Management Accounting · Transfer Pricing

Methods of Transfer Pricing for CMA Intermediate

Updated 10 October 2026 · Fact-checked

A transfer price is the price at which one division sells goods or services to another division of the same company. The main methods are market-based, cost-based (variable cost, full cost, cost plus), negotiated and dual pricing. To solve a question, find each division's limits, apply the method asked and state its merits and demerits.

Understand Methods of Transfer Pricing

A company with divisions often has one division supply goods to another. The price charged on that internal sale is the transfer price. It is a revenue for the selling division and a cost for the buying division. It cancels out for the company as a whole, but it changes how profit is split between divisions.

That split matters because divisions are judged on their own profit or ROI, and managers act to improve their own numbers. A good method gives a price that is fair, helps the company as a whole and keeps divisional managers motivated.

Market-based pricing uses the price at which the same product sells in an outside market. It works best when the market is competitive and the product is standard. The selling division is treated like an independent business. It may be adjusted downward for savings such as selling, packing and bad debt costs that the internal sale does not incur. It fails when no market price exists, or when the market is imperfect.

Cost-based pricing has three forms. Under variable (marginal) cost, the price equals variable cost per unit. The buyer gains, but the seller earns no contribution towards fixed cost and no profit. Under full cost, the price equals variable plus fixed cost per unit. The seller recovers cost but earns no profit, and inefficiencies get passed on to the buyer. Under cost plus, a mark-up on full cost (or on variable cost) is added, so the seller earns a profit. The mark-up is often arbitrary, and the method gives little reason to control cost.

Negotiated pricing is a price agreed by the two divisional managers through bargaining. It suits situations with no clear market price or with spare capacity. It gives autonomy, but it takes time, can cause conflict and depends on negotiating skill. Dual pricing uses two prices for one transfer. The selling division is credited with a higher price (such as market price or cost plus), and the buying division is charged a lower one (such as variable cost). Both divisions look good. The difference is adjusted at head office, and the method can hide true profitability and weaken cost control.

Key rules to remember

Market-based transfer price: Transfer price = External market price − Savings on internal sale (selling, packing, collection costs); Use the plain market price if no savings are stated.
Variable cost transfer price: Transfer price = Variable cost per unit; Seller's fixed cost is not recovered, so the seller shows a loss equal to fixed cost at full volume.
Full cost transfer price: Transfer price = Variable cost per unit + Fixed cost per unit; Fixed cost per unit depends on the volume used, so state the volume.
Cost plus transfer price: Transfer price = Cost per unit + Mark-up % × Cost per unit; Check whether the mark-up is on full cost, variable cost or on selling price.
Negotiation range (general rule): Minimum price (seller) = Variable cost per unit + Opportunity cost per unit; Maximum price (buyer) = Lower of outside purchase price and net marginal revenue; Opportunity cost per unit is the contribution per unit lost on external sales given up because of the internal transfer. It is zero when the seller has spare capacity. A deal is possible only if minimum ≤ maximum.

How to solve Methods of Transfer Pricing questions

Use this order for any question on methods of transfer pricing, whether numerical or theory.

1Read the question and note which method or methods are asked, and whether numbers are given.
2List the seller's variable cost, fixed cost, capacity and output, and the buyer's outside price or net realisation.
3Check whether the seller has spare capacity or is fully used, and whether a market price exists.
4Calculate the transfer price under each required method, showing the formula and the working.
5Work out each division's profit at that price and, if asked, the company's profit.
6Compare methods and give merits and demerits in short bullets, linked to the figures.
7State your conclusion clearly: the price or method suggested and the reason.

Quickest way: Three-line method for numerical questions

When to use it: Use it when time is short and the question asks for the transfer price under one or more methods.

Write the seller's variable cost per unit and fixed cost per unit on top of the page.
Add or subtract in order: variable cost, then full cost, then mark-up, then market price less savings.
Write one merit and one demerit per method in a single line each, using the standard wording.

Common mistakes in Methods of Transfer Pricing

Taking full cost as variable cost only, or the reverse.
Students rush through the cost data and miss the fixed cost line.
Fix: Write variable cost and fixed cost separately first, then add them for full cost.
Applying the mark-up on the wrong base in cost plus pricing.
The wording 'profit of 20%' is read without checking whether it is on cost or on selling price.
Fix: Check the base. On cost: price = cost × 1.20. On selling price: price = cost ÷ 0.80.
Ignoring selling-cost savings in a market-based price.
Students copy the market price as the transfer price.
Fix: Deduct costs that are not incurred on the internal sale, such as selling and packing, when given.
Saying dual pricing changes the company's total profit.
The two prices make each division's profit look higher.
Fix: Remember the two prices only change divisional figures. A head office adjustment removes the difference on consolidation.
Listing demerits without linking them to the method.
Students memorise generic points such as 'not fair'.
Fix: Tie each point to the method: for example, full cost passes on the seller's inefficiency; variable cost gives the seller no profit.

