Management Accounting · Divisional Performance Measurement

Transfer Pricing Methods and Numerical Problems for CMA Inter

Updated 10 October 2026 · Fact-checked

Transfer pricing sets the price at which one division sells goods or services to another division of the same company. Methods are market-based, cost-based, negotiated and dual pricing. To solve problems, find the minimum price (variable cost plus opportunity cost) and the maximum price (the buyer's limit), then pick a price between them.

Understand Transfer Pricing

A large company is often split into divisions, each run as a profit centre or investment centre. When one division supplies goods to another, the company needs a price for that internal sale. This is the transfer price. It is revenue for the selling division and cost for the buying division. For the company as a whole it nets to zero, but it changes how profit is split between divisions.

That split matters because managers are judged on divisional profit, ROI or residual income. A bad transfer price can make a manager reject a deal that is good for the company, or accept one that harms it. A good transfer price gives goal congruence: what is best for the division is also best for the company. It also keeps divisional autonomy and lets you judge each division fairly.

The common methods are these. Market-based: use the external market price, possibly less savings such as selling and packing costs the seller avoids on internal sales. Cost-based: use variable cost, full cost, or cost plus a mark-up. Negotiated: the two divisions bargain within a range. Dual pricing: the seller is credited at one price (usually market or full cost plus mark-up) and the buyer is charged another (usually variable or standard cost), with the difference adjusted at head office.

Market price works best when the market is competitive and the product is the same. Cost-based prices are used when there is no market. Full cost can push the buyer to refuse deals the company should accept, because the seller's fixed costs are treated as if they were variable. Cost plus gives the seller no push to control costs if actual costs are passed on, so standard costs are better.

The key idea for any problem is the range. The seller will not sell below its minimum transfer price. The buyer will not pay above its maximum transfer price. A deal helps the company only if the minimum is below the maximum. Any price in the range makes both divisions better off than not trading.

Key rules to remember

Minimum transfer price (seller): Minimum price = Variable (marginal) cost per unit + Opportunity cost per unit; Opportunity cost is the contribution the seller loses by selling internally. It is nil if the seller has spare capacity.
Opportunity cost with full capacity: Opportunity cost = Contribution lost per unit on the external sale given up; So, with no spare capacity and a market for all output, minimum price = external selling price less any cost saved on internal sales.
Maximum transfer price (buyer): Maximum price = Lower of (net realisable value to the buyer, external purchase price of the same input); Net realisable value = buyer's selling price less its further processing costs, other than the transferred input.
Acceptable negotiation range: Minimum price ≤ Transfer price ≤ Maximum price; If the minimum exceeds the maximum, the transfer should not happen from the company's viewpoint.
Cost plus price: Transfer price = Cost per unit + Mark-up; Cost may be variable, full or standard. State which basis you use.
Market price less savings: Transfer price = Market price − Costs saved on internal sale; Savings include selling expenses, bad debts and packing the seller avoids.

How to solve Transfer Pricing questions

Use this order for any transfer pricing question, whether it asks for a price, a range or a decision.

1Read what is asked: the minimum price, the maximum price, a price under a stated method, or whether the company gains from the transfer.
2Note the capacity position of the selling division: spare capacity or full capacity. This decides opportunity cost.
3Compute the seller's variable cost per unit. Remove any fixed cost, as it is not relevant unless capacity is full and the question says otherwise.
4Compute opportunity cost: nil with spare capacity; with full capacity, the contribution lost on external sales (or external price less savings, as a total with variable cost).
5Add them to get the minimum transfer price. Then find the buyer's maximum from net realisable value or the outside purchase price, whichever is lower.
6Compare. If minimum ≤ maximum, the transfer helps the company and any price in between works. If not, buy or sell outside.
7State the price, show each division's profit effect if asked, and add one line of comment on goal congruence.

Quickest way: Range method in three lines

When to use it: Use for MCQs and for short parts of written questions where you need the price range or the decision quickly.

Write minimum = variable cost + lost contribution (zero if spare capacity).
Write maximum = lower of outside buying price and buyer's net realisable value.
If minimum ≤ maximum, transfer inside; the usual answer lies between the two. For a single price, pick the minimum for spare capacity or the market price for full capacity.

Common mistakes in Transfer Pricing

Using full cost as the minimum price when the seller has spare capacity.
Students think the seller must recover fixed cost on every unit.
Fix: With spare capacity, fixed cost is incurred whether or not the transfer happens. The minimum is variable cost only.
Ignoring opportunity cost when the seller is at full capacity.
Students stop at variable cost because it is the first step they learned.
Fix: Always ask whether each internal unit displaces an external sale. If yes, add the lost contribution.
Taking the maximum price as the buyer's selling price.
Students forget the buyer's own further costs.
Fix: Deduct the buyer's other costs from its selling price to get net realisable value. Then compare with the outside purchase price.
Passing market price unchanged when internal sales save costs.
Students treat market price as a fixed answer.
Fix: Subtract selling, packing and collection costs the seller avoids on internal sales, if the question gives them.
Judging the transfer by divisional profit instead of company profit.
Students look only at the seller or only at the buyer.
Fix: Check the company-level effect first: the outside alternatives and the net contribution. Then comment on each division.
Defining dual pricing as two prices without saying who pays what.
The term is memorised loosely.
Fix: State that the seller is credited at a higher price (market or full cost plus), the buyer is charged a lower one (variable or standard cost), and the difference is adjusted centrally.

