Though not a valuation method, transfer pricing is a technique that organizations use to assist in aggregate inventory management, especially when looking at, and adjusting margins. Formally defined transfer pricing is a practice used in accounting to transfer the cost of goods or services from one area of a business to another.
This transfer could be: different divisions, different segments or even interplant transfers. While transfer pricing does not change the value of inventory it can yield significant tax savings under commonly controlled companies. It should be noted that transfer pricing has very strict guidelines and you should always consult a licensed accountant, CPA or accounting attorney before engaging in transfer pricing. Put very simply, transfer pricing gives an organization the ability to transfer inventory between subsidiaries of a commonly controlled company or companies that are part of the same enterprise. This can lead to significant tax savings for corporations. While we won’t dig deep into this topic it is important for you to have a basic understanding of how this method works.
Transfer pricing is a practice used in accounting that allows a company to price transactions internally within businesses and between subsidiaries. These different subsidiaries or divisions must be owned by the same larger controlling company. A transfer price is used to determine the cost to charge another division, subsidiary, or holding company for goods or services rendered. As you might have guessed, this tactic is mostly used to adjust profit margins, cost of goods sold or assets that are still on hand. By doing this a company can reduce profits or increase profits based on their specific needs. Typically, transfer prices are reflective of the going market for that good or service. Transfer pricing can also be used with intellectual property.
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