Transfer price (TP) is defined as the cost of the goods or services that provide one profit center of a company to another profit center of the same organization. The value of these products or services is expressed in money and refers to the transfer price. There are some objectives of transfer pricing that play important role in the organization.
Pricing these transactions is a complicated procedure and depends on various external and internal elements, e.g., management policies, the nature of subsidiaries and market conditions, as well as laws and policies of the government. Evaluation of managers’ performance in both centers is also possible by the system for transfer price.
As mentioned above, the decision of transfer price is among the most crucial elements in assessing how a department performs or the director in charge of that division.
Most Important Objectives of Transfer Pricing
The following are the objectives of transfer pricing policy for an organization:
1) Profitability
To install a sense of business at the divisional level to ensure that the people who run divisions can concentrate on the profit part of their department. This results in an increase in the profits of every division and greater profitability for the company overall.
2) Maximum Utilization of Plant Capacity
To maximize the utilization of plant capacity. This can be a powerful method to boost the profits of a business in a short time. It is the main objectives of transfer Pricing.
3) Optimise Financial Resources
It is thought of as an objective and can profoundly impact the company’s performance. The primary factor in determining the optimal distribution of financial resources to different profit centers will be the efficiency of the particular profit center. The policies of transfer pricing in the organization primarily influence that. It is the main objectives of transfer pricing.
4) Transfer Pricing
To aid in the evaluation of the performance of a division, then you need to consider some factors:
- Compensation for the benefits provided by its other departments.
- Charging it for benefits, it has received from its other divisions. It is one of the objectives of transfer pricing.
5) Engage Managers
Inspiring managers to increase the profits of their divisions while being aware of the company’s overall goals. Generally, this is an objectives of transfer pricing.
6) Minimise Taxes
This is a goal that keep in mind by multinational corporations. It is a method of negotiating the transfer costs between different nations to lessen the tax burden of the entire organization appraisal.
Why Transfer Pricing is Most Important?
The efficiency of the system of transfer pricing system is crucial because of the following factors:
- Highly effective transfer pricing system eliminates situations with poor decisions that could result in massive losses.
- A flawed transfer pricing system that does not give fair share or due share to one of the involved divisions i.e., the receiver or the supplier, can create severe human behavior issues. This could manifest as anger, hostility, and the loss of motivational force. The benefits could be derived from a divisional form of organizational setup. These benefits can realize in this situation. There are steps to take to avoid these types of behavioral issues.
- A lapse in the aspect of a transfer pricing system could impact the profitability of a division. These negative results could discourage the manager of the division and other employees.
- The price calculation for transfer should be conducted with extreme care to ensure that the price represents the fair worth of the items or services being considered. Its significance lies because it’s among the main factors in assessing the divisions concerned and their respective heads.
- In some instances, a bad transfer pricing policy can cause conflict between two divisions which could be better for the divisions and the organization. The whole organization is the primary victim because of the resulting discontent, loss of resources, demoralization across different levels of staff, and so on. The possibility of avoiding conflicts is by establishing clear instructions for handling various scenarios, which are usually confronted by transferor and transferee divisions.