Chapter 13 Responsibility Accounting and Transfer Pricing in Decentralized Organizations

1. Cost Accounting Foundations and Evolutions Kinney, Prather, Raiborn Chapter 13 Responsibility Accounting and Transfer Pricing in Decentralized Organizations

2. Learning Objectives (1 of 2) • Explain the organizational characteristics used to determine if a firm should be centralized or decentralized • Clarify the relationship between responsibility accounting and decentralization • Contrast the four types of responsibility centers

3. Learning Objectives (2 of 2) • Explain why and how service department costs are allocated to revenue-producing departments • Explain why transfer prices are used and describe the types of transfer prices • Explain the difficulties that multinational companies may encounter when using transfer prices

4. Decentralization Continuum Factor Centralized Decentralized Age of firm Young Mature Size of firm Small Large Stage of product development Stable Growth Growth rate Slow Rapid Impact on profits of incorrect decisions High Low Management’s confidence in subordinates Low High Degree of control Tight Moderate/loose

5. Decentralization Continuum Factor Centralized Decentralized Geographic diversity Local Widespread Cost of communications Low High Ability to resolve conflicts Easy Difficult Level of employee motivation Low Moderate to high Level of organizational flexibility Low High Response time to changes Slow Rapid

6. Advantages of Decentralization • Personnel • train and screen aspiring managers • develop leadership qualities, problem-solving abilities, and decision-making skills • compare managers’ results • increase job satisfaction and job enrichment • Effective means of achieving organizational goals • Reduces decision-making time • Allows management by exception

7. Disadvantages of Decentralization • Lack of goal congruence • Suboptimization • pursuing the subunit manager’s goals instead of the company’s goals • Requires more effective communication skills • Managers must relinquish control • Expensive • train managers in decision-making skills • absorb cost of poor decisions • requires a sophisticated planning and reporting system

8. Responsibility Reports • Monetary and nonmonetary • Adjusted for the planning, controlling, and decision-making needs of each unit manager • Separates costs as controllable or noncontrollable by the unit manager

9. Capacity measures Target ROI Desired/actual market share Throughput Defects Backorders Complaints On-time delivery Manufacturing cycle efficiency Reduction of non-value-added time Employee suggestions received/implemented Unplanned production interruptions Schedule changes Engineering changes Safety violations Absenteeism Nonmonetary Measures

10. Plan Compare Gather actual data Managerial influence Compare Control Process Steps

11. Responsibility Accounting • Upward flow of information • from operations to top management • Unit level reports are detailed • Upper-level reports are summarized • Encourages management by exception • Major deviations are highlighted

12. Responsibility Accounting • Disadvantages of responsibility accounting include • Important details may not be visible at upper management levels • Managers might “promote” their unit while “blaming” their competitor units • Departmental interdependencies might not be visible

13. Responsibility Centers • Responsibility accounting systems identify, measure, and report on activities in responsibility centers • Cost center • Revenue center • Profit center • Investment center

14. Service Cost Allocation Methods • Direct method • Step method • Benefits-provided ranking • Algebraic method • Simultaneous equations

15. Service Cost Allocation • Allocated service department costs are included in the overhead application rate for the revenue-producing areas • Service department costs are allocated to products or jobs through normal overhead assignment procedures

16. Transfer Pricing Internal charges for the exchange of goods or services within the organization • Promote goal congruence • Make performance evaluation among segments more comparable • Transform a cost center into a pseudo- profit center • For internal use only • Eliminated on external financial reports • Encourages managers to be entrepreneurial

17. Transfer Pricing Systems • May cause disagreement among managers • Add costs and take time • May not work for all departments • May cause dysfunctional behavior • May cause underutilization or overutilization of services • Complicate tax planning for multinationals

18. Internal Objectives Better goal congruence Better performance evaluations More motivated managers Better cash management External Objectives Less taxes and tariffs Less foreign exchange risks Better competitive positions Better relations with government Multinational Transfer Pricing

19. Multinational Transfer Pricing • Develop guidelines that are followed on a consistent basis • Set transfer prices that reflect an arm’s-length transaction • Be prepared for transfer pricing audits • Consider Advance Pricing Agreements –binding contracts between a company and taxing authorities that set an acceptable transfer pricing methodology

20. Questions • What are some advantages and disadvantages of decentralization? • What are the four types of responsibility centers? • Why are transfer prices used?