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Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Questions
1. The extent to which decision-making responsibility is distributed throughout an organization determines whether a firm is centrally or decentrally organized. Decentralization refers to the end of the continuum where decision making is widely dispersed; centralization refers to the end of the continuum where decision making is made only by top management.
Exhibit 18-1 reflects criteria that help to determine whether a company should be decentralized. These characteristics are: * Mature in age
* Large size
* Product development in a growth stage * Rapid firm growth rate
* Low expected impact on profits of incorrect decisions * High confidence in subordinates' abilities
* Less rigorous historical degree of top management control
2. Even companies that are thought to be highly decentralized for most functions will often perform some functions centrally. Some functions which may be better handled centrally are:
* Capital project approval * Cash management
* Inventory control
* Evaluation of division profitability
Thus, most firms are neither purely centralized nor purely
3. Four potential advantages of decentralization are: * Executive training and development
* Job satisfaction
* Effectiveness and speed of decision making by local managers with intimate knowledge of problems
* "Management by exception principle" frees top management time
Three potential disadvantages of decentralization are: * Suboptimization
* Disruption because top management has difficulty in relinquishing control
* Potentially high costs of incorrect decisions by subordinates
4. Functions that are better
handled centrally Reasons
5. The process of implementing or utilizing a decentralized organizational structure can cause costs to be incurred. The following are potential costs of decentralization:
* suboptimization,
* conflict created because top management cannot or will not relinquish authority,
* significant adverse consequences of incorrect decisions by subordinates, and
* a more expensive control system is required.
These costs can be minimized through effective training and, if decentralization is to be effective, should be less than the benefits derived from the use of such a structure.
6. Decentralization is the degree to which decision-making
authority is delegated downward in an organization. Accounting reports should be prepared to reflect how managers of
significant segments of the organization perform relative to the authority delegated to them. The responsibility accounting system must be kept in sufficient detail to permit segment reporting.
7. The two basic functions of responsibility reports are to: * Provide operational managers with information needed for planning, controlling, and decision making for their areas
of responsibility.
* Assist top managers in evaluating how well operational managers fulfilled their responsibilities to the
organization.
8. It is sometimes appropriate for a company to prepare a single responsibility report for a division. However, many companies prepare two different responsibility reports for a division: one report, which is used to evaluate a manager's performance, shows only the costs controllable by that manager; the other responsibility report shows all costs incurred by and assigned to the division so that a notion of the total performance of the division can be gained. If the latter report can be
subdivided into controllable and noncontrollable costs of the division manager, then one report can effectively accomplish both purposes.
10. The goal of measuring performance is to objectively capture achievement of the organization's goals. To achieve goals, firms identify critical success factors. Some critical
success factors are more easily measured in nonmonetary units rather than monetary units. Examples of such factors include: customer satisfaction, throughput, and product quality.
11. The four types of responsibility centers are cost, revenue, profit, and investment centers. Cost centers focus primarily on costs. Revenue centers focus primarily on revenues. Profit centers focus on both revenues and costs. Investment centers focus on both profits and the investment base that is utilized to generate those profits.
12. While salaries are not the primary focus of a revenue center report, they may, nonetheless, be included if the revenue
center manager has significant control over labor rates and/or labor schedules.
13. Suboptimization is a condition whereby individual managers work to achieve results that are in their own best interests and that of their segments to the detriment of the overall company. Top managers must guard against such behavior of subordinates when authority is delegated to them in a
decentralized setting. Suboptimization results from segment
managers’ motivation to appear successful and gain rewards and
recognition. Sometimes, this motivation overrides the best interests of the company.
14. Service departments are internal departments that provide goods/services to other internal departments. Service departments typically provide few, if any, services to external constituents. Examples of service departments include training, personnel, accounting, electronic data processing, and legal services. Service departments are distinguished from operating departments in that service
15. Service department costs may be allocated to revenue-producing departments for a variety of reasons. Several of the more common reasons include the following: to encourage managers to use support areas in the most cost-beneficial manner; to make performance comparisons with independent organizations; to determine the full cost of production to make fair and acceptable pricing decisions; and to support decision making. (These are all enumerated in Exhibit 18-6.) Such allocations are not always useful from a decision-making standpoint
because the allocations bring costs that are uncontrollable by a department into that department.
