Content area
Full text
TRANSFER PRICES AFFECT THE PROFIT REPORTED IN EACH RESPONSIBILITY CENTER OF A COMPANY AND CAN BE USED TO INFLUENCE DECISION MAKING. SHOWING A VARIETY OF EXAMPLES, THE AUTHORS DESCRIBE THE FUNCTIONS AND TYPES OF TRANSFER PRICES AND DISCUSS THE POSSIBLE BEHAVIORAL CONSEQUENCES OF USING THEM.
Most companies now operate in an environment in which their products, markets, customers, employees, and technology are constantly changing. In such circumstances, the appropriate organizational form becomes important, and a decentralized organization is very common. The essence of decentralization is the freedom managers have at various levels to make decisions within their sphere of responsibility. This frequently involves determining a transfer price system within the company, which has the potential to become the most important and possibly the most interesting problem of management control.
Decentralization can simulate market conditions within a company between autonomously acting subunits- i.e., they reflect competition. Managers in such subunits or "business units" have different degrees of autonomy and a range of company decisions for which they are responsible. The cost center manager is typically responsible for costs, the profit center manager for costs and revenues, and the investment center manager for generating an adequate return on investment.
Because of the decentralization of decision making, the role of performance measurement and performance assessment within these responsibility centers becomes important. These issues lead to discussion and systematic analysis of transfer price functions between segments. 1 Companies often use transfer prices as substitutes for market prices either because market prices do not exist or because they do not facilitate internal trading and the synergies it creates. Even if synergies exist for internal trade, it is possible that market prices may not encourage this to happen. Thus top management often imposes a transfer price in order to benefit from these synergies. An added complication, however, is that sharing the synergistic benefits between responsibility centers is arbitrary, so the "correct" transfer price cannot exist. It is obvious that transfer prices affect the profit reported in each responsibility center, and, more importantly, companies can use transfer pricing to influence decision making.
We will look at the functions and different types of transfer prices and their possible behavioral consequences. The analysis, which is from a managerial point of view, argues...