This lesson explores transfer pricing as a mechanism for measuring performance and ensuring goal congruence in decentralised organisations. It covers the objectives of transfer pricing, the different methods used (market-based, cost-based, negotiated), and the controversies that arise in setting transfer prices. Transfer pricing is a core topic in the US CMA Performance Management section and is also addressed in CIMA curricula .

• Definition and Purpose: A transfer price is the price charged when one division of a company sells goods or services to another division of the same company. The primary purposes of transfer pricing are to:

  • Measure the performance of the individual divisions (profit or investment centres).

  • Ensure goal congruence, so that decisions made by division managers to maximise their own division’s profit also maximise the overall company’s profit .

• Transfer Pricing Methods:

  • Market-Based Transfer Price: This is the price that would be charged in an external market for the same product or service. It is generally considered the most objective and is preferred for achieving goal congruence when an external market exists.

  • Cost-Based Transfer Price: This is based on the cost of producing the transferred good or service (e.g., variable cost, full absorption cost, or cost-plus a markup). It is used when there is no external market price available. However, it can lead to suboptimal decisions if the cost is not a good reflection of the value of the product.

  • Negotiated Transfer Price: This is a price agreed upon by the buying and selling divisions through negotiation. It can be effective when both divisional managers have the autonomy to negotiate but can be time-consuming and may lead to conflict.

  • Dual Transfer Pricing: A system that uses different transfer prices for the selling and buying divisions to achieve a range of objectives, often balancing performance measurement and goal congruence.

• Controversies and Goal Congruence: Transfer pricing can create conflicts between divisions and challenges for performance evaluation . Issues such as inter-dependence of divisions, goal congruence, and allocation of costs of shared services all affect divisional performance substantially . A good transfer pricing system should provide reasonable incentive to the divisional manager to make decisions that are in the best interests of the overall company (goal congruence) . The system should also only include factors for which the divisional manager can be held accountable .