cn22ho.ppt

7/29/2019 CN22HO.ppt

1/30

2009 Foster School of Business Cost Accounting L.DuCharme 1

Management Control Systems,

Transfer Pricing, andMultinational Considerations

Chapter22

7/29/2019 CN22HO.ppt

2/30


Overview

What is a Management Control System?

Centralized vs. decentralized control structure

Transfer pricing: Function

Setting TPs

Dual TPs

Negotiated TPs (Calculating Min. & Max. range)

International tax issues

7/29/2019 CN22HO.ppt

3/30


Management Control Systems

A management control system is a means

of gathering and using information.

It guides the behavior of managers and

employees.

7/29/2019 CN22HO.ppt

4/30


Management Control Systems

Financial data

Formal control system

Nonfinancial data

Informal control system

7/29/2019 CN22HO.ppt

5/30


Evaluating Management

Control Systems

Motivation Goal congruence Effort

Lead to rewards

Monetary Nonmonetary

7/29/2019 CN22HO.ppt

6/30


Organization (control) Structure

Total decentralization

Total centralization

7/29/2019 CN22HO.ppt

7/30


Benefits of Decentralization

Creates greater responsiveness to local needs

Leads to gains from quicker decision making

Increases motivation of subunit managers

Assists management development and learning

Sharpens the focus of subunit managers

7/29/2019 CN22HO.ppt

8/30


Limitations of Decentralization

Suboptimal decision making may occur

Focuses the managers attention on the subunitrather than the organization as a whole

Increases the costs of gathering information

Results in duplication of activities

7/29/2019 CN22HO.ppt

9/30


Decentralization in

Multinational CompaniesDecentralization enables country managers to

make decisions that exploit their knowledge

of local business and political conditions.

Multinational corporations often rotate

managers between foreign locations

and corporate headquarters.

Control Problem: Barings Bank (200 yrs old)1995 Nick Leeson caused

over 1 B loss.

7/29/2019 CN22HO.ppt

10/30


Responsibility Centers

Cost

center

Revenue

center

Investmentcenter

Profitcenter

7/29/2019 CN22HO.ppt

11/30


Transfer Pricing

A transfer price is the price one subunit charges

for a product or service supplied to anothersubunit of the same organization.

Intermediate products are the products

transferred between subunits of anorganization.

7/29/2019 CN22HO.ppt

12/30


Transfer Pricing

Transfer pricing should: (1) help achieve

a companys strategies and goals.(2) fit the organizations structure

(3) promote goal congruence

(4) promote a sustained high level

of management effort

7/29/2019 CN22HO.ppt

13/30


Transfer-Pricing Methods

Market-based transfer prices

Cost-based transfer prices

Negotiated transfer prices

7/29/2019 CN22HO.ppt

14/30


Market-Based Transfer Prices

By using market-based transfer prices

in a perfectly competitive market, a

company can achieve the following:

Goal congruence

Management effortSubunit performance evaluation

Subunit autonomy

7/29/2019 CN22HO.ppt

15/30



Market prices also serve to evaluate the

economic viability and profitabilityof divisions individually.

7/29/2019 CN22HO.ppt

16/30



When supply outstrips demand, market prices

may drop well below their historical average.Distress prices are the drop in prices

expected to be temporary.

Basing transfer prices on depressed market prices will not

always lead to optimal decisions for an organization.

7/29/2019 CN22HO.ppt

17/30


Cost-based Transfer Prices

When transfer prices are

based on full cost plus a

markup, suboptimal

decisions can result.

7/29/2019 CN22HO.ppt

18/30


Dual Transfer Prices

An example of dual pricing is for Larry & Co.

to credit the Selling Division with112% of the full cost transfer price of $24.64

per barrel of crude oil.

Debit the Buying Division with the market-basedtransfer price of $23 per barrel of crude oil.

And debit a corporate account for the difference!

7/29/2019 CN22HO.ppt

19/30


Negotiated Transfer Prices

Negotiated transfer prices arise from the

outcome of a bargaining process between

selling and buying divisions.

