A transfer price is not a price charged by the company to external customers, so this is an incorrect description of transfer pricing. A transfer price is the price charged by one unit of the company to another unit of the same company for the services or goods produced by the first unit and "sold" to the second unit.
A transfer price is the price charged by one unit of the company to another unit of the same company for the services or goods produced by the first unit and "sold" to the second unit.
When there is an external market for the product, this is almost always the best transfer price to use for profitability and performance measurement, because it is objective. However, if no market price exists, a transfer price may be based on cost, such as the cost of production plus an opportunity cost, the variable cost, the full cost, or cost plus. A negotiated price or arbitrary pricing may also be used.
The transfer price is set as the current price of the selling division’s product in an arms-length transaction. When there is an external market for the product, this is almost always the best transfer price to use for profitability and performance measurement, because it is objective. It satisfies the "arm’s length" requirement by taxing authorities. Furthermore, it satisfies the management of the buying company that they are paying a fair price for the goods and the management of the selling company that they are receiving a fair price for the goods.
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