Question

Discuss the use of transfer pricing and its application to decision making

Answer 1

As we know that transfer pricing refers to the process of setting prices of goods & services which are sold between two inter-connected entities.

In other words we can say that when we have to fix prices for those goods & services which are sold & purchased between two inter-connected firms. These firms may be parent and subsidiary, two separate divisions of a same firm etc.

Now main question arise why this transfer pricing is so important for the firms?

Let’s know the main uses of transfer pricing and its’ application to decision making;

We know that management have to make decision about the price of products & services which need to be transferred by one division to another division of the same company. In this type of condition transfer pricing technique helps management to fix a reasonable price so that both division can be equally comfortable. Hence it is true that transfer pricing is very helpful for the management in decision making.

Followings are the some main use of transfer pricing;

1. Transfer pricing helps in minimization of tax burden on the company.

2. Transfer pricing is very useful in arranging the proper direction of the cash flow for the company.

3. Transfer pricing helpful in proper shifting of profits.

4. Transfer pricing is helpful in fixation of reasonable prices of goods & services to be transferred internally.

5. Transfer pricing is helpful in reducing profits in high tax rate regions so that overall tax liability can be minimized etc.