16. In addition to allocating service department costs to obtain a full cost of products or other cost objects, there are
behavioral consequences associated with allocating service department costs. Generally, managers become more sensitive to the support provided by the service area, which leads them to utilize this resource in a more cost-beneficial way and to recommend cost control improvements to the service department. However, such cost allocations can cause dysfunctional
behavior if the manager of the revenue-producing area perceives the cost allocation to be unfair.
17. The four criteria (benefits received, causation, equity, and ability to bear) are all relevant to making service department allocations and should, theoretically, be applied equally. However, it is often not practical to apply the equity
criterion because it is too difficult to achieve agreement on what is fair. Ability to bear is often not used because it results in unrealistic or profit-detrimental actions.
Therefore, most service department allocations are based on the benefits-received and causation criteria.
18. The direct method is the only method that does not allocate a service department's costs to other service departments. The step method does make such an allocation, but does so
sequentially based on a benefits-provided ranking. The algebraic method, unlike the other methods, recognizes reciprocal (give-and-take) exchanges of services among the service departments by providing a set of simultaneous equations to solve for the effects of such interchanges.
The only similarity among the methods is their ultimate objective - the assignment of service department costs to revenue-producing areas.
19. The direct method of allocating service department costs is the simplest method of allocation. It does not take into consideration services exchanged among service departments, however. The step method does take into consideration
services used between service departments, but only after a benefits-provided ranking order has been established. Because of the necessity to rank services, all service department
interaction is not accounted for using the step method. This method is more difficult than the direct method, but less difficult than the algebraic method. The algebraic method of allocating service department costs considers the
interrelationships of all departments through the use of
simultaneous equations. This method is very difficult to use without the aid of a computer, however, when more than two or three departments are involved. The algebraic method does provide the best measure of the usage of costs among
departments.
20. A benefits-provided ranking is necessary under the step method of allocating service department costs because, once costs are assigned out of an area, they cannot be reassigned to that area. The method requires the allocation process to begin with the area that provides the most service to all other areas and end with the area that provides most of its services only to revenue-producing departments. In this manner, some, but not all, service interrelationships are considered. Such a
ranking is not necessary in the algebraic method because all interrelationships among departments are considered.
21. The added costs are fictional and are caused by the
cross-allocation process of solving simultaneous equations. These fictional costs are ignored in the revenue-producing areas for the purpose of developing an overhead application rate.
22. Computer technology has reduced the burden of making the calculations that are required to solve simultaneous
equations. The computer handles such calculations at very low cost and a high level of precision.
23. Transfer prices are internally set (agreed on) prices with
which a “selling” division transfers goods or services to a “buying” division. The objectives are goal congruence,
24. Type of Center Recommended Type of Transfer Price & Usage Cost-Selling Cost-based: consistent with objective of Segment this type of center; this use is a way of allocating the center's cost to other centers.
Cost-Buying Preferably cost based: consistent with Segment this type of center; however, depending on
Revenue-Selling Market price: consistent with this type of Segment center; revenue from transfers of goods or services is recorded at the transfer price for internal reporting purposes.
Revenue-Buying Goods or services transfer prices should Segment be between the lower and upper limits with
acquired by the center for internal re-
25. In negotiating transfer prices among segment managers, the managers are expected to work together to (1) make choices that will maximize the efficiency and effectiveness of their respective divisions and (2) to contribute to overall company performance. For example, when it is in the best interest of the whole company for a buying division to purchase goods or services internally from a selling division, segment managers are expected to agree on a price to encourage this. If top management has properly trained, motivated, and evaluated these segment managers, the transfer price can be a device to promote such goal congruence.
In contrast, sometimes segment managers become myopic in their zeal to maximize the apparent performance of their own divisions. For example, sometimes a buying segment manager will choose to buy externally at a price lower than the
transfer price because it makes his division look better even though analysis would reveal that the whole company would do better were the acquisitions made internally. This is an example of suboptimization.
