Analyzing Cost-Plus and Negotiated Transfer Pricing in Finance

Desklib provides past papers and solved assignments for students. This report compares cost-plus and negotiated transfer pricing methods.

Cost Plus
Based on the cost-plus method, the suppliers computes the cost of procurement for the products and
then adds required mark-up to the cost so as to arrive at the appropriate profit based on the functions
which is performed for manufacturing the products or services, after adding the mark-up to the costs,
the price is determined and passed back to the customers. (Titman, 2012)
The following are the advantages of using the cost plus mark-up transfer pricing
 The formula is simple and easy to compute and assign them to various products and services
 This method enables the business to get guaranteed absorption of the costs which is involved in
the production of the products, if the company finds the cost are rising and could not able to
curtail them, then they can pass on the additional cost back to the customers.
 When the business is unable to forecast the demand, then they can use cost plus method for
deriving the price of the products. (Kaplan, 2012)
 This type of pricing method is more advantageous when the extent of competition cannot be
determined or forecasted, this can be applied to new products or technology oriented products
which has shorter life span
The following are the disadvantages of using the pricing method
 The business cannot able to accurately compute the total cost which is involved in the products,
mainly when the product lines are high.
 Ascertaining the service costs is also difficult hence this pricing method may not be suitable for
service oriented industries like Telecom etc.
Negotiated transfer pricing
The management needs to negotiate for a transfer price among the subsidiaries by not using the market
pricing as the fundamental price. This may arise when there is no apparent prices available as the
market may be very small or the products / services may be highly customized. The divisional managers
may tend to negotiate on the mutually agreed pricing for the category of the products.
Advantages
This type of transfer pricing method helps the business to take the lead among the other divisions of the
company, it can be stated that the procurement department may purchase from outside if the prices in
the market is lower than the internal division price.
This pricing method provides a complete autonomy for the business unit, the buyers and the sellers are
free to deal and negotiate on the prices without any intervention, this will enhance the autonomy and
increases motivation and morale of the employees in the unit, since they will be involved in critical
decisions making. (Brigham, 2012)

With the help of properly negotiated prices the managers can understand the appropriate transfer
prices which will satisfy the key requirements of their groups and can work in best interest of the
company.
Disadvantages
This pricing method is best suitable when the market price is high
When the pricing is wrong, both the divisions and the company as a whole may face loss
It may affect the morale of the managers if the decisions turns out to be bad or poor
References
Brigham, E.F. (2012). Financial Management Theory and Practice. Cengage Learning. 10th edition
Kaplan, R. S & Young, M.S. (2012). Management accounting. Prentice Hall. 4th edition
Titman. (2012). Financial Management. Prentice Hall. 7th edition