Question

Discuss briefly two (2) advantages and two (2) disadvantages of using the market-based transfer pricing for foreign operations.

Answer 1

Advantages of market based transfer pricing:

Many people believe that market-based transfer pricing, which bases the prices of goods off of what you'd find on the open market, is the best pricing method.

Market-based transfer pricing is perhaps the easiest form of transfer pricing when it comes to determining the price that will be paid between divisions of the same company. It uses the normal market rate that would be paid if the goods were bought on the open market. This means that both subsidiaries end up doing just as well as they would if they were selling or buying goods from a third party. If any other method is used, one subsidiary ends up making more than it should by cutting into the profits of the other.

Disadvantages of market based transfer pricing:

Market based transfer pricing has some disadvantages. It is very difficult to find perfectmarket and there is no established market price Kinney et al. (2012). Therefore, it is verydifficult to establish market based transfer pricing. Different price, discounts and credit termsallowed to different buyers. Because of this reason, it is very difficult to set up the rightmarket price to use Kinney et al. (2012). Sometime market price is not appropriate becauseinternal sales reduce packing, advertising or delivery expenditure. It is difficult to shiftresources from low priority to high priority division when market based transfer pricing isfixed. Highly specialized products are not suitable for market-based transfer pricing. Ready market does not exist where set up transfer pricing will be more difficult.