26. The upper limit is the lowest external market price for the product because this measures the amount for which the buying segment could acquire the product. The lower limit is the sum of the incremental costs of producing the product plus the opportunity cost of the facilities used; this is what the selling segment sacrificed to make the product.
27. Standard cost has the advantage of being known or agreed on in advance and of being a measure of efficient production. Actual cost may vary widely from month to month because of large
changes in production volume, seasonal variations, and efficiencies.
28. The biggest problem involves the definition and what is included in the term "cost." Cost can mean any of the
following: incremental or variable; absorption (product costs only); and absorption plus some portion of the segment's
nonproduction costs (selling and administrative). An amount for estimated opportunity costs for use of the facilities can be added to any of the above. In some cases, arguments can be made for reducing absorption costs by estimated savings in production or distribution costs on internal sales.
Another problem is that if actual costs include
29. Problems of using market-based transfer prices include * the possibility that no objective market price is known because the product has no exact counterpart in the market; * market price ignores any production or distribution savings on internally transferred goods; and
* current prices being temporarily nonrepresentative of a long-run price.
30. Negotiation can create teamwork and generate creative
solutions that better the whole company. It can, in contrast, create an unhealthy adversarial climate in which fierce
competition can lead to suboptimization. This creates a potential for exerting top management leadership to promote the former situation.
31. Dual pricing occurs when the selling division is permitted to record one transfer price (higher) and the buying division to record another (lower). This practice is intended to minimize suboptimization and create goal-congruent incentives for both divisions.
32. Where (1) user departments have significant control over the quantity and quality of services used and (2) there is a reasonable surrogate measure of service benefits provided to users, transfer prices can be an effective way of promoting proper use of resources and of reassigning service department costs. Setting the transfer price depends on (1) the nature of the service center (cost or profit center) and (2) the nature of the service itself (can it be acquired externally, is it recurring and uniform, and is it expensive?).
Advantages of transfer prices over allocation include * Motivation of user departments to suggest improvements and monitor usage;
* Inclusion of costs in user department's performance report (if user department controls the amount of service it
"buys");
* Promotion of services more beneficial to users; * Requires that transfer prices be justified; and
* Transforms a service department from cost center to profit center and this provides more performance measures.
33. Transfer pricing arrangements can be costly in terms of
suboptimization. Also, the process of setting transfer prices may be expensive when considering the time and effort that is involved in the buying and selling division. Lastly, the use of transfer pricing may be optimal in maintaining goal
34. Because transfer prices between multinational units of a company can affect profits and inventory values reported in two different countries, managers are cognizant of setting prices, within legal and ethical limits, to minimize income taxes and tariffs.
35. Student answers will vary. No solution provided.
39. a. From Personnel to Fabricating: (0.45 0.85) × $70,000 = $37,059
From Maintenance to Fabricating: (0.60 0.90) × $50,000 = $33,333
b. From Personnel to Finishing: (0.40 0.85) × $70,000 = $32,941
From Maintenance to Finishing: (0.30 0.90) × $50,000 = $16,667
40. Checking:
Administration (.30÷0.80) × $90,000 $ 33,750
Personnel (.30÷0.80) × $60,000 22,500
Accounting (.40÷0.80) × $90,000 45,000
Direct costs 90,000 $191,250
Savings:
Administration (.40÷0.80) × $90,000 $ 45,000 Personnel (.20÷0.80) × $60,000 15,000
Accounting (.20÷0.80) × $90,000 22,500
Direct costs 75,000 $157,500
Loans:
Administration (.10÷0.80) × $90,000 $ 11,250 Personnel (.30÷0.80) × $60,000 22,500
Accounting (.20÷0.80) × $90,000 22,500
Direct costs 150,000
41. Administration Costs ($90,000)
Accounting Costs ($90,000 + $9,000 + $7,667)
Checking [$106,667 × (0.40÷.80)] $53,334
Maintenance Costs ($40,000 + $6,000 + $16,500)
Stamping [$62,500 × (.50÷0.85)] $36,765 Assembly [$62,500 × (.35÷0.85)] 25,735 $62,500
c. The cost allocation is affected by the order in which costs are assigned because the cost allocated from a particular service department depends on the amount of cost allocated to that service department from other service departments; the amount of costs allocated from other service departments depends on the
benefits-provided ranking.
