Intersegment Sales

You work in the boot division of a major footwear manufacturer. You need shoelaces for all the boots you make. The conglomerate you work for also owns a shoelace manufacturer, so that's where you go to purchase the supply you need.

By making these transactions, you're engaged in intersegment sales. The term applies to product sales that take place between two parts of the same company.

It may seem like a pointless enterprise (like moving money from your left pocket to your right pocket), but the transactions are necessary for accounting purposes. The parent company needs to keep track of where all the money goes. As such, those shoelaces you bought need to be accounted for. Even though the money all stays within the same larger company, the transfer of funds in exchange for the product helps keep the records clear and allows the parent firm to see how individual divisions are performing.

Related or Semi-related Video

Cost Accounting: How Does Transfer Prici...2 Views

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And finance Allah Shmoop How does transfer pricing work Oh

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all right You work at the multinational multi divisional conglomerate

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Global Mega Giga Tek Co You had the purchasing team

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at Fragrance to the bed It's the firm's perfumed diaper

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division for babies who really like to be you know

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pampered your product combines perfume Fragrance is with specialty diapers

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for that upper class baby ready for a night out

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pretends like Coco not caca and Low Do not quite

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ready for du toilette To create the product you buy

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diapers from one source and perfume from another source Then

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your team of highly trained spritz ologists applies the perfume

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to the diapers Luckily global Mega Giga Techo has a

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diaper division and a perfume division or a maybe unluckily

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for you life just got more complicated because of transfer

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pricing Well the company bigwigs air happy that everything stays

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in house You can get all your raw materials from

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within the global mega family and that's great But it's

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also a headache Why Well because if you bought diapers

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from one vendor you'd have a market price for them

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You'd negotiate hard and pick the best deal for your

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company from the eighteen purveyors of fine nappies for the

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spirited pre millennial set Same deal with the perfume but

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here that's not the case because you're essentially buying from

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well yourself And that's a problem because the prices now

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aren't quote market unquote They're kind of made up sorta

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Yes you can get in the zone of a market

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price but often there really isn't a kind of market

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clearing price for a million nappies like nobody else buys

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them in that kind of bulk And then how do

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you account for shipping charges and well breakage or ribcage

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or whatever else costs money in acquiring those diapers Luckily

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there exists the magic of transfer pricing transfer pricing tracks

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expenses for separate departments within the same firms that do

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internal business with each other like it more or less

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sets the A price right sets the transfer prices prices

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which you're transferring stuff from one division to another Well

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the goal is to fairly attribute pricing to each division

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such that everyone feels equally unfairly treated You could imagine

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that the manager of the diaper sales division has her

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own income statement and she probably earns her bonus based

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on how profitable that division runs that year Well if

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the big bad boss at corporate wants to show more

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profit in the Global Mega Diaper Corp Then that boss

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will lean on Missa Schimmel bottom to sell or rather

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to transfer price her diapers at very cheap prices so

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that Diaper Corp looks much more profitable than it really

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would be or it paying market prices for its well

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very raw materials Meanwhile the same thing's going on at

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Globo sent Corp the higher the price they get for

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the perfume they send you the better their numbers will

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look More bonuses more promotions more cover stories in perfume

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industry monthly On the other side of things you have

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a similar incentive to get prices down like that's your

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job The less you pay for the raw materials while

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the better your profits look again Big bonuses at stake

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here inside the division Better chance to climb that day

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You know Slippery corporate ladder Yes these accounting gymnastics may

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seem silly All the money just ends up in the

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same big mega glop Huge corporate bottom line in the

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end right Well if you send money to global mega

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Diaper Corp Well it shows up on their quarterly reports

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The Wall Street The Net Number two Global won't change

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whether the diapers and perfume are transfer priced expensive or

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transfer price cheap It's all global mega Giga Tech owes

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money in the end literally but it matters for internal

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accounting is that you have to think about it and

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do it There are bonuses and the egos and all

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the corporate game of thrones stuff at stake here But

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there are legitimate business reasons to transfer Pricing allows accountants

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to figure out the true cost and profitability of different

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products This information allows global mega tow make informed decisions

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about production distribution and marketing like what products are worth

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keeping which ones should expand or killed If a manager

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just grabbed a bunch of diapers or walked off with

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a drum full of perfume without charging those cost to

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their division wealth and when all the beans are coming

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at the end of the day it would be impossible

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to track the cross it took to actually make those

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items So they all have to be tracked And the

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resulting numbers would then cloud how well or poorly each

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division was doing And you can imagine that there have

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been times in business when an internal division is simply

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poorly run like what if the perfume business could only

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make that perfume for one hundred dollars a gallon But

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the manager of Frog Rasta Beibei could by that same

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identical perfume from another vendor for only seventy dollars a

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gallon Well since the perfume diaper people are bonus on

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profits why shouldn't they be allowed to buy that product

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the best way they can buy it And it may

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mean that the global sent division should in fact be

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tossed out you know like a an old diaper and

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shut down So transfer pricing shines a bright light on

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the line operations of a business and allows managers to

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figure out the true value of each of their products

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without accurate transfer pricing A big company like global Mega

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wouldn't be able to identify which products are inside really

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profitable divisions and which ones are a drag on the

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firm's finances So to get the diapers on Global Mega

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Stipe ER division well you'll have to pay for the

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product right It's time to go over now to the

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Diaper Co And buy some diapers Well how do you

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set that price Well there are three basic methods First

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some details about the diapers A package of one hundred

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diapers retails for fifty bucks It cost the diaper unit

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twenty bucks to produce Okay now here the three methods

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One pay for the cost of producing the diapers So

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under the first method you'll just reimburse the diaper unit

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for its costs in producing them You pay him twenty

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bucks for the hundred diapers That's it The second method

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You pay full retail price you'd give diaper code that

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fifty dollars that they would have gotten if the diapers

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had been sold at their store All right Third method

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a negotiated amount somewhere in between Yeah some figure higher

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than the cost but not quite the full retail price

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So basically you'd get on the phone with some sales

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guy at Diaper Co And basically just work out a

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deal The transfer price you pay will depend on the

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situation If diaper code isn't working at capacity you know

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a price that cost or close to it makes sense

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They can crank up production than pretty easily without causing

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a problem that I propose you get wouldn't get made

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if he didn't want them to be made However if

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Diaper Cho is constantly selling out well then a transfer

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price at or near retail price would make sense They

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have orders piling up and if a cell to you

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for a cheap price they're losing money selling to others

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at a much higher price They're having trouble filling all

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their orders Every diaper you take is a diaper then

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that they can't sell to a retail price paying customer

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You're literally costing them sales when you get the diapers

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for closer to twenty bucks than fifty So you should

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be treated Don't just like any other customer right Well

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turns out diaper Cho is near capacity You'll have to

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pay near full price However you negotiate a volume discount

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and so you pay forty five bucks per package of

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one hundred diapers Meanwhile you get another ten percent off

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by promising that Jimmy the best softball player at Fragrance

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Beibei will play for Diaper Co At the next company

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picnic so you end up paying forty dollars fifty cents

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for one hundred count package Alright now time to buy

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the perfume when you call over global sent Corp They

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have a deal for you Owed it to Tidewater Hasn't

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been selling very well And they have a lot of

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it sitting in the warehouse and are happy to get

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rid of it You Khun basically get it at cost

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Plus you talked them into letting you use some of

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their pre cut budget just to take the extra barrels

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of perfume off their hands So yeah that's transfer pricing

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We could go into more depth but for now we'll 00:07:26.773 --> [endTime] just start with a spritz yellow

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