Transfer Pricing

Sangeeta Pandit

Management Control
Systems
MIS/MCS is a system where
information is gathered/collected
The information is used to help and
coordinate planning and control
It guides and improves decision
making

Kinds of information
Total organization level-cash flows, total
employment, ROI.
Customer/market level-competitors prices,
geographical spread of customers
Individual/department level-material costs,
absenteeism department level
Individual/activity level-number of orders
per employee, transaction time of
placement of order and receipt of goods

All Information
Financial
Non Financial
External sources

Types of MCS
Formal-rules, procedures,
performance
measures.accounting systems,
quality control systems..
Non formal- culture, unwritten rules,
acceptable behavior, slogans
reinforce culture-Citi never sleeps..

Purpose of MCS

MCS ultimate purpose is:

Motivation
Goal Congruence
Effort

Design of MCS
Depends on structure of an
organization
Centralized
Decentralized

Benefits of Decentralization

Understanding local pulse of market

Quicker decision-making
Increases motivation of managers
Management talent is developed
Concentrated focus

Disadvantages of
Decentralization
Dysfunctional decision making
Sub-unit goal and organization goalconflict & self-interest
Costs increase
Duplication of activities

Blend of both systems

Too much decentralization-Barings PLC..
Too much centralization-Eccho shoe
co..Laxmi Mills, Sri Ram group..
Generally marketing and pricing is
decentralized & long term financing & capital
investments is centralized
MNCs need to have a degree of
decentralization

Performance Evaluation
To measure performance of units in
an organization whether following
centralized or decentralized
structure, MCS creates
Reponsibilty Centers like Cost ,
Revenue, Profit or Investment

Specific to Decentralization of
decision making at unit level
To coordinate actions & to evaluate
performance, in this structure, where
there is independent decision
making, MCS uses Transfer Pricing
There are three Transfer-Pricing
Models
Market-based
Cost-based
Negotiated price

Market-based method
Under this method transfer is made
at the market price. The department
requiring goods is perceived as buyer
& department supplying goods is
perceived as seller
This is based on opportunity cost
principle
Instead of this method Cost plus
profit method is also used
Expected rate of return is added to

Cost-based method
Costs could be calculated as per
principles of:
1. Absorption costing
2. Standard cost
3. Marginal Cost

Negotiated Price method

In this method , the
consignor/consignee unit does price
discovery from outside sources &
then price is fixed
This method is used when quotations
or reliable quotations are not
available

Comparison of Transfer
Pricing Methods
Criteria

Market Price

Cost based

Negotiated

Achieves Goal
Congruence

Yes, if mkts are

competitive

Often, but not

always

Yes

Useful for
evaluating subunit
performance

Yes, if mkts are

competitive

Difficult unless
Transfer price
exceeds full
costs

Yes, but transfer

prices are
affected by
bargaining
strengths

Motivates
management
effort

Yes

Yes, if based on Yes

budgeted costs.
Incentive to
control costs is
less if on actual
costs

Preserves subunit autonomy

Yes, if mkts are

competitive

No, as it is rule
based

Yes

Other factors

Mkt may not

Useful for

Need to be