Intersegment Sales

And finance Allah Shmoop How does transfer pricing work Oh

all right You work at the multinational multi divisional conglomerate

Global Mega Giga Tek Co You had the purchasing team

at Fragrance to the bed It's the firm's perfumed diaper

division for babies who really like to be you know

pampered your product combines perfume Fragrance is with specialty diapers

for that upper class baby ready for a night out

pretends like Coco not caca and Low Do not quite

ready for du toilette To create the product you buy

diapers from one source and perfume from another source Then

your team of highly trained spritz ologists applies the perfume

to the diapers Luckily global Mega Giga Techo has a

diaper division and a perfume division or a maybe unluckily

for you life just got more complicated because of transfer

pricing Well the company bigwigs air happy that everything stays

in house You can get all your raw materials from

within the global mega family and that's great But it's

also a headache Why Well because if you bought diapers

from one vendor you'd have a market price for them

You'd negotiate hard and pick the best deal for your

company from the eighteen purveyors of fine nappies for the

spirited pre millennial set Same deal with the perfume but

here that's not the case because you're essentially buying from

well yourself And that's a problem because the prices now

aren't quote market unquote They're kind of made up sorta

Yes you can get in the zone of a market

price but often there really isn't a kind of market

clearing price for a million nappies like nobody else buys

them in that kind of bulk And then how do

you account for shipping charges and well breakage or ribcage

or whatever else costs money in acquiring those diapers Luckily

there exists the magic of transfer pricing transfer pricing tracks

expenses for separate departments within the same firms that do

internal business with each other like it more or less

sets the A price right sets the transfer prices prices

which you're transferring stuff from one division to another Well

the goal is to fairly attribute pricing to each division

such that everyone feels equally unfairly treated You could imagine

that the manager of the diaper sales division has her

own income statement and she probably earns her bonus based

on how profitable that division runs that year Well if

the big bad boss at corporate wants to show more

profit in the Global Mega Diaper Corp Then that boss

will lean on Missa Schimmel bottom to sell or rather

to transfer price her diapers at very cheap prices so

that Diaper Corp looks much more profitable than it really

would be or it paying market prices for its well

very raw materials Meanwhile the same thing's going on at

Globo sent Corp the higher the price they get for

the perfume they send you the better their numbers will

look More bonuses more promotions more cover stories in perfume

industry monthly On the other side of things you have

a similar incentive to get prices down like that's your

job The less you pay for the raw materials while

the better your profits look again Big bonuses at stake

here inside the division Better chance to climb that day

You know Slippery corporate ladder Yes these accounting gymnastics may

seem silly All the money just ends up in the

same big mega glop Huge corporate bottom line in the

end right Well if you send money to global mega

Diaper Corp Well it shows up on their quarterly reports

The Wall Street The Net Number two Global won't change

whether the diapers and perfume are transfer priced expensive or

transfer price cheap It's all global mega Giga Tech owes

money in the end literally but it matters for internal

accounting is that you have to think about it and

do it There are bonuses and the egos and all

the corporate game of thrones stuff at stake here But

there are legitimate business reasons to transfer Pricing allows accountants

to figure out the true cost and profitability of different

products This information allows global mega tow make informed decisions

about production distribution and marketing like what products are worth

keeping which ones should expand or killed If a manager

just grabbed a bunch of diapers or walked off with

a drum full of perfume without charging those cost to

their division wealth and when all the beans are coming

at the end of the day it would be impossible

to track the cross it took to actually make those

items So they all have to be tracked And the

resulting numbers would then cloud how well or poorly each

division was doing And you can imagine that there have

been times in business when an internal division is simply

poorly run like what if the perfume business could only

make that perfume for one hundred dollars a gallon But

the manager of Frog Rasta Beibei could by that same

identical perfume from another vendor for only seventy dollars a

gallon Well since the perfume diaper people are bonus on

profits why shouldn't they be allowed to buy that product

the best way they can buy it And it may

mean that the global sent division should in fact be

tossed out you know like a an old diaper and

shut down So transfer pricing shines a bright light on

the line operations of a business and allows managers to

figure out the true value of each of their products

without accurate transfer pricing A big company like global Mega

wouldn't be able to identify which products are inside really

profitable divisions and which ones are a drag on the

firm's finances So to get the diapers on Global Mega

Stipe ER division well you'll have to pay for the

product right It's time to go over now to the

Diaper Co And buy some diapers Well how do you

set that price Well there are three basic methods First

some details about the diapers A package of one hundred

diapers retails for fifty bucks It cost the diaper unit

twenty bucks to produce Okay now here the three methods

One pay for the cost of producing the diapers So

under the first method you'll just reimburse the diaper unit

for its costs in producing them You pay him twenty

bucks for the hundred diapers That's it The second method

You pay full retail price you'd give diaper code that

fifty dollars that they would have gotten if the diapers

had been sold at their store All right Third method

a negotiated amount somewhere in between Yeah some figure higher

than the cost but not quite the full retail price

So basically you'd get on the phone with some sales

guy at Diaper Co And basically just work out a

deal The transfer price you pay will depend on the

situation If diaper code isn't working at capacity you know

a price that cost or close to it makes sense

They can crank up production than pretty easily without causing

a problem that I propose you get wouldn't get made

if he didn't want them to be made However if

Diaper Cho is constantly selling out well then a transfer

price at or near retail price would make sense They

have orders piling up and if a cell to you

for a cheap price they're losing money selling to others

at a much higher price They're having trouble filling all

their orders Every diaper you take is a diaper then

that they can't sell to a retail price paying customer

You're literally costing them sales when you get the diapers

for closer to twenty bucks than fifty So you should

be treated Don't just like any other customer right Well

turns out diaper Cho is near capacity You'll have to

pay near full price However you negotiate a volume discount

and so you pay forty five bucks per package of

one hundred diapers Meanwhile you get another ten percent off

by promising that Jimmy the best softball player at Fragrance

Beibei will play for Diaper Co At the next company

picnic so you end up paying forty dollars fifty cents

for one hundred count package Alright now time to buy

the perfume when you call over global sent Corp They

have a deal for you Owed it to Tidewater Hasn't

been selling very well And they have a lot of

it sitting in the warehouse and are happy to get

rid of it You Khun basically get it at cost

Plus you talked them into letting you use some of

their pre cut budget just to take the extra barrels

of perfume off their hands So yeah that's transfer pricing

We could go into more depth but for now we'll 00:07:26.773 --> [endTime] just start with a spritz yellow