Worked examples

Example 1

Division A makes component X. Variable cost is ₹40 per unit and fixed cost is ₹15 per unit at normal output. A has spare capacity of 5,000 units. Division B needs 5,000 units of X and can buy them outside at ₹58 each. B's final product sells for ₹120, and B's own further cost is ₹50 per unit excluding X. (a) Find the minimum and maximum transfer prices. (b) Should the transfer take place? (c) What gain does the company make on 5,000 units?

Show the solution

Spare capacity, so opportunity cost is nil. Minimum price = ₹40 variable cost.
B's net realisable value = ₹120 − ₹50 = ₹70 per unit.
Outside purchase price = ₹58. Maximum price = lower of ₹70 and ₹58 = ₹58.
Minimum ₹40 is below maximum ₹58, so the transfer is worthwhile.
Company gain per unit = ₹58 − ₹40 = ₹18, being the saving versus buying outside.
Total gain = ₹18 × 5,000 = ₹90,000.

Answer: Minimum ₹40, maximum ₹58. The transfer should take place at any price between ₹40 and ₹58. The company gains ₹90,000 on 5,000 units.

Example 2

Division P makes a part with variable cost of ₹70 per unit. It sells all output outside at ₹100 per unit and has no spare capacity. Selling and packing costs of ₹6 per unit are saved on internal sales. Division Q wants 2,000 units. Q can buy the same part outside at ₹100 and its net realisable value for the part is ₹115. (a) Find P's minimum transfer price. (b) Find Q's maximum price. (c) Comment on the transfer.

Show the solution

P has full capacity, so each internal unit displaces an external sale.
Contribution on an external sale = ₹100 − ₹70 − ₹6 = ₹24 per unit. The ₹70 excludes the ₹6 selling and packing cost, which P incurs only on external sales. So the contribution given up is ₹24.
An internal unit has variable cost of ₹70 and no selling or packing cost. Minimum price = ₹70 + opportunity cost ₹24 = ₹94.
Check: ₹94 equals the market price of ₹100 less the ₹6 saved on internal sales.
Q's maximum = lower of NRV ₹115 and outside price ₹100 = ₹100. The NRV of ₹115 is not binding, because Q can buy outside at the lower price of ₹100.
Range is ₹94 to ₹100. Minimum is below maximum, so the transfer is worthwhile.
Company gain per unit = Q's outside cost ₹100 − (P's variable cost ₹70 + contribution lost ₹24) = ₹6. On 2,000 units this is ₹6 × 2,000 = ₹12,000. It equals the selling and packing cost avoided on internal sales.

Answer: Minimum ₹94, maximum ₹100. Transfer is worthwhile at a price between ₹94 and ₹100. The company gains ₹12,000 on 2,000 units (₹6 per unit), which is the selling and packing cost avoided. NRV of ₹115 is not binding because the outside price of ₹100 is lower.

Exam tips

Always state the capacity position first. Most marks in numerical questions are tied to correct opportunity cost.
Show minimum and maximum prices as separate labelled lines, then conclude with the range. Step marks follow this layout.
In theory parts, compare methods on goal congruence, autonomy, fairness and ease of use, and give one limit of each.
In MCQs, check whether the seller has spare capacity before using any option. This removes wrong options fast.
Close written answers with one line on the company-level effect, since ICMAI expects interpretation, not just numbers.

Practice questions from Divisional Performance Measurement

Transfer Pricing in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Transfer Pricing: frequently asked questions

What is the difference between market-based and cost-based transfer pricing?

Market-based pricing uses the price in the outside market, often less costs saved on internal sales. Cost-based pricing builds the price from the seller's cost, either variable, full or standard, sometimes with a mark-up. Market-based pricing suits competitive markets, while cost-based pricing is used when no market exists.

How do you find the minimum transfer price using opportunity cost?

Add the seller's variable cost per unit to the contribution it loses by selling internally. If the seller has spare capacity, nothing is lost and the minimum is just the variable cost. If it is at full capacity, the lost contribution is that of the external sale given up.

What is dual pricing in transfer pricing?

In dual pricing the selling division is credited with one price, such as market price, and the buying division is charged a different one, such as variable cost. The difference is adjusted at head office. It can motivate both divisions, but it may hide inefficiency and complicate the accounts.

Why does transfer pricing affect goal congruence?

Managers act to improve their own division's results. If the transfer price makes a company-beneficial transfer look unprofitable to one division, the manager may refuse it. A good transfer price makes the divisional decision match the company's best decision.