Which transfer pricing method is simple to administer but may misstate profit?

Which transfer pricing method is simple to administer but may misstate profit?

• A. Market-based
• B. Negotiated
• C. Variable-cost
• D. Cost-plus

Answer: (D)

Cost-plus transfer pricing is straightforward because you simply take the production cost and add a standard markup to determine the transfer price. That makes it easy to administer, since it uses internal cost data and a predefined margin instead of chasing external prices or negotiating terms. The trade‑off is the risk of misstate profits. By including all costs (including fixed overhead) in the cost base and applying a fixed markup, the price may not reflect actual market value or capacity usage. If capacity is underutilized or if cost figures drift, the transfer price can overstate or understate the true profitability of the divisions, since it doesn’t adjust for market conditions or opportunity costs.

Cost-plus transfer pricing is straightforward because you simply take the production cost and add a standard markup to determine the transfer price. That makes it easy to administer, since it uses internal cost data and a predefined margin instead of chasing external prices or negotiating terms.

The trade‑off is the risk of misstate profits. By including all costs (including fixed overhead) in the cost base and applying a fixed markup, the price may not reflect actual market value or capacity usage. If capacity is underutilized or if cost figures drift, the transfer price can overstate or understate the true profitability of the divisions, since it doesn’t adjust for market conditions or opportunity costs.