Cost based transfer prices

In this lesson

1. 0:00 Cost plus pricing for transfer prices
2. 1:05 Why actual cost creates perverse incentives
3. 2:36 Using standard cost as fairer approach
4. 3:43 Incremental versus full cost debate
5. 5:03 Marginal cost transfer pricing option
6. 6:04 Worked example: calculating Division L's total cost

About this lesson

By the end, you'll be able to calculate transfer prices using cost plus markup and determine total costs for receiving divisions, a skill essential for Performance Management and Strategic Business Leader case studies. Cost-based transfer pricing starts with a simple formula: take the cost of producing an intermediate product, add a profit markup, and you have your transfer price. However, the critical decision is which cost figure to use. Actual cost creates a dangerous incentive problem—the supplying division profits more by spending more, so they have no motivation to control costs. This approach is generally seen as unfair and inefficient for the wider business. Standard cost offers a better solution. By setting a predetermined cost at the start of the period, you give the supplying division a clear target to beat. If they produce below standard cost, they keep the extra profit as an incentive. If they exceed it, that's their loss. This approach feels fairer to both divisions because the receiving division knows exactly what they'll pay, and costs are controlled. The final consideration is whether to include fixed costs in your transfer price calculation. Full cost plus (including fixed costs) favours the supplying division, while marginal cost plus (variable costs only) favours the receiving division. There's no universally "right" answer—it depends on the business context and which division bears responsibility for those costs. Understanding these trade-offs will help you analyse transfer pricing decisions in exam scenarios.

Duration: 8m