within the organization or sell externally (Terpstra & Sarathy, 2011).This applies to optimize a division’s performance since it can satisfy the demand for both the organization and the outside clients. A perfect market also means that a division can source materials from external market sources.
Negotiated transfer price is arrived at when divisional heads in an organization negotiate for a transfer price among them. It is based on a division’s product or service variable cost as the lower limit of transfer price and market price as the upper limit (Terpstra & Sarathy, 2011).
It is preferred to market transfer pricing when products in the market are of lower quality than those produced internally, market forces are unfavorable and dependent on different tax regimes applicable for products sourced externally as in international markets.
Terpstra, V. & Sarathy, R. (2001). International Marketing, 8th edn, Chicago IL: Dryden Press. Retrieved April 5, 2011, from http://www.palgrave.com/business/lambin/students/pdfs/Note%2014.pdf