Worked examples

Example 1

Division A makes a component with variable cost ₹40 per unit and fixed cost of ₹2,00,000 for a normal output of 10,000 units. It transfers all units to Division B. Compute the transfer price per unit under (a) variable cost, (b) full cost and (c) cost plus 25% on full cost. State the profit of A in each case.

Show the solution

Fixed cost per unit = ₹2,00,000 ÷ 10,000 = ₹20.
(a) Variable cost price = ₹40. A's revenue = 10,000 × ₹40 = ₹4,00,000. A's cost = ₹4,00,000 + ₹2,00,000 = ₹6,00,000. Loss = ₹2,00,000.
(b) Full cost = ₹40 + ₹20 = ₹60. Revenue = ₹6,00,000. Cost = ₹6,00,000. Profit = nil.
(c) Mark-up = 25% × ₹60 = ₹15. Price = ₹60 + ₹15 = ₹75. Revenue = ₹7,50,000. Profit = ₹7,50,000 − ₹6,00,000 = ₹1,50,000.

Answer: Transfer price: (a) ₹40, loss ₹2,00,000; (b) ₹60, nil profit; (c) ₹75, profit ₹1,50,000.

Example 2

Division X makes 5,000 units of a part with variable cost ₹120 per unit. The market price is ₹200 per unit, and an internal sale saves selling and packing cost of ₹15 per unit. Division Y can buy the same part outside at ₹200. X has spare capacity, so the internal transfer does not displace any outside sales. Find (a) the market-based transfer price and (b) the range within which a negotiated price can fall. Also state the gains of Y and X if the price agreed is ₹170.

Show the solution

(a) Market-based price = ₹200 − ₹15 = ₹185.
(b) Seller's minimum price = variable cost + opportunity cost. The question gives variable cost as ₹120 and does not say it includes the ₹15 selling and packing cost, so use ₹120.
With spare capacity the opportunity cost is nil, so minimum = ₹120 + ₹0 = ₹120.
Buyer's maximum price = outside purchase price = ₹200 (assuming no lower net marginal revenue limit applies).
Negotiation range = ₹120 to ₹200, as the minimum is below the maximum.
At ₹170, Y saves ₹200 − ₹170 = ₹30 per unit. Total saving = 5,000 × ₹30 = ₹1,50,000.
X earns ₹170 − ₹120 = ₹50 per unit over its variable cost, which is 5,000 × ₹50 = ₹2,50,000 in total.

Answer: Market-based price is ₹185. A negotiated price can lie between ₹120 (X's variable cost, with no opportunity cost) and ₹200. At ₹170, Y gains ₹1,50,000 and X gains ₹2,50,000 over its variable cost. (If the question stated that the ₹120 already includes the ₹15 avoided on internal sales, the minimum would be ₹105.)

Exam tips

For 'discuss' questions, give each method a short definition, one merit and one demerit. Use bullets to earn quick step marks.
In numerical questions, always show fixed cost per unit and the volume used. Marks go to working, not only the final price.
Read the mark-up carefully: on cost or on selling price. Most lost marks come from this.
Link the method to the situation. Market price suits a competitive market, negotiation suits spare capacity, and variable cost suits a buyer facing low demand.
For MCQs, remember that dual pricing uses two prices and that variable cost transfer gives the seller no profit contribution towards fixed cost.

Practice questions from Transfer Pricing

Methods of 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.

Methods of Transfer Pricing: frequently asked questions

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

Cost-based pricing sets the price from the seller's own cost, with or without a mark-up. Market-based pricing uses the price that outsiders pay for the same product. Market-based pricing treats divisions as independent businesses, while cost-based pricing is easier when no market exists.

What is a negotiated transfer price?

It is a price agreed through bargaining between the selling and buying divisional managers. It must fall between the seller's minimum and the buyer's maximum price. It gives autonomy but can be slow and cause conflict.

How does dual pricing work?

The selling division is credited with a higher price, such as the market price. The buying division is charged a lower price, such as variable cost. Both divisions report good results, and head office adjusts the difference at company level.

What are the merits and demerits of cost plus transfer pricing?

Cost plus is simple and gives the seller a profit. Its demerits are that the mark-up may be arbitrary and it gives little reason to control cost, since higher cost raises the price.