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Agenda Today

Agenda Today. Review some chapter 12 ideas Outline transfer pricing issues Go over EVA case Outsource, Inc. Profit Centers. Responsibility elements Sales prices Sales volumes Sales mix Promotional activities Other terms of sale. Profit Centers (Cont.). Direct cost elements

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Agenda Today

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  1. Agenda Today • Review some chapter 12 ideas • Outline transfer pricing issues • Go over EVA case Outsource, Inc. EMBA 802

  2. Profit Centers • Responsibility elements • Sales prices • Sales volumes • Sales mix • Promotional activities • Other terms of sale EMBA 802

  3. Profit Centers (Cont.) • Direct cost elements • Production activity costs • Order-getting costs • Order-filling costs • Marketing expenses • Support activity costs • Costs associated with other terms of sale EMBA 802

  4. Profit Centers (Cont.) • Other possible responsibility elements • Receivables • Inventories • Plant & equipment • Examples? EMBA 802

  5. Investment Centers • Profit centers with additional responsibility elements • Investment in current operating assets • Investment in plant & equipment EMBA 802

  6. Investment Centers • Challenges • Allocation of common assets • Cash • Receivables • Warehouse space • Transportation resources • Valuation of investment • Inflation and currency effects EMBA 802

  7. Invest.Centers (Cont.) • Examples • Lazarus store in City Center Mall • Marysville Honda plant • EDS processing centers EMBA 802

  8. Divisions • Divisions are investment centers whose managers have the broad decision-making authority associated with decentralized management systems • Divisions may have a variety of legal forms (corporations, unincorporated, etc.) EMBA 802

  9. Divisions • Divisions vary greatly in size • Financial controls dominate since the decision-making is decentralized EMBA 802

  10. Transfer Pricing • A transfer price is the price at which a product or service is transferred from one entity to another entity within the same firm. Typically when products are moved from one cost center to another within a manufacturing system, the transfer price is the cumulative cost of the product to date. EMBA 802

  11. Transfer Pricing • In a standard cost system, when products are transferred out of a cost center, they are transferred at their standard cost. The difference between the standard cost credited (received) for the product transferred, and the cost of the resources that are allowed by the standards for the production achieved, are the cost variances. EMBA 802

  12. Manufacturing Process 1 Inputs Outputs at Standard Cost Materials Labor Manufacturing Process 1 Manufacturing Process 2 Support Support Difference between cost of inputs and standard cost of outputs = variances EMBA 802

  13. Support Service • When a support service is charged to other entities at a predetermined price, that amounts to a transfer price. If the transfer price is a budgeted cost, as in the previous slides, the difference between the budgeted prices of the services provided to others, and the cost of resources used by the entity, are cost variances. EMBA 802

  14. Services in General • When a service is provided to other entities in the same firm at a predetermined price, that amounts to a transfer price. If the transfer price were a budgeted cost, then like the previous slides, the difference between the budgeted cost of the services provided and the cost of resources actually used to provide those services would be cost variances. EMBA 802

  15. Therefore, • we have dealt with transfer prices in the context of cost centers. The transfers between cost centers can be made at budgeted, standard, or actual cost. The objective of a cost center is to create a positive difference between the actual costs incurred and the budgeted cost allowance for the output levels achieved. EMBA 802

  16. Revenue Centers • In the case of revenue centers, we are tracking revenues by responsibility center, where the emphasis in on generating revenues. Normally, there are no transfers involved with revenue centers. EMBA 802

  17. Profit & Investment Centers Profit centers and investment centers have profit responsibility--usually in the form of the control of both revenues and costs. Therefore, transferring goods and services out of a profit center at cost is inconsistent with the idea of having profit responsibility. Normally, for true profit centers, there should be a meaningful “profit” component. EMBA 802

  18. Pricing Goods and Services In a market economy, prices determine economic activity. Prices determine what resources are offered, and how they are used to produce which products and services. Activities cease when they are no longer “economic”; but persist when they are “economic.” Economic activity is the result of independent decisions made based on available prices. EMBA 802

  19. Pricing Goods and Services Large, decentralized organizations simulate market economies by allowing internal (transfer) prices to guide intra-firm economic activity. Ideally, managers would be free to price transfers of goods and services at a mutually agreed upon price, as in a market economy. Divisions would buy from the best sources and sell to maximize their own profitability. EMBA 802

  20. Decentralization Purposes • Decentralize managerial responsibilities to local managers. • Provide managerial incentives to operating executives • Isolate economic efficiency by responsible entity EMBA 802

  21. Decentralization Purposes • Distribute overall profitability among contributing entities • Distribute overall profitability among taxing entities EMBA 802

  22. Transfer Pricing Methods • Transfer pricing methods that include a profit element include: • Marginal cost (economic theory) • Administered prices • Cost-plus prices • Negotiated prices • Market prices EMBA 802