44.
Administration Personnel Department Base % Base % Admin. (A) n/a n/a 10 11.11 Pers. (P) $ 75,000 6.25 n/a n/a College Texts 600,000 50.00 50 55.56 Prof. Pubs. 525,000 43.75 30 33.33
Total $1,200,000 100.00 90 100.00 rounded
A = $225,000 + 0.1111P P = $175,000 + 0.0625A
A = $225,000 + 0.1111(175,000 + 0.0625A) A = $225,000 + $19,443 + 0.0069A
0.9931A = $244,443 A = $246,141
P = $175,000 + 0.0625($246,141) P = $190,384
College
Dept. Admin. Pers. Texts Prof. Pubs. Direct costs $225,000 $175,000 $1,125,000 $475,000 Admin. (246,141) 15,384 123,071 107,686 Pers. 21,152 (190,384) 105,777 63,455 Total $ 0 $ 0 $1,353,848 $646,141
Note: The Administration column does not actually sum to zero because of rounding.
45. a. The upper limit is the best external price = $15.00 The lower limit is variable production cost = $7.20 + opportunity cost
b. Minimum price is regular price = $21.75
46. a. Lower limit is the variable cost ($1.50 + $1.90 + $0.80) + $7.30 lost CM = $11.50; this is the normal selling price less the normal variable costs excluding the $0.50 variable selling expense.
c. $217,187.50 ÷ 1.25 = $173,750 cost for 25,000 units = $6.95 cost per unit
DM $1.50 + DL $1.90 + VOH $0.80 + FOH $2.75 = $6.95
$131,250 ÷ 1.25 = $105,000 for 25,000 units
= $4.20 per unit
DM $1.50 + DL $1.90 + VOH $0.80 = $4.20
Mr. Leon is defining cost as variable cost, while Goodbrake Division defines cost as absorption cost.
47. a. Total variable cost
Variable production cost $14 Variable selling cost 3
$17 per unit
b. Full production cost
Variable $14.00 FOH ($300,000 ÷ 200,000) 1.50
$15.50 per unit
c. Total variable production + necessary selling Variable production $14
Necessary selling 2
$16 per unit
d. Market price $25.60 per unit or $25.60 - $1 for advertising = $24.60
48. a. The rapid increase in food costs has created a
significant difference between the “historical cost” of items and the “replacement cost” of items. Because
transfers between stores are made at historical costs, the transferring store loses in the transaction because it must replace the transferred item at replacement cost. This situation creates an incentive for stores to
misrepresent the actual inventories on hand when transfers are requested by sister stores.
49. a. A
The variance could have been caused by volume of activity being above the expected level, or by operating costs exceeding the expected level. We would need more information to determine the actual causes.
c. Budget Actual Variance Revenues $40,000 $38,500 $(1,500) Variable costs:
Meals $ 4,500 $ 5,400 $ (900) Lodging 13,500 16,200 (2,700) Supplies 1,000 1,200 (200) Contribution margin $21,000 $15,700 $(5,300) Direct fixed costs:
Facilities rent $3,600 $ 4,200 $ (600) Advertising 2,100 2,900 (800) Speakers 5,000 7,500 (2,500) Segment margin $10,300 $ 1,100 $(9,200) Allocated fixed costs 2,500 2,500 0 Net operating income
(loss) $ 7,800 $(1,400) $(9,200)
By far, the biggest contributor to the financial failure of the seminar was the inability to achieve the budgeted level of revenue per participant. Expected revenue, based on the actual number of participants, would have
been 120 × $400 = $48,000. However, actual revenues fell
52. a. The report is not in accordance with the concept of
responsibility accounting. In responsibility accounting, each manager's performance is judged by how well (s)he manages those items directly under his/her control. Responsibility accounting does not recognize the
allocation of common costs to segments. While including the corporate costs may be useful in calling attention to these activities, differences between budgeted and actual for these items are beyond the control of the Machining Department supervisor and are not properly chargeable to him/her. Thus, corporate costs should not be included in the report.
