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What is transfer pricing?

Harold Averkamp, CPA, MBA

Definition of Transfer Pricing

Transfer pricing involves setting a price that will be used when one responsibility center of a company sells goods or services to another responsibility center of the same company. The responsibility centers are often profit centers of a decentralized corporation such as related subsidiary corporations, separate divisions of a corporation, or some other subunits.

Depending on the production capacity and the demand for each subunit’s goods or services, a transfer price could be based on cost, market prices, variable costs plus an opportunity cost, or some other amount.

A concern with transfer pricing is whether the transfer price will cause a subunit’s manager to take the action that is best for the company as a whole.

Example of Transfer Pricing

Assume that Giant Corporation has several subsidiary companies including Sub1 and Sub2. Sub1 manufactures electronic components that it sells to companies throughout the world. Sub2 manufactures a unique consumer gadget that uses a component that Sub1 manufactures. Sub1 sells the component for $20 to its many outside customers and its cost to manufacture the unit is $12.

The transfer price is the amount that Sub2 will pay Sub 1 for each component it needs. If Sub 1 has idle capacity, it can make an additional profit even with a transfer price of less than $20. However, Sub2 will be able to sell far more of its profitable consumer gadgets if its cost of the component from Sub 1 is $16. It may be in the best interest of Giant Corporation to arrange for both Sub1 and Sub2 to agree to a transfer price of $16.

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About the Author

Harold Averkamp

For the past 52 years, Harold Averkamp (CPA, MBA) has
worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on

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