Advantages of Transfer Pricing

(a) Transfer pricing is similar to cost apportionment and allocation in that values of one department are passed to another. For cost apportionment and allocation systems, costs of one department are passed to another with the objective of accumulating costs for product cost information purposes. In a sense, apportionment and allocation provides a mechanism of transfer pricing primarily based on input measures such as floor area or direct labor hours.  Under transfer pricing arrangements, values of one department are also passed to another.  Output measures of activities are used to charge departmental costs and allowable profits to other departments. The information produced can be used to accumulate product costs. Where transfer prices are cost based and make no allowance for profits, the results would differ from apportionment and allocation systems only with regard to the basis for transferring costs between departments.

(b) Where performance measurement is linked to rewards such as promotion or salary, the method of transfer price can have a direct impact on the motivation of the divisional manager. For example, a divisional manager appraised on a profit centre basis will be in a position of advantage where high transfer prices are established for the particular division. The effect of motivating managers to improve profits may lead to bargaining for transfer pricing methods which provide the highest transfer prices for their particular divisions. In a transfer pricing situation, as in a number of accounting situations, there will inevitably be winners and losers. The challenge to the accountant is to devise a transfer pricing methodology which ensures that the winners are those who will benefit the organization most in the long term.

(c) Some multinational companies are in a position to use transfer pricing to reduce total taxation costs. This can be achieved by establishing transfer prices towards the higher end of the spectrum of allowable values in countries with low taxation. This would tend to lead to high profits in countries with low taxation and lower profits in countries with higher taxation. Governments in some countries take steps from time to time to regulate the operation of transfer pricing systems for this reason.