Responsibility Accounting &ampamp; Transfer Pricing

Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,Decentralization, Responsibility Centers, and Transfer Pricing,CentralizationandDecentralizationSpectrum,High degreeofdelegation of duties,power, andauthoritytolowerlevels of theorganization,High degreeofretentionofduties,power,and authoritybytopmanagement,Decentralized,Centralized,Neither centralization nordecentralization isnecessarilyadesirableorganizationalgoal!,Decentralization in Organizations,Benefitsof,Decentralization,Topmanagement,freedtoconcentrate,onstrategy.,Lower-levelmanagers,gain experiencein,decision-making,.,.,Decision-making,authorityleadsto,jobsatisfaction.,Lower-leveldecision,oftenbasedon,betterinformation,.,.,Improvesability to,evaluatemanagers.,Decentralization in Organizations,Disadvantages of,Decentralization,Lower-levelmanagers,maymakedecisions,without seeingthe,“big picture,.,.”,Maybealack of,coordinationamong,autonomous,managers.,Lower-levelmanagers,objectives maynot,bethoseofthe,organization,.,.,Maybedifficult to,spreadinnovativeideas,intheorganization.,Decentralization andSegments,Asegmentisanypartoractivityofanorganizationaboutwhichamanager seeks cost, revenue, or profitdata.Asegment canbe,.,. .,.,.,QuickMart,AnIndividual Store,A Sales Territory,A ServiceCenter,Cost,Profit, andInvestmentsCenters,Cost Center,A segmentwhosemanagerhascontrolover costs,butnot overrevenuesorinvestmentfunds.,Cost,Cost,Cost,Cost,Profit, andInvestmentsCenters,ProfitCenter,A segmentwhosemanagerhascontroloverbothcostsandrevenues,butnocontrolover investmentfunds,.,.,Revenues,Sales,Interest,Other,Costs,Mfg. costs,Commissions,Salaries,Other,Cost,Profit, andInvestmentsCenters,Investment Center,A segmentwhosemanagerhascontrolover costs,revenues,and investments in operatingassets,.,.,CorporateHeadquarters,Cost,Profit, andInvestmentsCenters,Responsibility,Center,Cost,Center,Profit,Center,Investment,Center,Cost,profit,andinvestment,centers areall,knownas,responsibility,centers.,ReturnonInvestment,(,(ROI)Formula,ROI =,Net operating income,Average operating assets,Cash,accountsreceivable,inventory,plantandequipment,andother,productive assets.,Incomebefore interest,andtaxes,(,(EBIT,),),ReturnonInvestment,(,(ROI)Formula,RegalCompany reportsthe following:,Netoperating income,$,$30,000,Average operatingassets,$,$200,000,Sales,$,$ 500,000,$30,000,$200,000,=,15%,ROI =,ControllingtheRateofReturn,Threeways to improveROI .,.,.,.,.,Increase,Sales,Reduce,Expenses,Reduce,Assets,ControllingtheRateofReturn,Regalsmanager wasable to increase sales to $600,000 which increasednetoperating incometo,$,$42,000.,Therewasnochange in theaverage operatingassetsofthe segment,.,.,Let,scalculatethe newROI,.,.,ReturnonInvestment,(,(ROI)Formula,Netoperating income,Sales,Salesaaaaaaaaa,Averageoperatingassets,ROI,=,=,$42,000,$600,000,$600,000,$200,000,21%,Wecanmodify ouroriginalformula slightly:,ROI,=,=,ROI,=,=,WeincreasedROI from15,%,% to 21%,Margin,Turnover,Criticisms of ROI,Intheabsenceofthebalanced,scorecard, managementmay,notknowhowtoincreaseROI.,Managersofteninherit many,committedcostsoverwhich,they havenocontrol.,ManagersevaluatedonROI,mayreject profitable,investment opportunities,.,.,TheBalancedScorecard,Management translatesits strategy intoperformancemeasuresthatemployeesunderstandandaccept.,Performancemeasures,Financial,Customers,Learningandgrowth,Internalbusinessprocesses,Criticisms of ROI,Asdivisionmanager at Winston, Inc., yourcompensation packageincludesasalaryplusbonusbasedonyour divisionsROI -,-,- thehigheryourROI, thebiggeryourbonus.,ThecompanyrequiresanROIof15,%,% on allnewinvestments,-,-yourdivisionhasbeenproducinganROI of 30%.,Youhaveanopportunitytoinvestinanewprojectthat willproduceanROIof25,%,%.,Asdivisionmanager would you,investinthisproject?,Criticisms of ROI,Asdivisionmanager,I wouldnt investin,that projectbecause,itwouldlowermypay,!,!,Criticisms of ROI,Gee,.,.,.,. .,I thoughtwewere,supposedtodowhat,wasbestforthe,company!,ResidualIncome,-,-Another MeasureofPerformance,Netoperating income,abovesome