Transfer Pricing – this topic brings important concepts together – variable and fixed costs, performance evaluation, pricing, tax avoidance and economics. For this reason, Transfer Pricing is covered extensively in your undergraduate years, as well as in PGDA.
Transfer Pricing is not always important. If divisions or companies are independent, it means that they do not trade goods and services with one another, transfer pricing is not an issue. As soon as they trade with each other though, that interdependence makes transfer pricing vital.
In a nutshell – what price should they charge one another? In decreasing order of importance, consider these issues:
- The TP must result in what is best for the group. It needs to maximise group, not divisional, profit. Goal congruence is key.
- The TP should promote the autonomy of your divisional managers. They need to be empowered to take responsibility for their divisions, and ideally not feel imposed on by head office.
- The TP should allow for effective performance evaluation, and ensure that divisions are treated fairly. A final, important step, is to ensure that the TP is economically realistic – this is to avoid any accusations of tax evasion.
This is a topic that is trending at SAICA – read this AccountacySA article here.
This is a topic that can include complex calculations, but it is vital that you don’t get stuck in the weeds of crunching numbers, you need to understand the qualitative side of Transfer Pricing. It is vital that you understand and can discuss key issues like these:
Why TP? Because divisions are selling to each other and a fair price needs to be charged.
What is the best TP? It depends! The TP must create max profit for the group and ideally promote accurate performance evaluation, autonomy, fairness and not upset the tax authorities.