Transfer pricing
Transfer pricing is the internal price one division charges another for goods or services supplied.
Also known astransfer price
FrameworkTransfer pricing
See it move
A three-step flow diagram shows how a transfer price moves through the organisation: the selling division charges an internal price and records it as revenue, the transfer price is the agreed internal charge, and the buying division pays that price and records it as a cost. Profit shifts between divisions depending on where the price is set, but the group's total profit is unaffected because the internal revenue and cost cancel on consolidation. The flow illustrates why transfer pricing is a matter of profit allocation rather than value creation.
The formula
Variables
- Variable cost per unit in the selling division (€ per unit)
- Opportunity cost per unit — contribution margin foregone on lost external sales; zero when the selling division has idle capacity (€ per unit)
Floor below which the selling division is worse off accepting the internal transfer than its best outside alternative.
Check yourself
Division A sells a component to Division B at an internal transfer price of €50 per unit. If the price is raised to €65 per unit, which outcome correctly describes the result?