Negotiated Transfer Pricing: Definition & Examples Video

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  • 0:02 What Is Negotiated…
  • 0:47 Why Have Negotiated…
  • 1:15 Advantages and Disadvantages
  • 2:03 Example
  • 2:40 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Transfer pricing is an important part of the internal bookkeeping of an organization. In this lesson, we'll look at negotiated transfer pricing, a method by which companies keep track of hard-to-price goods.

What Is Negotiated Transfer Pricing?

While many small companies may only make one or two items and quickly transfer those out through sales, many larger companies have supply chains that see raw materials transformed multiple times before they leave the organization. For example, a plastic widget company may not only own the widget factory, but also the factory that mixes the plastic needed to make the widgets.

For good accounting records to be kept, it's essential that some form of transfer pricing is used to keep track of the purchasing habits and competitive nature of the company. In this lesson, we'll focus on negotiated transfer pricing, which is the system by which representatives from each part of the company negotiate a price for a product without basing it off of market prices.

Why Have Negotiated Transfer Pricing?

So why even go to the trouble of negotiating a price? Simply put, goods don't appear out of nowhere. By setting transfer prices, we can track just how much a good is costing us to produce at every step of the production process. Otherwise, managers at earlier ends of the supply chain may not be incentivized to keep their costs low because no one will ever find out that they're being lazy. Likewise, managers at the end of the supply chain don't have to wonder why a good costs so much.

Advantages and Disadvantages

One of the biggest advantages of negotiated transfer pricing is that it works even if there is not a market for a particular good. Let's say that you were a manager for a backpack manufacturer and needed to know the cost of waterproof headphone holes for a backpack. There's not exactly a big market for such things, so having your assembly subsidiary and your waterproof headphone hole subsidiary negotiate a price is your best solution.

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