Determining Transfer Price and Performance Measurement Approach

This report discusses the determination of transfer price and the appropriate method for its calculation. It also explores different approaches for determining transfer price, such as negotiated pricing method and dual transfer price method. Additionally, it examines the impact of transfer price on the performance of the company and provides recommendations for optimizing performance and efficiency.

Management accounting

EXECUTIVE SUMMARY
Generally,organizations apply the decentralization method for running the operations. With this
aspect, sometimes internal transfer takes place among the division due to which the role of
transfer price is very important. The present study revolves around the determination of transfer
price with the main objective of enhancement of the productivity and efficiency of the overall
company. It is the price at which one department transfers its goods and services to another
department. There are several approaches such as negotiated pricing method, cost method,
market price and others, by which transfer price can be determined by the company. The study
concludes that the performance basis approach is most suitable to evaluate the overall efficiency
of the business.

Table of Contents
Introduction......................................................................................................................................4
Assessment 3...................................................................................................................................4
Task 1...........................................................................................................................................4
Task 2...........................................................................................................................................8
Task 3.........................................................................................................................................10
Conclusion.....................................................................................................................................12

INTRODUCTION
In large corporations, the company divides its operation into some departments. Sometimes, one
department of a company can sell its product outside the company or transfer its product to other
division as per the requirement. At the time of transfer of goods to another department, the
determination of the transfer price plays a significant role. Along with this, the manager of the
division is accountable for their performance of the division. Therefore they want to improve the
performance if division (Davies et al. 2018). The present report is related with the Raven
Industries, which has three distinct divisions. The report contains the issues related to the
determination of the transfer price and appropriate method which should be considered for
transfer price. Along with this, among the transfer pricing and the performance measurement
approach, the recommendation to the company also provided, which assist in the optimization of
performance and effectiveness.
TASK 1
Explanation related to the statement made by Cleveland for the determination of transfer price
The issue of transfer price arises at the time when the division of one company transfers its
goods or services to other division of the company. Generally, the departmental manager
isresponsible for the performance of their own division. Therefore they want to determine the
transfer price in such a way by which profit of the department can be maximized (Wu, and Lu,
2018). On the other hand, other division may not want to pay the higher price for purchasing of
the product. Therefore, sometime conflicts may take place in the department. Generally, it is
closely related with the market price of the product, so that there will be no significant difference

in purchasing or selling in the external market or to another department (Tran, Croson, and
Seldon, 2016).
In the present case, Raven Industries has three divisions. The cushion division of the company
sells its product to the furniture division at the variable cost of the product. No profit is earned by
the cushion division from this transfer; therefore, it assists in the reduction of the performance of
the division. Since the product has the external market, and by this cushion division can generate
the profit and improve its performance. Therefore the manager of the cushion division was not
happy with the existing performance and wants to transfer the furniture division at the transfer
price, which is based on the contribution margin approach. It has seemed that manager of the
cushion division was right, as he is accountable for the performance of division; therefore,
maximization of the profit of division is the main objective. Moreover, due to the external
market of the product, he can sell the product and generate profits. On the basis of this, for
performance measurement, the determination of the transfer price should be based on market
price instead of the variable cost.
Description of the other approaches that could be used by the company to ascertain the transfer
price, except manufacturing cost or market price
The ascertainment of the transfer price plays a very important role related to the performance of
the company. There are several methods by which the transfer price can be determined, which
are as follows –
Negotiated transfer price method
This method is formed on the basis of negotiation among the buying division and selling a
division of a company. This method is suitable; it is probable that negotiation assists in the

overall profitability of the company, which would be adopted by the related parties. For the
implementation of this method, the formal meeting can be called by the top executives of the
company (Hamamura, 2019). In this meeting, managers of the buying and selling department
make the discussion and decide the transfer price. Moreover, this method is workable only if it
impacts the profit centre of business. However, implementation of this method is not very easy,
as it is time-consuming. Further, conflict may arise among the buying division and selling
division (Johnson, Johnson, and Pfeiffer, 2016).
It has been observed that negotiated price is the results of the discussion among the two
divisions; there are so many advantages of this method, which are as follows –
 This method is consistent with the main motive of the decentralization. Since, the main
objective of decentralization is to improve the performance and effectiveness of the
operations of the company by delegating the responsibility and authority to the other
divisions (Clempner, 2019).
 Negotiated pricing method also safeguards the autonomy of the division.
 Further, it is likely that managers of the department have full knowledge regarding the
cost and advantages of the transfer as compared with the other executives of the company
(Sengul, 2018). Therefore, they can decide the price in a proper manner, which leads to
the overall profitability of the company.
When this method is implemented in a company for the determination of the transfer price, then
the managers of the department who are involving in the transfer make the discussion and agreed
on the terms and condition. They may choose not to transfer if the terms and condition of transfer
price are not agreed upon by the managers. Further, the selling division of the company will

