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And finance Allah Shmoop How does transfer pricing work Oh

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all right You work at the multinational multi divisional conglomerate

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Global Mega Giga Tek Co You had the purchasing team

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

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division for babies who really like to be you know

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pampered your product combines perfume Fragrance is with specialty diapers

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for that upper class baby ready for a night out

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pretends like Coco not caca and Low Do not quite

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ready for du toilette To create the product you buy

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diapers from one source and perfume from another source Then

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your team of highly trained spritz ologists applies the perfume

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to the diapers Luckily global Mega Giga Techo has a

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diaper division and a perfume division or a maybe unluckily

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for you life just got more complicated because of transfer

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pricing Well the company bigwigs air happy that everything stays

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in house You can get all your raw materials from

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

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also a headache Why Well because if you bought diapers

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

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

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company from the eighteen purveyors of fine nappies for the

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spirited pre millennial set Same deal with the perfume but

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

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

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

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Yes you can get in the zone of a market

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

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clearing price for a million nappies like nobody else buys

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them in that kind of bulk And then how do

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you account for shipping charges and well breakage or ribcage

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or whatever else costs money in acquiring those diapers Luckily

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there exists the magic of transfer pricing transfer pricing tracks

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expenses for separate departments within the same firms that do

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internal business with each other like it more or less

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sets the A price right sets the transfer prices prices

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

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the goal is to fairly attribute pricing to each division

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such that everyone feels equally unfairly treated You could imagine

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that the manager of the diaper sales division has her

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own income statement and she probably earns her bonus based

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on how profitable that division runs that year Well if

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the big bad boss at corporate wants to show more

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profit in the Global Mega Diaper Corp Then that boss

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will lean on Missa Schimmel bottom to sell or rather

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to transfer price her diapers at very cheap prices so

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that Diaper Corp looks much more profitable than it really

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would be or it paying market prices for its well

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

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Globo sent Corp the higher the price they get for

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the perfume they send you the better their numbers will

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look More bonuses more promotions more cover stories in perfume

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industry monthly On the other side of things you have

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

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job The less you pay for the raw materials while

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the better your profits look again Big bonuses at stake

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here inside the division Better chance to climb that day

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You know Slippery corporate ladder Yes these accounting gymnastics may

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seem silly All the money just ends up in the

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same big mega glop Huge corporate bottom line in the

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end right Well if you send money to global mega

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Diaper Corp Well it shows up on their quarterly reports

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

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whether the diapers and perfume are transfer priced expensive or

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

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money in the end literally but it matters for internal

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accounting is that you have to think about it and

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do it There are bonuses and the egos and all

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the corporate game of thrones stuff at stake here But

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there are legitimate business reasons to transfer Pricing allows accountants

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to figure out the true cost and profitability of different

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products This information allows global mega tow make informed decisions

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about production distribution and marketing like what products are worth

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keeping which ones should expand or killed If a manager

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just grabbed a bunch of diapers or walked off with

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a drum full of perfume without charging those cost to

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their division wealth and when all the beans are coming

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at the end of the day it would be impossible

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to track the cross it took to actually make those

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items So they all have to be tracked And the

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resulting numbers would then cloud how well or poorly each

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division was doing And you can imagine that there have

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been times in business when an internal division is simply

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poorly run like what if the perfume business could only

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make that perfume for one hundred dollars a gallon But

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the manager of Frog Rasta Beibei could by that same

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identical perfume from another vendor for only seventy dollars a

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gallon Well since the perfume diaper people are bonus on

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

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the best way they can buy it And it may

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mean that the global sent division should in fact be

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tossed out you know like a an old diaper and

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shut down So transfer pricing shines a bright light on

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the line operations of a business and allows managers to

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figure out the true value of each of their products

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without accurate transfer pricing A big company like global Mega

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

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profitable divisions and which ones are a drag on the

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

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

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

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Diaper Co And buy some diapers Well how do you

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set that price Well there are three basic methods First

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some details about the diapers A package of one hundred

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diapers retails for fifty bucks It cost the diaper unit

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twenty bucks to produce Okay now here the three methods

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One pay for the cost of producing the diapers So

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

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for its costs in producing them You pay him twenty

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

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

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fifty dollars that they would have gotten if the diapers

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had been sold at their store All right Third method

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a negotiated amount somewhere in between Yeah some figure higher

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than the cost but not quite the full retail price

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

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guy at Diaper Co And basically just work out a

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deal The transfer price you pay will depend on the

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

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a price that cost or close to it makes sense

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They can crank up production than pretty easily without causing

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

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

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Diaper Cho is constantly selling out well then a transfer

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price at or near retail price would make sense They

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have orders piling up and if a cell to you

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

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

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their orders Every diaper you take is a diaper then

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

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

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for closer to twenty bucks than fifty So you should

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

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

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pay near full price However you negotiate a volume discount

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and so you pay forty five bucks per package of

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one hundred diapers Meanwhile you get another ten percent off

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by promising that Jimmy the best softball player at Fragrance

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Beibei will play for Diaper Co At the next company

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picnic so you end up paying forty dollars fifty cents

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for one hundred count package Alright now time to buy

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the perfume when you call over global sent Corp They

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

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been selling very well And they have a lot of

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it sitting in the warehouse and are happy to get

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rid of it You Khun basically get it at cost

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Plus you talked them into letting you use some of

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their pre cut budget just to take the extra barrels

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

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

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