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A transfer price is the monetary value recorded in a company’s accounting records when one division transfers a good or service to another business unit (Lanen, 2016, P. 584). It is a device to motivate managers to act in the best interests of the company (Lanen, 2016, P. 586). Sometimes this is disregarded, and managers act in his or her own self-interest. This is done by increasing the transferring price to make a bigger profit. The transfer price negotiated between the divisions can have a huge effect on the reported performance and subsequent decisions made. The transfer price affects the division managers’ decision about whether to engage in the transaction (Lanen, 2016, P. 584). Managers of the selling division and the buying division are both evaluated on their divisions profit, and not on the overall company profit. Therefore, they consider, how the sale will impact their division, internally and externally. Having this type of mindset, can affect corporate profitability negatively. For example, If the buying division perceived the transferring price of the selling division to be too high, the buying division decides not to buy the goods because it would be impossible to make a profit. Therefore, the buying division decides to buy cheaper goods from an outside supplier. If the transaction would have occurred between the two divisions, only one would be profitable. This is because the higher the transfer price is, the lower the profit, and return on investment or economic value added, the buying division will receive (Lanen, 2016, P. 585). Which will result in a higher profit for the selling division. Overall, it would not be profitable for the company. In my opinion, changing profits can result in each division making different decisions, as a result of that decision, group profits may be affected.
Transfer price is the price to transfer goods or services to another department of the same organization. Since the basis of evaluation for companies is the profitability of individual departments, transfer pricing presents quite a dilemma. Each department's managers tries to increase his own profitability . However, this affects the overall profitability of the company.
If the selling department quotes too high a price, the buying department will purchase from outside resulting in loss of revenue for the company. If the buying department quotes too low a price, the selling department may decide not to sell, again resulting in loss of revenue and subsequent profitability. Thus, changing profits individually can affect individual decisions affecting the overall profitablity of the company.
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