agree on the terms and conditions of transfer price only if the profit on transfer is equivalent or
more than on profit on the sale of goods or services to the external market. Similarly, buying
division will agree to buy the product and services internally only if the transfer price less than or
equivalent to the market price of the cost of the product (Trang, 2016). Moreover, if the transfer
price is less than the cost of the product, then in such case, the loss will be incurred to the selling
division, and manager of selling division will not agree to make the transfer. Just like this, if the
transfer price is determined too high, then in such case buying division will not agree to buy the
product internally. Therefore, in this method,the transfer price is determined on the basis
acceptable range, within which the return of both the division involving in the transfer would
enhance (Martini, 2015).
By considering the perspective of the seller, transfer price must be set in such a way, by which
division can cover the variable cost along with the loss of contribution from the sale of goods to
the external market. On the other hand, on the basis of the viewpoint of the buyer, the transfer
price should be less than or equivalent to the cost of purchasing the product from the external
supplier. (Hofmann, and van Lent, 2017)
Dual Transfer Price Method
If the transfer price is determined differently for the buying division and selling division, then it
is referred to as a dual transfer pricing method. In this method, selling division charges the
transfer price, which may be based on cost plus some profit margin. On the other hand, buying
division will record the transaction at the cost of the product. The main motive of this method is
to encourage the buying division to purchase the product from the other department (Hamamura,
2018). Similarly, selling division also agree to transfer, as the profit of division will not be

compromised because of the transfer. If the company has adequate spare capacity, then this
method will assist in the overall profitability of the organization. However, at the time of
consolidation of the results of the department, then the head office of the company is required to
make the entry,which eliminates the unrealized profit. By considering the above analysis, the
following advantages can be achieved by the company, which are as follows –
 Buying division of the company will purchase the product at the least cost; therefore,
they wish to buy the product internally instead of the external market (Bouwens,
Hofmann, and van Lent, 2017).
 Similarly, selling division can generate the profit as the transfer price is normally based
on the market price. Therefore the manager wants to transfer the product to another
department.
Therefore, it can be said that Raven Industries can apply the negotiated pricing method or dual
pricing method for the determination of the transfer price while selling the product of the cushion
department to the furniture department. It satisfies the main objective of the decentralization and
could enhance the overall profitability of the company (Christensen, 2018).
TASK 2
The cushion division sales its product to furniture division at the variable cost. The given
solution is based on the determination of the transfer price based on the contribution margin
approach. As per this method, contribution earned by the cushion division is computed on the
basis of sales of its product to the external market, and this is applied on sales to furniture
division.

Computation of contribution earned by the cushion division on sales to the external market is as
follows –
Table 1 Computation of Total sales of Cushion Division
Particulars Amount
Revenue generated from external market $3,500,000
Variable cost $2,660,000
Contribution $840,000
% of contribution to sales 24
Transfer price for sales to furniture department $620,000
Sales from outside market $3,500,000
Total sales of Cushion Division $4,120,000
 Revenue generated from external market
Particulars Amount in $
Total Sales $4000000
Transfer to Furniture Division $500000
Revenue from external market $3500000
 Variable cost
= 3040000/4000000*3500000
= $2660000
 Contribution = Sales – Variable cost
 Transfer price is computed on the basis of contribution earned from the external market,
that is 500000+24% = $620000
Computation of the Revised Profit statement

