Thequestion about which price the Toner Division should charge thePrinter Division revolves around the subject of transfer pricing. Atransfer price refers to a price at which services or goods aretransferred from one department or a division to another [CITATION CIM16 l 1033 ].However, there are problems associated with transfer pricing. First,it is not easy to maintain the required level of autonomy indivisions because all centers are inter-relatedand therefore, a function of one department is likely to influenceanother division. Secondly, it is sometimes difficult to assess adivisions’ performance fairly this is because divisional managerscare about their own performance and are therefore more likely toshun transfer prices which would lead to losses as opposed toprofits. Finally, there is a conflict about the level of output setby the organization as whole and the actualization of such profitscan only become a reality if all individual divisions or departmentsachieved their own limits. Therefore, an ideal transfer price shouldaddress three issues by taking the following measures. First, thetransfer price should have a selling price that allows the transferdivision, Toner to have a return for its activities while the PrinterDivision should incur a cost for the initial toner which it couldhave otherwise bought externally. Second, the transfer price shouldbe fairly commercial to enable divisions to be evaluated in terms oftheir performance. Third, the transfer price should at the end of theday maximize profits. Unfortunately, all three idealsituations can only occur in an absolute world.
However,there are some advantages of using transfer pricing withindepartments of a company. The use of such a system can assist in goalcongruency. This may motivate the managers from the Toner and Printdepartments to make decisions which may improve the profits of theirdivision as well as their company as a whole. Second, it can preventsome decisions which might be dysfunctional for instance, makingdecisions which can only favor the Toner department at the expense ofthe Print division. The divisions of a company are interrelated andthus a decision made in one department will have an effect on anotherdivision. The system of transfer pricing can allow both the Print andToner departments to be assessed commercially, therefore the managerscan be evaluated based on their divisional performance. Finally, abalance between the departments and the organization as a whole iskept as divisional autonomy is not weakened [CITATION BPP141 p 417 l 1033 ].
TheToner Division of is responsible for making theinitial toners. The cartridges can be sold to the external market ata price of $ 35.00 (70% * $50). On the other hand, the PrinterDivision would be required to purchase the initial toner from themarket at a retail price of $50 if it does not acquire theminternally. The limits on which the transfer price should be setshould consider the minimum and maximum prices. The minimum priceshould take into consideration the fact that the price should belower than the opportunity cost and the marginal cost. The supplyingdivision should not accept a price below $ 35.00. The reason for thisis that, the opportunity cost of the cartridges is $ 35 (70% * $50)which happens to be the price at which the Toner division would sellto retail stores if it does not deliver the cartridges to thereceiving division. The maximum price for the initial toner should beset at $ 50 since the Printer Division would buy the initial toner atthe lowest retail price. However, the maximum price should take intoconsideration any cost savings incurred in the delivery and packingof the initial toners [CITATION BPP141 p 416 l 1033 ].
Inthe case of , it seems like there is a $ 15 differencebetween the maximum and the minimum transfer prices. The $ 15represents the money saved as a result of making the cartridgesinternally. If the Printer department had bought the initialcartridges from the market, would have made a loss of$ 50 for every cartridge purchased. Therefore, the transfer price forthe initial toner cartridge should be set at $ 35.00.
BPP Learning Media. (2014). Performance Measurement. London: BPP Learning Media.
CIMA. (2016, September 12). Transfer Pricing. Retrieved September 12, 2016, from CIMA: http://www.cimaglobal.com/Events-and-cpd-courses/Events/Mastercourses/Technical-skills/Tax-strategy-planning-and-compliance/Fundamentals-of-transfer-pricing—New/