What is the Transfer Price Accounting

When a product is sold from one subsidiary to another within a company, it is known as transfer pricing. It influences the purchasing behavior of the subsidiaries and may have an impact on the income tax for the company as a whole Transfer prices are usually used when individual entities of a huge multi-entity firm are measured and treated as separately run entities. Another name for transfer price is transferred cost.

Methods of Transfer Pricing

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Here are a number of ways which can help you to derive a transfer price:

Transfer price methods

  • Market rate transfer price
  • Adjusted market rate transfer price
  • Negotiated transfer pricing
  • The contribution of margin transfer pricing
  • Cost plus transfer pricing

Market rate transfer price

The market price is the simplest and most elegant transfer price. This helps the upstream subsidiary to sell either internally or externally and can earn similar profits. It can also help you earn the highest possible profit, unlike mandated pricing schemes, which are subject to the odd profit vagaries.

Adjusted market rate transfer price

If you are unable to get right the market pricing technique then use the general concept, by making some adjustments to the price. For example, you can reduce the market price for the absence of bad debts, since corporate management is likely to intervene and make you pay by force if there is a risk of non-payment.

Negotiated transfer pricing

You have to negotiate a transfer price between subsidiaries, without considering any market price as a baseline. The main reason why this kind of situation arises when there is no discernible market price because of two reasons, one the market is very small and the second the goods are highly customized.  The relative negotiating skills of the parties impact the prices.

The contribution of margin transfer pricing

If you want to derive a transfer price and there is no market price at all, then substitute it by creating a price based on a component’s contribution margin. ·  Cost-based transfer pricing. Ensure that each subsidiary transfers its products to other subsidiaries, on top of which successive subsidiaries add their costs to the product. Overall it means the final subsidiary that sells the completed goods to a third party will acknowledge the entire profit linked to the product.

Cost-plus transfer pricing

If you do not find any market price at all on which you can base a transfer price, you could consider using a system that can create a transfer price depending on the cost of the components, which is being transferred. You can do this by adding a margin onto the cost, where you compose the standard cost of a component, add a standard profit margin, and utilise the result as the transfer price.

More and number of countries have started embracing Transfer Pricing (“TP”) and regulations which includes mandatory documentation, Transfer Pricing has indeed become very complex. In India, with the ongoing enforcement of Transfer pricing regulations in the country and continuous adjustments being made, which focusses on both new and more complicated issues focusses on a reality that TP controversies are the expensive and quite time-consuming thing to deal with and it results in double taxation of income and may lead to uncertainty.

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