An Academic Exercise: Transfer Pricing

I enjoyed my evening class tonight. We talked about Transfer Pricing, which was more than interesting, but undeniably tough.

Transfer Pricing starts with two guidelines: the management accountant will try to utilise the resources in a group and there has to be a fair allocation of profits between the division managers in dispute.

What is actually Transfer Pricing, you ask? Well, it is about the price that a division should charge another under the same group for its service and goods, with the benefit of the group in mind.

What is a division then? A division, in my own word, is defined as an entity controlled by a man (the division manager) who is fully responsible for the profitability of its operation, including planning, production, financial and accounting activities. A division can be a unit of a parent company, or it can be a wholly or partially owned subsidiary. There are obviously profit responsibility and independence of action.

David Solomons identifies four advantage of divisionalisation:
1) It being especially suitable when the company decides to diversify, as the top management cannot claim to be an expert, specialist in all industries.

2) By giving the manager the freedom to exercise their creativity is a motivating factor in itself. In addition, his remuneration and bonus are profit-based.

3) The top management in HQ can just allow the managers to run their own day-to-day operation, to measure their own profitability. Thus, they can just monitor the division's progress and focus on the strategic planning of the group.

4) Finally, the division is a good training ground for development of future top management.