CHAPTER 22

1. CHAPTER 22 Management-Control Systems, Transfer Pricing, and Multinational Considerations © 2012 Pearson Prentice Hall. All rights reserved.

2. Management Control Systems • Management control systems are a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and other employees. © 2012 Pearson Prentice Hall. All rights reserved.

3. Management Control Systems • Many management control systems contain some or all of the balanced scorecard perspectives: • Financial • Customer • Internal business process • Learning and growth © 2012 Pearson Prentice Hall. All rights reserved.

4. Management Control Systems • Consist of formal and informal control systems: • Formal systems include explicit rules, procedures, performance measures, and incentive plans that guide the behavior of its managers and other employees. • Informal systems include shared values, loyalties, and mutual commitments among members of the company, corporate culture, and unwritten norms about acceptable behavior. © 2012 Pearson Prentice Hall. All rights reserved.

5. Evaluating Management Control Systems • To be effective, management control systems should be closely aligned to the firm’s strategies and goals. • Systems should be designed to fit the company’s structure and decision-making responsibility of individual managers. © 2012 Pearson Prentice Hall. All rights reserved.

6. Evaluating Management Control Systems • Effective management control systems should also motivate managers and their employees. • Motivation is the desire to attain a selected goal (goal-congruence) combined with the resulting pursuit of that goal (effort). © 2012 Pearson Prentice Hall. All rights reserved.

7. Two Aspects of Motivation • Goal congruence exists when individuals and groups work toward achieving the organization’s goals—managers working in their own best interest take actions that align with the overall goals of top management. • Effort is exertions toward reaching a goal, including both physical and mental actions. © 2012 Pearson Prentice Hall. All rights reserved.

8. Organization Structure and Decentralization • Decentralization is the freedom for managers at lower levels of the organization to make decisions. • Autonomy is the degree of freedom to make decisions. The greater the freedom, the greater the autonomy. © 2012 Pearson Prentice Hall. All rights reserved.

9. Decentralization vs. Centralization • Total decentralization means minimum constraints and maximum freedom for managers at the lowest levels of an organization to make decisions. • Total centralization means maximum constraints and minimum freedom for managers at the lowest levels of an organization to make decisions. • Companies’ structures generally fall somewhere in between these two extremes, as each has benefits and costs. Structure chosen cost vs. benefit analysis. © 2012 Pearson Prentice Hall. All rights reserved.

10. Benefits of Decentralization • Creates greater responsiveness to subunit’s customers, suppliers, and employees • Leads to gains from faster decision making • Increases motivation of subunit managers • Assists management development and learning • Sharpens the focus of subunit managers © 2012 Pearson Prentice Hall. All rights reserved.

11. Costs of Decentralization • Leads to suboptimal decision making, which arises when a decision’s benefit to one subunit is more than offset by the costs or loss of benefits to the organization as a whole. • Also called incongruent decision making or dysfunctional decision making © 2012 Pearson Prentice Hall. All rights reserved.

12. Costs of Decentralization • Focuses manger’s attention on the subunit rather than the company as a whole • Results in duplication of output • Results in duplication of activities © 2012 Pearson Prentice Hall. All rights reserved.

13. Decentralization and Multinational Firms • Multinational firms, companies that operate in multiple countries, are often decentralized because centralized control of a company with subunits around the world is often physically and practically impossible. • Decentralization enables managers in different countries to make decisions that exploit their knowledge of local business and political conditions and to deal with uncertainties in their individual environments. • Biggest drawback to international decentralization: loss or lack of control. © 2012 Pearson Prentice Hall. All rights reserved.

14. Choices about Responsibility Centers • Regardless of the degree of decentralization, management control systems use one or a mix of the four types of responsibility centers: • Cost center • Revenue center • Profit center • Investment center © 2012 Pearson Prentice Hall. All rights reserved.

15. Transfer Pricing • Transfer price—the price one subunit (department or division) charges for a product or service supplied to another subunit of the same organization. • Management control systems use transfer prices to coordinate the actions of subunits and to evaluate their performance. © 2012 Pearson Prentice Hall. All rights reserved.

