Transfer Pricing Strategies - Essay Example

Two proposed pricing strategies are outlined in the case study detailing how the transfer pricing between divisions may take place in case one division deals with another division.
Reading Company’s overall price quote is based upon charging full price less variable selling and distribution expenses. This is approximately $11.80 per unit however; it is greater than the bid price of $7.60 as prepared by Millwall. Under this arrangement, if Reading accepts the proposal of Millwall, it may be incurring a loss of $4.12 per unit. The calculations are as under:
Selling Price offered by Reading = $11.80 per unit
Counteroffer made by Millwall = $7.68 per unit
Total Difference = $4.12 per unit

If Reading takes up this option, it may face a per-unit loss of $4.12 however, an increased number of orders from Millwall can result in better utilization of its excess capacity. To consider this option, Reading therefore may need to assess whether the overall revenue and profitability of the division will increase if this transaction is carried out.
The key influence of this on the attitude of Reading on intra-company business will therefore be reshaped by the way its profitability, as well as the revenue, is increased besides registering a substantial increase in the overall capacity.

Another important aspect of this whole transaction may be based on the assumption that during the intra-company business, Reading may not have to incur any selling expenses therefore this may result in substantial savings for it in terms of cost reduction.

If Reading adapts the second option of charging the standard full manufacturing cost plus 15%, as proposed by the Finance Manager, the overall loss will be approximately $1.68 per unit. The calculations are as under:
Selling Price offered by Reading = $11.80 per unit
Offer made by Finance Director = $10.12 per unit
Total Difference = $1.68 per unit

The above option, therefore, suggests that adapting the option of standard manufacturing cost plus markup can certainly reduce the overall per-unit loss when compared with the market price of the component. This option reduces the loss per unit for Reading (if compared with the market price of the component) therefore adapting such an option may offer more leverage to Reading in terms of its ability to further increase its profitability while at the same time reducing the costs. Read More