7/29/2019 CN22HO.ppt

20/30


General Guideline: min. & max.

transfer price

Minimum transfer price= Incremental costs per unit incurred

up to the point of transfer

+ Opportunity costs per unit to the selling divisionIncremental cost often times = variable cost

Opportunity costs often times = lost CM

Opportunity costs could = lost savings

Maximum transfer price = Market price

7/29/2019 CN22HO.ppt

21/30


Min. & Max. transfer price--examples

Some examples:

(1) Slowcar

(2) S.F. Manufacturing

7/29/2019 CN22HO.ppt

22/30


Slowcar Company

The Assembly Division of SLOWCAR Company has offered to purchase90,000 batteries from the Electrical Division (ED) for $104 per unit. At anormal volume of 250,000 batteries per year, production costs per battery are:

Direct materials $40

Direct labor 20

Variable factory overhead 12

Fixed factory overhead 42

Total $114

The Electrical Division has been selling 250,000 batteries per year to outsidebuyers for $136 each. Capacity is 350,000 batteries/year. The AssemblyDivision has been buying batteries from outside suppliers for $130 each.

Should the Electrical Division manager accept the offer? Will an internaltransfer be of any benefit to the company?

7/29/2019 CN22HO.ppt

23/30


SF Manufacturing

The SF Manufacturing Co. has two divisions in Iowa, the Supply Division andthe BUY Division. Currently, the BUY Division buys a part (3,000 units)from Supply for $12.00 per unit. Supply wants to increase the price to BUY to$15.00. The controller of BUY claims that she cannot afford to go that high,as it will decrease the divisions profit to near zero. BUY can purchase the

part from an outside supplier for $14.00. The cost figures for Supply are: Direct Materials $3.25

Direct Labor 4.75

Variable Overhead 0.60

Fixed Overhead 1.20

A. If Supply ceases to produce the parts for BUY, it will be able to avoid one-

third of the fixed MOH. Supply has no alternative uses for its facilities.Should BUY continue to get the units from Supply or start to purchase theunits from the outside supplier? (From the standpoint of SF as a whole).

(What is the min. & max. transfer price if BUY and SUPPLY negotiate?)

7/29/2019 CN22HO.ppt

24/30


SF Mfg.continued

Now, assume that Supply could use the facilities currently used to produce the3,000 units for BUY to make 5,000 units of a different product. The newproduct will sell for $16.00 and has the following costs:

Direct Materials $3.00

Direct Labor 4.30

Variable Overhead 5.40

B. What is the min. & max. transfer price if BUY and SUPPLY negotiate?

C. What should be done from the companys point of view? Why?

7/29/2019 CN22HO.ppt

25/30


Comparison of Methods

Achieves Goal Congruence

Market Price: Yes, if markets competitive

Cost-Based: Often, but not always

Negotiated: Yes

7/29/2019 CN22HO.ppt

26/30



Useful for Evaluating Subunit Performance


Cost-Based:Difficult, unless transfer

price exceeds full cost

Negotiated: Yes

7/29/2019 CN22HO.ppt

27/30



Motivates Management Effort

Market Price: Yes

Cost-Based:

Yes, if based on budgeted

costs; less incentive ifbased on actual cost

Negotiated: Yes

7/29/2019 CN22HO.ppt

28/30

2009 Foster School of Business Cost AccountingL.DuCharme

28


Preserves Subunit Autonomy


Cost-Based: No, it is rule based

Negotiated: Yes

7/29/2019 CN22HO.ppt

29/30

2009 Foster School of Business Cost AccountingL.DuCharme

29


Other Factors

Market Price: No market may exist

Cost-Based:Useful for determining

full-cost; easy to implement

Negotiated:Bargaining takes time and

may need to be reviewed

7/29/2019 CN22HO.ppt

30/30

2009 Foster School of Business Cost Accounting L.DuCharme30

Multinational Transfer Pricing

IRC Section 482 requires that transfer prices

for both tangible and intangible property

between a company and its foreign division

be set to equal the price that would be

charged by an unrelated third party in a

comparable transaction (arms length).This still leaves a little room to wiggle.

cn22ho.ppt

Documents