management accounting by horngren 11th edition chapter 22

8/2/2019 Management Accounting by Horngren 11th edition chapter 22

http://slidepdf.com/reader/full/management-accounting-by-horngren-11th-edition-chapter-22 1/60

22 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Management Control Systems,

Transfer Pricing, andMultinational Considerations

Chapter 22




Learning Objective 1

Describe a management

control system and its

three key properties.




Management Control Systems

A management control system is a means

of gathering and using information.It guides the behavior of managers and employees.




Management Control Systems

Financial data

Formal control system

Nonfinancial data

Informal control system




Evaluating Management

Control Systems

Motivation Goal congruence Effort

Lead to rewards

Monetary Nonmonetary





Describe the benefits and

costs of decentralization.




Organization Structure

Total decentralization

Total centralization




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




Costs of Decentralization

Suboptimal decision making may occur

Focuses the manager’s attention on the subunit rather than the organization as a whole

Increases the costs of gathering information

Results in duplication of activities




Decentralization in

Multinational Companies

Decentralization enables country managers to

make decisions that exploit their knowledgeof local business and political conditions.

Multinational corporations often rotate

managers between foreign locationsand corporate headquarters.




Responsibility Centers

Cost

center

Revenue

center

Investmentcenter

Profitcenter





Explain transfer prices and four

criteria used to evaluate them.




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 an organization.




Transfer Pricing

Transfer pricing should help achieve

a company’s strategies and goals. – fit the organization’s structure

– promote goal congruence

– promote a sustained high level

of management effort





Calculate transfer prices using

three different methods.




Transfer-Pricing Methods

Market-based transfer prices

Cost-based transfer prices

Negotiated transfer prices




Transfer-Pricing

Methods Example

Lomas & Co. has two divisions:

Transportation and Refining.

Transportation purchases

crude oil in Alaska and

sends it to Seattle.

Refining processes

crude oil

into gasoline.




Transfer-Pricing

Methods Example

External market price for supplying

crude oil per barrel: $13

Transportation Division:

Variable cost per barrel of crude oil $ 2

Fixed cost per barrel of crude oil 3

Total $ 5

The pipeline can carry 35,000 barrels per day.




Transfer-Pricing

Methods Example

External purchase price for

crude oil per barrel: $23

Refining Division:

Variable cost per barrel of gasoline $ 8

Fixed cost per barrel of gasoline 4

Total $12

The division is buying 20,000 barrels per day.




Transfer-Pricing

Methods Example

The external market price to outside

parties is $60 per barrel.The Refining Division is operating

at 30,000 barrels capacity per day.




Transfer-Pricing

Methods Example

What is the market-based transfer price

from Transportation to Refining?

$23 per barrel

What is the cost-based transfer price

at 112% of full costs?




Transfer-Pricing

Methods Example

Purchase price of crude oil $13

Variable costs per barrel of crude oil 2

Fixed costs per barrel of crude oil 3

Total $18

1.12 × $18 = $20.16

What is the negotiated price?

Between $20.16 and $23.00 per barrel.




Transfer-Pricing

Methods Example

Assume that the Refining Division buys

1,000 barrels of crude oil from the

Transportation Division.The Refining Division converts these 1,000

barrels of crude oil into 500 gallons of

gasoline and sells them.What is the Transportation Division operating

income using the market-based price?




Transfer-Pricing

Methods Example

Transportation Division:

Revenues: ($23 × 1,000) $23,000Deduct costs: ($18 × 1,000) 18,000

Operating income $ 5,000

What is the Refining Division’s operating income using the market-based price?




Transfer-Pricing

Methods Example

Refining Division:

Revenues: ($60 × 500) $30,000Deduct costs:

Transferred-in ($23 × 1,000) 23,000

Division variable ($8 × 500) 4,000

Division fixed ($4 × 500) 2,000





Transfer-Pricing

Methods Example

What is the operating income of both

divisions together?Transportation Division $5,000

Refining Division 1,000

Total $6,000




Transfer-Pricing

Methods Example

What is the Transportation Division’s operating

income using the 112% of full cost price?

Transportation Division:Revenues: ($20.16 × 1,000) $20,160

Deduct costs: ($18.00 × 1,000) 18,000


What is the Refining Division operating

income using the full cost price?




Transfer-Pricing

Methods Example

Refining Division:

Revenues ($60 × 500) $30,000Deduct costs:

Transferred-in ($20.16 × 1,000) 20,160

Division variable ($8.00 × 500) 4,000

Division fixed ($4.00 × 500) 2,000





Transfer-Pricing

Methods Example

What is the operating income of both

divisions together?Transportation Division $2,160

Refining Division 3,840

Total $6,000





Illustrate how market-based

transfer prices promote goal

congruence in perfectly

competitive markets.




