Nonprofit Accounting: Setting Transfer Pricing Policies

nonprofit accountingAmong the many topics in nonprofit accounting, one of the least considered is setting transfer pricing policies. Transfer policies are often forgotten or neglected, yet they are critical for an accurate evaluation of your organization’s income and expenses.

Transfer pricing means establishing the price for one division of your company to charge another when it must “sell” or set a price for its goods or services to another group internally. An example is a nonprofit that has a training division. The division offers training courses to members, but it also offers the same courses to employees. If it charges members $25 per person for a workshop, it must set a transfer price for employees to receive the same training session or the accounts do not adequately reflect the work at the nonprofit.

Problems with Transfer Pricing

Many transfer pricing issues occur when the internal department selling the goods or services has an incentive to charge the full amount, while the group purchasing it has an incentive to seek lower costs. This often happens within a company when there’s a push for each unit or department to make a profit and come in under budget.

In the case of internal transfer, the two may have difficulty negotiating prices since negotiations do not serve either party’s best interest. Instead, the purchasing group usually capitulates and pays more than it should for a service internally than they could get from an external source.

Nonprofit Accounting Tips for Better Transfer Pricing

The following tips and strategies may be helpful when setting transfer pricing within your nonprofit organization:

  • Get accurate data: Smart accounting for nonprofits starts with accurate data. To make better decisions around setting prices, you must first have an accurate depiction of the costs that go into the goods being priced. This is where having a good nonprofit financial accounting system helps because it is easier to extract data from such systems and analyze it to build price points.
  • Create fair policies for all departments: Written policies prevent miscommunication and mishaps during transfer policies. They also help organizations and companies set fair prices for all. A written policy can clarify how transfer pricing agreements can be reached and how to conduct internal transfers.
  • Understand autonomy: Some companies do well with a high degree of autonomy granted to both parties during a transfer negotiation. Assessing and understanding how much autonomy is healthy for your organization is an essential part of setting transfer pricing policies.

Why Transfer Pricing Is Important

Nonprofit accounting must include accurate information about all aspects of expenses and income. If you do not account for transfer prices, you aren’t accounting for everything that impacts your balance sheet. Without knowing what your transfer costs are, you could miscalculate and under- or overestimate costs for your organization. Transfer pricing makes things fair, balanced, and transparent in your financials.

The IRS has also stepped up its review of nonprofit compliance with transfer pricing rules. Organizations that do not have documentation regarding their transfer pricing policies and rules may come under additional IRS scrutiny. Adjustments, penalties, and loss of tax-exempt status may result if the IRS investigates and finds your organization’s transfer pricing inadequately documented or handled. It pays to be proactive and take steps now to create the rules and documentation necessary to clarify how it is handled.

Although transfer pricing is most often thought of as a way to improve tax tracking and reporting, especially in cross-border transfers, it is also an integral part of accounting for nonprofits. Understanding and managing transfer pricing can help your nonprofit improve its financial management and compliance with taxation and financial rules and guidelines.

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