Minimum Transfer Pricing

Transfer pricing refers to setting up a price for the transaction between different business units of a same Organization .A minimum transfer price is the minimum price a division of a company can charge to the other division of the same company for a product or service. We see transfer pricing from the point of view of the selling division. We consider the minimum selling price that the selling division could be able to sell for. This need not necessarily be the same price that the selling division would be happy to sell for.

Methods to calculate Minimum Transfer Price:

1. It can be calculated as the Minimum Transfer price = Marginal Costs
2. Or the Marginal costs added to Opportunity costs.

The general economic transfer price rule is that the minimum transfer price must be greater than or equal to the marginal cost of the selling division.

The ideal minimum transfer price to be set to keep the selling division happy is

Marginal cost + Opportunity cost.

Opportunity Cost refers to the cost of the next best alternative forgone. Marginal Cost refers to the cost of producing one extra or additional unit of the output. We need to know if the selling division has spare capacity or not.
• Having Spare Capacity:
The opportunity cost will be zero. This is because workers and machines are not fully utilized.
• Not having Spare Capacity:
If the selling division has spare capacity the minimum transfer price is just marginal cost.

For example: A division is making jeans. The cost of making one jeans is ₹1000.The division can sell the jeans outside in the market for ₹1500. The opportunity cost of not selling the jeans externally is ₹500.The marginal cost of 1 jeans is ₹200.The new minimum transfer Price is ₹700 (₹500+₹200). Anything less than this amount would be a loss to the Selling division.

Opportunity Cost + Marginal Cost = Ideal Minimum Transfer Price

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