Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 14

How does the choice of a transfer price affect the operating profits of both segments involved in an intra company transfer? Why is the choice of a transfer price important if the total profits of the firm are unaffected by this choice?

Step 1 of 5

Transfer Pricing: impact on the individual divisions

Intercompany transfer or inter-division transfer of goods and services affects the balance sheet of individual divisions in significant ways. Let us assume that there are two divisions A & B within a company. Output of A can be sold into the market as well as it could be supplied as input to division B for further processing. In the interconnected transactions like this, the profit of both the divisions depends to a large extent on the prices they pay for the input raw materials.