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

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

Answer: (B)

Cost-plus transfer pricing is straightforward to implement because it uses the producing division’s cost base and simply adds a standard markup. That reliance on internal cost data makes administration quick and routine, with little need for extensive external price comparisons or lengthy negotiations.

But this simplicity comes at the cost of accuracy in measuring profit. The cost base can include allocated fixed overheads or shared costs that aren’t actually caused by the intercompany transfer, and the markup may not reflect the true value or market conditions for the goods transferred. As a result, the profits reported by the divisions can be distorted, potentially misaligned with the true economic value of the transaction and causing suboptimal decisions.

Other methods have different trade-offs: market-based prices rely on external prices and may be harder to obtain; negotiated prices depend on bargaining and can be lengthy; variable-cost pricing ignores fixed costs, which can misstate long-run profitability.