The report compares actual performance to a static budget. A static budget fails to distinguish between the production control and the cost control responsibilities of the department supervisor. Cost control is involved with seeing that output is produced at the least possible cost, consistent with quality standards. All dollar
amounts in the report deal with cost control and tell nothing about how well variable costs were controlled during the month. The budget costs are based on an
activity level of 3,000 units per month, whereas actual costs were incurred at an activity level of 3,185 units per month. A flexible budget should be used in the report because it can be tailored for any level of activity
within a relevant range. This would result in the meaningful comparison of the actual cost of producing 3,185 units with the budgeted cost of producing 3,185 units.
Many of the fixed manufacturing overhead items may not be controllable at the department level. The degree of controllability of these cost items is not stated in the question. If there is some degree of control at the department level, that should be included in the report. Furthermore, the inclusion of these costs communicates that these costs are a necessary part of the
b. Western Plains, Inc.
Machining Department Performance Report For the Month Ended October 31, 2003
Under/(Over) Budget
c. Review favorable unit and component variances to
determine if realistic budgets were set. Note that all of the controllable manufacturing cost variances were
54. a. Administration Costs ($750,000)
Accounting Costs ($495,000 + $25,685 = $520,685)
Base Allocation
Promotion Costs ($360,000 + $30,822 + $106,504 = $497,326) Residential: $518,836 + $214,487 + $325,834 = $1,059,157 P. Mgmt.: $66,781 + $51,773 + $17,149 = $135,703
55. a. Case 1 upper limit = $65
Case 1 lower limit = ($30 + 10 + 3 + ($6 - 1)) + (Lost CM of $26) = $74
Lost CM = $75 – ($30 + $10 + $3 + $6)
Case 2 upper limit = $52
Case 2 lower limit = ($20 + 8 + 2 + ($4 - 1)) + (Lost CM of $26) = $59
Lost CM = $60 – ($20 + $8 + $2 + $4)
Interpretation: When, as in both cases in this problem, the lower limit exceeds the upper limit, the intracompany transfers should not be made because the company will be worse off.
b. Selling price = Variable cost + $10
Case 1 selling price = ($30 + 10 + 3 + (6-1)) + $10 = $58 Case 2 selling price = ($20 + 8 + 2 + (4-1)) + $10 = $43
c. Dual transfer prices for Case 1:
Speaker’s selling price (from part (b)) = $58
Sound System’s purchase price = ($65 - 10) = $55
Speaker's Division manager should demonstrate that the whole company will be worse off if this is done based on the answer to part (a):
Contribution margin lost by Speaker Division $26 Savings to Sound System by "purchasing"
56. a. * Current external selling price, $2,616
Selling Division -fair value since most are produced and sold at this price externally.
Buying Division -price is higher than what could be purchased elsewhere so this would make its
performance report appear worse than by buying externally.
* Total variable production cost ($1,050)+ 20% = $1,260 Selling Division - contributes minimally to covering fixed costs and therefore no profit is shown from these "sales" as opposed to external sales. There is little incentive to sell internally if the selling division can sell all its output
externally.
Buying Division -less than external purchase price, therefore it is more beneficial to the bottom line of Construction Equipment Company.
* Total product ($1,500) cost + 20% = $1,800
Selling Division -covers some but not all costs for this division, therefore incentive to sell
internally isn't there if Engine Division can sell its output externally.
Buying Division -purchase price below external so better for margin in this division.
* Bid price from external supplier ($2,320)
Selling Division- allows for some profit which is an incentive to sell internally unless it can sell
all its output externally.
Buying Division -no incentive to buy internally
since it costs the same as to buy from an external supplier.
b. Upper limit = $2,320
Lower limit = costs of $1,200 + contribution margin of $1,416 = $2,616
b. Variable cost = $10 + $3 + $4 + $2 = $19; $19 58. a. To maximize short-run contribution margin, the Quayside Division should accept the contract from Saxon Company. This conclusion is supported by the following
calculations.