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





Market prices also serve to evaluate the

economic viability and profitabilityof divisions individually.





When supply outstrips demand, market prices

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

expected to be temporary.





Avoid making suboptimal

decisions when transfer

prices are based on full

cost plus a markup.




Cost-Based Transfer

Prices Example

The Refining Division of Lomas & Co. is

purchasing crude oil locally for $23 a barrel.The Refining Division located an independent

producer in Alaska that is willing to sell 20,000

barrels of crude oil per day at $17 per barreldelivered to the pipeline (Transportation Division).




Cost-Based Transfer

Prices Example

The Transportation Division has excess

capacity and can transport the crude oil

at its variable costs of $2 per barrel.

Should Lomas purchase from the

independent supplier?

Yes.

There is a reduction in total costs of $80,000.




Cost-Based Transfer

Prices Example

Alternative 1:

Buy 20,000 barrels from thelocal supplier at $23 per barrel.

The total cost to Lomas is:

20,000 × $23 = $460,000




Cost-Based Transfer

Prices Example

Alternative 2:

Buy 20,000 barrels from the independentsupplier in Alaska at $17 per barrel and

transport it to Seattle at $2 per barrel.

The total cost to Lomas is:20,000 × $19 = $380,000




Cost-Based Transfer

Prices Example

Suppose the Transportation Division’s

transfer price to the Refining Divisionis 112% of full cost.

What is the cost to the Refining Division?




Cost-Based Transfer

Prices Example

Purchase price of crude oil $17

Variable costs per barrel of crude oil 2Fixed costs per barrel of crude oil 3

Total $22

1.12 × $22 = $24.64$24.64 × 20,000 = $492,800




Cost-Based Transfer

Prices Example

What is the maximum transfer price?

It is the price that the Refining Division canpay in the local external market ($23).

What is the minimum transfer price?

The minimum transfer price is $19 per barrel.





Understand the range over

which two divisions negotiate

the transfer price when

there is unused capacity.




Prorating

Lomas & Co. may choose a transfer price

that splits on some equitable basis thedifference between the maximum transfer

price and the minimum transfer price.

$23 – $19 = $4Suppose that variable costs are chosen as

the basis to allocate this $4 difference.




Prorating

The Transportation Division’s variable

costs are $2 × 1,000 = $2,000.The Refining Division’s variable costs to

refine 1,000 of crude oil into 500 barrels

of gasoline are $8 × 500 = $4,000.




Prorating

The Transportation Division gets to keep

$2,000 ÷ $6,000 × $4 = $1.33.

The Refining Division gets to keep

$4,000 ÷ $6,000 × $4 = $2.67.

What is the transfer price from theTransportation Division?

$17.00 + $2.00 + $1.33 = $20.33




Dual Pricing

An example of dual pricing is for Lomas & Co.

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

per barrel of crude oil.

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




Negotiated Transfer Prices

Negotiated transfer prices arise from the

outcome of a bargaining process between

selling and buying divisions.





Construct a general guideline

for determining a minimum

transfer price.




Comparison of Methods

Achieves Goal Congruence

Market Price: Yes, if markets competitive

Cost-Based: Often, but not always

Negotiated: Yes





Useful for Evaluating Subunit Performance


Cost-Based:Difficult, unless transfer

price exceeds full cost

Negotiated: Yes





Motivates Management Effort

Market Price: Yes

Cost-Based:

Yes, if based on budgeted

costs; less incentive if

based on actual cost

Negotiated: Yes





Preserves Subunit Autonomy


Cost-Based: No, it is rule based

Negotiated: Yes





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




General Guideline

Minimum transfer price= Incremental costs per unit incurred

up to the point of transfer

+ Opportunity costs per unit to the selling division




General Guideline

Assume a perfectly competitive market,

with no idle capacity.

Transportation Division can sell all the crude oil

it transports to the external market in Seattle

for $23 per barrel.


($19 + $4) or ($13 + $2 + $8) = $23 = Market price




General Guideline

Assume that an intermediate market exists

that is not perfectly competitive, and the

selling division has idle capacity.

If the Transportation Division has idle

capacity, its opportunity cost of transferring

the oil internally is zero.





General Guideline

It would be $15 per barrel for oil purchased

under the long-term contract, or...$19 per barrel for oil purchased and

transported from the independent

supplier in Alaska.





Incorporate income tax

considerations in

multinational

transfer pricing.



End of Chapter 22

management accounting by horngren 11th edition chapter 22

Documents