Inter‐Divisional Transfer Pricing: An Artificial Accounting System or a Real Business Tool?

Abstract

Transfer pricing, although a relatively new area, is now a large and complex subject. In large diversified and integrated companies, the necessity to identify separate “profit centres” generates “internal” prices or transfer prices from one subsidiary to another, from one product line to another or even from one function to another. As the movements of funds generated by these transfer prices remain strictly within the company books, and therefore do not generate any profit for the whole enterprise, it appears that the mechanism of setting the level of transfer prices is purely an artificial accounting technique which should not deserve too much management time and should not influence real business decisions. An enormous amount of internal time is, however, spent by the management of most large companies in discussing and negotiating transfer prices. This seems to be a waste of time and effort but is a logical consequence of the definition of separate profit centres. The primary objective of the company should be to maximise overall profit, which means the addition of the financial results of each profit centre, and therefore the transfer price system should be designed to reach that objective.