Table 2 Statement of Total Cost of all divisions
Variable Costs Carpet Division Furniture Division
Cushion
Division
Direct Material $500,000 $1,000,000 $1,030,000
Direct Labor $500,000 $200,000 $1,030,000
Variable overhead $750,000 $50,000 $1,030,000
Selling expenses $480,000 $480,000 $412,000
Administrative Expenses $85,000 $140,000 41200
Total Variable cost $2,315,000 $1,870,000 $3,543,200
Fixed Cost 250000 50000
Selling expenses 120000 120000 100000
Administrative Expenses $215,000 $360,000 $360,000
Total Fixed Cost 585000 530000 460000
Total Cost $2,900,000 $2,400,000 $4,003,200
Revised Profit Statement
Table 3 Revised Profit Statement of Raven Industries
Particulars Carpet Division Furniture Division
Cushion
Division
Total Sales of all department $3,000,000 $3,000,000 $4,120,000
Less - Total Cost 2900000 2400000 4003200
Net Profit $100,000 $600,000 $116,800
By considering the above statement, it has been analyzed that if the cushion division sales their
products to furniture division on the basis contribution margin approach, then it definitely
enhances the performance of division as well as the overall company. Along with this, there are
several approaches which can be applied by the Raven Industries for the determination of the
transfer price.

TASK 3
To,
The CEO
Cushion Division.
Dear Sir,
Subject: Discussion relating to transfer pricing and performance measurement approach which
would assist in optimizing the performance and efficiency of company.
Transfer price is the price at which the company sells its goods, services, which consist of
labour, parts or any other products to its other division or it's subsidiary (Ansoff& et al. 2019).
On the other hand, performance measurement is the technique which is applied for measuring the
performance of the division. In the present case, it is given that Raven Industries has three
distinct divisions, in which Cushion division sales its products to furniture division. It is given
that; transfer price represents the variable cost. In other words, the cushion division transfers its
product to furniture division at cost price, which is the variable cost incurred by division for the
production of one unit its product. By this method, the manager of the cushion division was not
happy with the performance of the company. Therefore he wants to implement the contribution
margin method for determination of the transfer price. As per this method, the transfer price is
consisting of the contribution that can be generated by the external sale of the product. There are
three managerial accounting areas, which are affected by the transfer price, which are, transfer
price ascertain costs and revenue among the transacting division and impact on the performance
analysis (Whittington, 2016). If the company applies the cost method for the ascertainment of the
transfer price, then cushion division will not want to sell the product to furniture division, as

there is no generation of profit by this transfer. On the other hand, cushion division has an
external market for the selling of the product, by which the department can generate the profit.
Thus the application of the cost method for the ascertainment of transfer price was not in order.
If the division does not have any external market for the selling of the product, then is such case
the department will agree to sell their product at the cost. In the given problem, it is stated that
cushion division has an external market for the product, by which it can generate profit by selling
their product. Further, for measuring the performance, determination of price through the
contribution based margin approach is the good technique (Baldenius, and Michaeli, 2017).
By considering the above analysis, it has been observed that optimization of the performance and
efficiency of the company is possible through by implementation of the performance
measurement approach (Meyer & et al. 2017). Therefore, the same is recommended to the Raven
Industries to implement the performance-based approach instead of transfer pricing approach. By
this approach, the divisional manager gets motivated to sell the product internally, which leads
towards improvement in the profitability. In addition, it also gives the opportunity to the manager
to review and assess the performance of each division, by which they can make the strategies and
plans and allocate the resources of the company accordingly (Hofmann, and Indjejikian, 2018).
Along with this, the performance of one department can influence or motivate the other
departmental manager for improvising the activities of the department. Further, the company can
identify the division whose performance is not as per the strategies, so take the proper actions by
which optimum utilization of the resources is possible (Reineke, and Weiskirchner-Merten,
2018). Moreover, it also gives the separate responsibility to each divisional manager, so that they
take all actions carefully and put the efforts for improvising the performance. However,
sometimes by this company may face challenges, because there is a possibility that divisional

manager may implement their own strategies, which may not come as per the overall plans of
companies (Holzhacker& et al. 2019).
By considering the advantages of performance measurement, it is recommended thatthe company
should use the performance measurement approach, which would assist the company in
optimizing its performance and effectiveness.
Thanks.
With Regards.
CONCLUSION
Transfer price plays a significant role with respect to the performance of the division as well as
the overall company. There are several methods by which a company can determine the transfer
price, at which one division of company transfer its goods or services to other division. All
methods are suitable as per the requirement or demand of the product. By considering the above
analysis, it has been concluded that the primary goal of any company is to enhance the
performance of division, which assistsin the overall profitability of the company. in this problem,
cushion division should transfer its products to furniture division at the contribution margin
approach, which leads to accelerating the growth of the company. Along with this, the company
can apply the different transfer pricing approach for the determination of the transfer price.
Moreover, by the implementation of the performance measurement approach, the company can
optimize its effectiveness as well as productivity.

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