Many companies find it mutually beneficial to transfer products to another department or a subsidiary. Instead of charging regular retail price for the products, the accountants for the transferring and receiving centers agree on a transfer price. In order for the transaction to be beneficial to both parties, the transfer price must be higher than the incremental cost of creating the product but lower than the current market price.
Calculate the minimum transfer price for the firm transferring the product. The minimum transfer price equals the incremental cost to create one product. The incremental price includes direct labor, direct material and direct overhead costs but excludes the expenses the transferring center would have incurred whether or not it made the product. In other words, the minimum transfer price should be the additional cash outflows the company incurs by making the transferred product.
Find the maximum transfer price for the product. In general, the maximum transfer price for a product is the price a firm would have to pay for the product on the open market. Reference accounting records to calculate the average price the company has paid in the past for the same quantity of the transferred item. Alternatively, get quotes from one or two suppliers for the same quantity of the transferred goods.
Set the transfer price per item between the minimum and maximum price calculated. Add a percentage profit or include fixed project costs to arrive at a transfer price suitable for both parties. If the price is set below the minimum price, the transferring center will take a loss at the expense of the receiving firm. Conversely, the receiving center won't benefit if the transfer price is set above the maximum.
Multiply the transfer price per item by the quantity of items transferred to arrive at the total transfer price. For example, say that a product has a transfer price of $15, and 100 items are transferred. The total transfer price is $15 multiplied by 100, or $1,500.
Record the transfer price as an intracompany expense to the receiving center and as intracompany revenue and cost of goods sold to the transferring center. For example, say that the item priced at $15 cost $10 to produce. The receiving firm debits the item asset account and credits intracompany expense for $1,500. The transferring firm debits cash for $1,500 and credits sales revenue for $1,500. It then debits cost of goods sold for $1,000 and credits the inventory account for $100.