Talks about transfer pricing normally presume the firm's aim is to maximize profit while making the best use of existing capacity. This article differs by investigating the impact of transfer pricing on capital budget decisions. In decentralized companies, decision authority for investment is assigned to department managers whose capital budgets comprise sales from internal transfers. When a selling department is under capacity, a transfer price is recommended by economic theory based on differential cost. Here the seller generates sales that are sufficient to recoup operating costs, but not enough to recover capital costs.
Thus, some investments that would have raised corporate shareholder value will be rejected by division supervisors. Market-based transfer pricing overcomes this conflict by allocating investments on inter-firm trades to the division that was selling. Nevertheless, marketplace transfer pricing may bring about shortfalls to corporate gain. Nonetheless, we argue in favor of the usage of transfer pricing on the assumption that long term value creation takes precedence over short-term gain.
Transfer Pricing for Aligning Divisional and Corporate Decisions Case Study Solution
PUBLICATION DATE: September 15, 2008 PRODUCT #: BH293-HCB-ENG
This is just an excerpt. This case is about FINANCE & ACCOUNTING
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