Limitations of Market Transfer pricing

Limitations of Market Transfer pricing

In market transfer pricing, the market price is used for internal transfers. The main advantage of using this method is fair price method. This method can only be used, when an external market exists. There are some limitations of market transfer pricing, which have been explained below

1.    Market Price Changes

First important limitation of market transfer pricing is its continuous fluctuation.Market price continuously changes over the period of time and therefore cannot be used as standard for transfer pricing.

2.    Market Price Non Availability

Second limitation of market transfer price is non availability of market price.Market price may not be available for many products (specially for technical Goods). Therefore market pricing cannot be widely used by the organization.

3.    More than One Market Price

There may be more than one market price for a product i.e. retail price, or wholesale price. It is difficult to establish that what market price is to be used as market price.

Characteristics of Dual Transfer Pricing

Characteristics of Dual Transfer Pricing

1.    Seller not Willing to Sell

In dual transfer pricing selling division are not willing to sell the goods at price offered by buying department. Selling department is interested at higher price than offered price by the purchasing department.

2.    Buyer is not willing to Buy

In dual transfer pricing, buyer is not willing to buy, because the price charged by the seller is regarded is too high. Buyer is interested at lower price than offered price. No transfer can take place due to this conflict.

3.    Head Quarter Buy & Sell

In dual transfer pricing, selling department transfer the goods at desired price to the head office, and head office then transfer the good to purchasing department at willing price (acceptable price to buyer). It means two different prices are used for transfer.

4.    Head office take disadvantage

In dual transfer pricing, head office treat the selling department profit as head office expenses. It means the buying department and selling department performance is not affected.

5.    Autonomy is at stake

In dual transfer pricing the autonomy of decision making department is at stake. Autonomy of decision making at divisional level is one of the fundamental objective of transfer pricing, which is at stake under this method.

6.    Complicated Accounting

Dual pricing complicate the accounting process and a cost are charged to the head office against profit of selling department is difficult to explain. Expense in head office account creates a lot of confusion.

Limitations of Negotiated Transfer Pricing

Limitations of Negotiated Transfer Pricing

Under this method transfer prices between department and division are decided on the bases of negotiation between these departments. This type of pricing is regarded as fair deal, because both parties are satisfied.

1.    Conflict

First limitation of negotiated transfer pricing is conflict creation  between departments. failed negotiation between departments may result in conflict. This conflict situation is not favorable for organization, because conflict may bring disintegration within the organization.

2.    Use of Domination

Under negotiated pricing, the powerful or dominating division may influence the transfer price in its favor; therefore the advantage of fair deal may not be achieved in such circumstances.

3.    Time Consuming Job

Negotiation pricing is a time consuming effort and  would consume a lot time of management. This time can be used on an issue which can bring real profit to the organization.

4.    No Real Benefit

Negotiated pricing will not bring any real advantage or benefit to the organization because transfer pricing is just a method of measuring performance of divisional performance. It has no direct role in improving the profitability of organization.

Transfer Pricing Concept

Transfer Pricing Concept

Transfer pricing is a concept related to internal sales i.e. sales is made by one department to another department. The prices at which these transfer are made are known as transfer price. Transfer price does not affect the overall profit, because profit on division is cost of another division.

Transfer Pricing Objective

1.    Full autonomy

Transfer pricing is source of full autonomy of decision making to the divisional manager. It means divisional manager enjoys full authority of decision making and therefore is total responsible for investment center performance.

2.    Fair Performance Valuation

Transfer pricing ensures fair performance evaluations. Transfer pricing allows selling department to charge a fair price for its goods. Thus performance of selling department would not be negatively affected by such transfer.

Types of Transfer Price

Transfer can be made on cost and above cost (adding some profit) and market price.

1.    Transfer at Cost

Selling department may transfer the goods to purchasing department either on marginal cost or full cost. It means that transfer cost may be categorized into full cost and marginal cost method.

2.    Transfer at Cost Plus

Selling department may charge some profit to the purchasing department. Management will decide about the profit margin on the transfer.

3.    Transfer at Market Price

Selling department may transfer the goods to purchasing department at market price. This method can only be used where external market for good exists.