  23. Transfer Price = Internal Price Corporate Entity Primary or inter-mediate producer Transfer price Intermediate Producer or Distributor Final price External Customer EMBA 802

  24. Note!! • The selling division’s “price” is the buying division’s cost for divisional performance measurement purposes. • Production mix and volume decisions are incremental analysis-type decisions in a multi-entity context. EMBA 802

  25. Three Perspectives • The total firm • Selling division • Purchasing division EMBA 802

  26. Artic Delights Total Per Unit Sales $17,500 $ 1.75 Variable cost 10,000 1.00 Contribution margin $ 7,500 $ .75 Machine & rental cost 6,000 .60 Income from operations $ 1,500$ .15 EMBA 802

  27. Sandwich Stands We do not know the ultimate sales price to final customers, but price increases are not at issue. 1. Sandwich stands should buy from Artic Delights so long as the purchase price paid by the stand exceeds the variable cost of producing ice cream. EMBA 802

  28. Artic Delights 2. Artic delights should produce so long as the purchase price is above variable cost of $1 per gallon. Do companies ever produce for less than variable cost? How would one analyze a situation like that? 3. If stands can but ice cream for $1.50, Artic Delights will have to drop its price. EMBA 802

  29. Artic Delights 4. How does the transfer price affect the profitability of (a) Artic Delights excluding the stands, (b) each Sandwich stands, and (c) Artic Delights and its stands. • (a) The higher the transfer price, the higher the profits of Artic Delights, excluding the stands. The lower the price, the lower the income from operations. EMBA 802

  30. Artic Delights 4 (b). The higher the transfer price, the lower the income of each stand, and the lower the compensation of each manager. The lower the transfer price, the higher the income of each stand and the higher the compensation of each manager. EMBA 802

  31. Artic Delights 4 (c). When the stands are included with the results of Artic Delights, profitability is reduced to the extent that transfer prices are lower and the managers earn a higher return. This is a real problem in terms of balancing compensation and incentives. EMBA 802

  32. EFG Company • Division S (Supplying) Subassemblies: Price $260 Variable cost 200 Contribution margin $ 60 Widgets: Price $150 Variable cost 125 Contribution margin $ 25 EMBA 802

  33. EFG Company Division P (Purchasing) Product B: Price $400 Variable cost* 160 Contribution margin $240 Gadget: Price $180 Variable cost 150 Contribution margin $ 30 EMBA 802

  34. EFG Company Case A: Maximum external sales: Division S - 1,600 subassemblies (capacity = 2,000 units) Division P - 500 Gadgets (capacity = 1,000 units) EMBA 802

  35. EFG - Case A Division S Production: 1,600 subassemblies for external sale 400 subassemblies for Div. P Division P Production: 400 units of Product B 500 Gadgets EMBA 802

  36. EFG - Case B Case B: Maximum external sales: Division S - 1,600 subassemblies - 200 widgets (capacity = 2,000 units) Division P - 600 Gadgets (capacity = 1,000 units) EMBA 802

  37. EFG - Case B Division S Production: 1,600 subassemblies for external sale 400 subassemblies for Div. PDivision P Production: 400 units of Product B 600 Gadgets EMBA 802

  38. EFG - Case C Case C: Maximum external sales: Division S - 1,500 subassemblies - 200 widgets - 600 subs to P (capacity = 2,000 units) EMBA 802

  39. EFG Case C (Div. S) Division S Production: 1,500 subassemblies for external sale 500 subassemblies for Div. P 0 Widgets EMBA 802

  40. EFG Case D (Div. S) Case D: Maximum external sales: Division S - 1,500 subassemblies - 300 widgets - 600 subs to P for $220 (capacity = 2,000 units) EMBA 802

  41. EFG Case D (Div. S) Division S Production: 1,500 subassemblies for external sale 200 subassemblies for Div. P 300 Widgets for external sale Subassemblies to outside get $60 Widgets get $25 Subassemblies get $20 (at TP of $220) EMBA 802

  42. EFG Overview • The key issue is to set a transfer price that takes advantage of excess capacity when it exists. The fact that one cannot earn the market price may be more of a temporary problem than a measure of one’s inefficiency. • Generally $200 < price < $240, but this depends on the other markets. EMBA 802

  43. Evaluation Questions • Were any of the “calculators” like the ones for learning curves and the internal rate of return of any benefit? • Would calculators be useful for such topics as standard cost systems, etc. • Looking back, were the graded problems/cases useful in terms of getting together to work on homework? • Would you recommend quizzes again? EMBA 802

  44. Evaluation Questions • Was having some MC questions available to study useful? • Was the web page helpful? • If yes, what would make it more helpful? EMBA 802

  45. Final Examination Discussion • Content • Preparation • Presentation • Grading EMBA 802

  46. Quiz Discussion? EMBA 802

  47. EMBA 802

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