The basis for transfer prices is that the subunit managers make decisions; they are required to focus on how their decision will influence the performance of the subunit without assessing their effect on the overall company performance. Thus, transfer prices make it easy for the subunit manager to process information and make decisions. In a transfer system that is well designed, the manager puts more focus on optimizing the performance of the subunit, and in so doing, the performance of the company is optimized (Datar, Horngren & Rajan, 2012).
Usually, there are three forms of transfer prices; market-based transfer prices, cost-based transfer, and negotiated transfer prices. Each form complies with organization and performance assessment in a different level. The transfer prices to be used rely on the environmental conditions and specific objectives of the company. In this case, the form of transfer to be used is the market-based transfer prices. In order to develop a performance measurement system for the firm, the following conditions must be met. First, a market or its substitute must exist for the intermediate product. However, this condition is generally not fully met. In most cases, there are a number of comparable products with different prices present. Second, the transaction of the firm’s divisions may not have a significant effect on the market price.