minimum,returnonoperating,assets,ResidualIncome,A division of Zepher,Inc.hasaverageoperatingassets of $100,000 andisrequiredtoearn areturn of 20%ontheseassets,.,.,Inthecurrentperiodthe division earns $30,000,.,.,Let,scalculateresidualincome.,ResidualIncome,Motivation andResidualIncome,Residualincomeencouragesmanagersto,make profitableinvestmentsthatwould,berejectedbymanagersusingROI,.,.,Company A,sreturnoninvestment,(,(ROI)is:,A)36%,.,.B)20%,.,.C)15%,.,.D)4%.,Thefollowing information is availableonCompany A,:,:,Sales,$,$900,000,Netoperating income36,000,Stockholders, equity100,000,Average operatingassets180,000,Minimum required rateofreturn15%,Thefollowing dataare availableforthe South Division ofRedrideProducts,Inc.andthe singleproduct it makes:,Unit sellingprice,$,$20,Variablecost perunit$12,Annualfixedcosts,$,$280,000,Average operatingassets,$,$1,500,000,Howmanyunitsmust South selleachyear to haveanROI of 16%?,A)240,000.,B)1,300,000,.,.,C)65,000,.,.,D)52,000,.,.,Allotherthings equal,a company,sreturnoninvestment,(,(ROI)wouldgenerallyincreasewhen:,A)salesdecrease.,B)average operatingassetsincrease,.,.,C)operatingexpensesincrease,.,.,D)operatingexpensesdecrease,.,.,TRANSFERPRICING,Atransferpriceisthepricechargedwhen onesegment (forexample,adivision)providesgoodsorservicestoanothersegment of thesamecompany.,TRANSFERPRICING SomePoints,Transferpricesare necessarytocalculatecostsinacost,profit, or investmentcenter.,Thepurchasingdivisionwill naturallywant alow transfer price andselling division willwanta hightransferprice,.,.,From thestandpoint of thefirm as awhole, transfer pricesinvolve “takingmoneyout of onepocketand puttingitintotheother,.,.”,Anoptimal transfer priceisonethatleadsdivisionmanagerstomake decisionsthat areinthebestinterestsofthe firmasawhole.,Production capacity (numberofbatteries)300,000,Selling price perbattery to outsiders,$,$40,Variablecostsperbattery,$,$18,Fixedcostsperbattery,(,(basedoncapacity,),),$,$7,BarkerCompanyhasaVehicle Division thatcoulduse thisbatteryinitsforklifttrucks.TheVehicleDivisionwouldlike to buy50,000batteries peryear.Itispresentlybuying these batteriesfrom an outsidesupplierfor $39perbattery.,EXAMPLE:TheBatteryDivisionofBarkerCompanymakesa standard 12-voltbattery.,From thestandpoint of theentirecompany,notransfershouldtake place since thecompany gives up $40inrevenues,but saves only,$,$39 in costs.,Suppose theBattery Division is operatingatcapacity.,What is thelowestacceptabletransferpricefrom theviewpointofthe sellingdivision,?,?,But, thepurchasing division willnot paymore than,$,$39,thecostfrom buyingthebatteries fromthe outside,.,.Sothetwo managers willnot be abletoagreetoatransferpriceandnotransferwillvoluntarilytake place.,AssumeagainthattheBatteryDivisionisoperatingatcapacity, butsuppose thatthe divisioncanavoid,$,$4invariablecosts, suchassellingcommissions,onintracompanysales.,What is thelowestacceptabletransferpricefrom theviewpointofthe sellingdivision,?,?,Once again,thepurchasingdivisionwill notpaymorethan $39,the costfrombuyingthe batteriesfrom theoutside.,Inthis caseanagreement is possible.Anytransferpricewithin therange,$36Transferprice$39,From thestandpoint of theentirecompany,thistransfershouldtake place since thecost of thetransferis,$,$36and thecompany saves $39,for anet gainof,$,$3,.,.,COST-BASED TRANSFER PRICES,Transferpricesbasedoncostareeasily understoodand convenienttouse anddonotrequirenegotiation.,Unfortunately,cost-based transfer priceshave severaldisadvantages:,Cost-based transfer pricescanleadtobaddecisions.,(,(For example, theydontincludeopportunitycostsfrom lostsales,.,.),Theonlydivisionthat willshowanyprofit on thetransactionistheone thatmakesthe final saletoanoutsideparty.,Cost-based transfer pricesprovide no incentiveforcontrolofcostsunlesstransfers aremade atstandardcost.,MARKET,-,-BASEDTRANSFERPRICES,When there is an activemarketfor theitem being transferred,themarket price maybea suitable transfer price.,However,when there is idlecapacity, themarketpricewilloverstatethe realcosttothecompanyofthetransferand maylead thepurchasing division managertomakebaddecisions.,