Internal buying decisions, Strategic Management

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Transfer pricing is applied internally within a group for management accounting purposes e.g. to measure the performance of divisions.   Increasing or decreasing an internal transfer price will have no effect on group profit, but it will affect the profitability of both the internal seller and buyer.  Most profit centres e.g. divisions, are normally autonomous and have their own financial results 'ring fenced' e.g. a separate accounting system maintained for each profit centre.

Accounting convention for financial reporting (IAS 27 consolidated and separate financial statements) dictates that if there has been trading between group companies, then sales and purchases have to be removed 100% from the turnover and cost of sales, when reporting group  consolidated financial results.   For this reason, whatever transfer price is set, the price an internal seller receives, is equal to the cost the internal buyer pays, therefore the effect on group financial results when changing   or varying transfer prices would always be nil.

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