16. Transfer Pricing • The transfer price creates revenues for the selling subunit and purchase costs for the buying subunit affecting each subunit’s operating income. • Intermediate product—the product or service transferred between subunits of an organization. © 2012 Pearson Prentice Hall. All rights reserved.

17. Three Transfer Pricing Methods • Market-based transfer prices • Cost-based transfer prices • Hybrid transfer prices © 2012 Pearson Prentice Hall. All rights reserved.

18. Market-Based Transfer Prices • Top management chooses to use the price of similar product or service that is publicly available. Sources of prices include trade associations, competitors, and so on. © 2012 Pearson Prentice Hall. All rights reserved.

19. Market-Based Transfer Prices • Lead to optimal decision-making when three conditions are satisfied: • The market for the intermediate product is perfectly competitive. • Interdependencies of subunits are minimal. • There are no additional costs or benefits to the company as a whole from buying or selling in the external market instead of transacting internally. © 2012 Pearson Prentice Hall. All rights reserved.

20. Market-Based Transfer Prices • A perfectly competitive market exists when there is a homogeneous product with buying prices equal to selling prices and no individual buyer or seller can affect those prices by their own actions. • Allows a firm to achieve goal congruence, motivating management effort, subunit performance evaluations, and subunit autonomy. • Perhaps should not be used if the market is currently in a state of “distress pricing.” © 2012 Pearson Prentice Hall. All rights reserved.

21. Cost-Based Transfer Prices • Top management chooses a transfer price based on the costs of producing the intermediate product. Examples include: • Variable production costs • Variable and fixed production costs • Full costs (including life-cycle costs) • One of the above, plus some markup • Useful when market prices are unavailable, inappropriate, or too costly to obtain © 2012 Pearson Prentice Hall. All rights reserved.

22. Hybrid Transfer Prices © 2012 Pearson Prentice Hall. All rights reserved. • Takes into account both cost and market information • Types of hybrid transfer prices: • Prorating the difference between maximum and minimum transfer prices • Dual pricing • Negotiated pricing

23. Hybrid Transfer Pricing • Prorating the difference between the maximum and minimum cost-based transfer prices. • Dual-pricing—using two separate transfer-pricing methods to price each transfer from one subunit to another. Example: selling division receives full cost pricing, and the buying division pays market pricing. © 2012 Pearson Prentice Hall. All rights reserved.

24. Negotiated Transfer Prices • Occasionally, subunits of a firm are free to negotiate the transfer price between themselves and then to decide whether to buy and sell internally or deal with external parties. • May or may not bear any resemblance to cost or market data. • Often used when market prices are volatile. • Represent the outcome of a bargaining process between the selling and buying subunits. © 2012 Pearson Prentice Hall. All rights reserved.

25. Comparison of Transfer-Pricing Methods © 2012 Pearson Prentice Hall. All rights reserved.

26. Transfer Pricing Illustration © 2012 Pearson Prentice Hall. All rights reserved.

27. Transfer Pricing Example A © 2012 Pearson Prentice Hall. All rights reserved.

28. Minimum Transfer Price • The minimum transfer price in many situations should be: • Incremental cost is the additional cost of producing and transferring the product or service. • Opportunity cost is the maximum contribution margin forgone by the selling subunit if the product or service is transferred internally. © 2012 Pearson Prentice Hall. All rights reserved.

29. Multinational Transfer Pricing and Tax Considerations • Transfer prices often have tax implications. • Tax factors include income taxes, payroll taxes, customs duties, tariffs, sales taxes, value-added taxes, environment-related taxes, and other government levies. © 2012 Pearson Prentice Hall. All rights reserved.

30. Multinational Transfer Pricing and Tax Considerations • Section 482 of the U.S. Internal Revenue Code governs taxation of multinational transfer pricing. • Section 482 requires that transfer prices between a company and its foreign division or subsidiary equal the price that would be charged by an unrelated third party in a comparable transaction. • Transfer price could be market-based or “cost-plus” based. © 2012 Pearson Prentice Hall. All rights reserved.

31. © 2012 Pearson Prentice Hall. All rights reserved.