(62)---TRANSFER PRICING.(2).

The use of market price as a basic for transfer prices

Market price as the transfer price.

If an external market price exists for transferred goods, profit center managers will be aware of the price they could obtain or the price they would have to pay for their goods on the external market, and they would inevitably compare this price with the transfer price.

Adjusted market price.
Internal transfers are often cheaper than external sales, with savings in selling and administration costs, bad debt risks and possibly transport/delivery costs. It would therefore seem reasonable for the buying division to expect discount on the external market price. The transfer price might be slight less than market price, so that A and B could share the cost savings from internal transfers compared with external sales. It should be possible to reach agreement on this price and on output levels with a minimum of intervention form head office.

The merits and disadvantages of market value transfer prices.
A market- based transfer price therefore seems to be the ideal transfer price because the buying division is likely to benefit from a better quality of service, greater flexibility, and dependability of supply. Both division may benefit from cheaper costs of administration, selling and transport. A market price as the transfer price would therefore result in divisions which would be in the best interest of the company or group as a whole.

Market value as a transfer price does have certain disadvantages.

• The market price may be a temporary one, induced by adverse economic conditions, or dumping, or the market price might depend on the volume of output supplied to the external market by the profit center.
• A transfer price at market value might, under some circumstances, act as a disincentive to use up any spare capacity in the divisions. A price based on incremental cost, in contrast, might provide an incentive to use up the spare resources in order to provide a marginal contribution to profit.
• Many products do not have an equivalent market price so that the price of a similar, but not identical, product might have to be chosen. In such circumstances, the option to sell or buy on the open market does not really exist.
• There might be an imperfect external market for the transferred item, so that is the transferring division tried to sell more externally, it would have to reduce its selling price.