This video discusses the use of cost-based transfer prices.
Companies may base the transfer price on the cost for the selling division to produce the intermediate product. The cost used may be the (1) variable cost, (2) full cost (variable cost plus the fixed cost), or (3) cost-plus (cost plus a markup).
Cost-based transfer prices are frequently used because they are easy to calculate and understand. However, the use of cost-based transfer pricing has several disadvantages. The use of full-cost transfer pricing may lead to suboptimal decisions when the selling division has excess capacity (it may result in too high a price being charged). Also, the use of a cost-based transfer price does not result in any profit being recognized by the selling division (unless cost-plus is used). This gives the selling division little incentive to control its costs.