1. Quayside transfer to Ridgetop:
Transfer price (3,000 × $1,500) $4,500,000 Variable cost
Purch.from Park (3,000 × $600) $1,800,000
Proc by Quayside (3,000 × $500) 1,500,000 (3,300,000)
Contribution Margin $1,200,000
2. Quayside accepts Saxon contract:
Selling price (3,500 ×× $1,250) $4,375,000
b. Quayside's Division decision to accept the contract from Saxon Company is in the best interest of the company as the decision increases the overall contribution margin of the company. This conclusion is supported by the
following calculations.
Revenues and cost savings to Providence Products Inc:
Sales by Quayside to Saxon (3500 × $1,250) $4,375,000
Sales by Park to Essex (3000 × $400) 1,200,000
Cost savings (variable costs avoided by not accepting the Ridgetop order)
Park's savings (3,000 × $300) 900,000
Quayside’s savings (3,000 × $500) 1,500,000 $7,975,000
Expenditures incurred by Providence Products Variable costs incurred for Saxon order
Quayside (3,500 × $400) $1,400,000
Park (3,500 × $250) 875,000
Variable cost incurred for purchase
Ridgetop from Essex (3,000 × $1,500) 4,500,000
Transfer price revenue = 2,060 × $40 = $82,400
Actual Var. EDP Costs = $90,000 = $43.69 trans. price Total hours used 2,060
Therefore, $40 proved to be a less-than-adequate transfer price because it left the EDP Department with a loss (for internal evaluation purposes) of $7,600 ($90,000 - $82,400).
Cases
60. To achieve Fashion's goals, the manager of the department should purchase the materials needed at the lowest price
available to Fashion Division at the present time. The three possible prices are as follows:
Koenig’s price is $8.00
Deluxe Products LeatherWorks
Division's price is 9.00 Thompson Company's price is 7.00 Fashion Division should purchase from Thompson.
For the Fashion Division of Deluxe Products to achieve the overall company's goals, the following analysis is required to compare the costs of the three bidders:
Koenig's price is $8.00 LeatherWorks Division's price [intercompany
transfer price is computed as follows: Sales price - Profit margin
[$9.00 - (0.40 × $9.00)] = 5.40 Thompson Company's price is $7.00. However,
the profit margin of Ridley Chemical should
be deducted [$7.00 - (0.30 × $2.00)] 6.40
From the company's standpoint, the costs that should be
considered for the make-or-buy decision are the variable costs per square foot as long as there is available capacity and no additional fixed costs would be incurred. For any division to achieve the overall company goals to maximize profit, variable costs to the company must be minimized. The purchasing
division (Fashion in this case) must choose the best price available to it. LeatherWorks should consider lowering its price to meet the competition from Thompson.
(IMA adapted)
61. a. Regular selling price $6.50
Regular selling price less variable selling and
distribution expenses ($6.50 - $0.60) $5.90
Standard manufacturing cost plus 15%
[($3.20 + $1.20) × 1.15] $5.06
Standard variable manufacturing cost plus 20%
b. Andalusia Division management's attitude at the present time should be positive to each of these prices in
decreasing order because Andalusia apparently has unused capacity. Andalusia division management's performance is evaluated based on return on investment (ROI) and each of these prices exceeds variable costs that will increase Andalusia' ROI.
At the time when all existing capacity is being used, Andalusia Division management would want the
intercompany transfer price to generate the same amount of profit as outside business in order to maximize
division ROI.
c. Negotiation between the two divisions is the best method to settle on a transfer price. The company is organized on a highly decentralized basis and each of the four conditions necessary for negotiated transfer prices exist. These conditions are as follows:
* An outside market exists that provides both parties with an alternative.
* Both parties have access to market price information.
* Both parties are free to buy and sell outside the company.
* Top management supports the continuation of the decentralized management concept.
d. No, corporate management should not become involved in this controversy. The company is organized on a highly decentralized basis, which top management must believe will maximize long-term profits. Imposing corporate
restrictions will adversely affect the current management evaluation system because division management would no longer have complete control of its profits. Also, the addition of corporate restrictions could have a negative impact on division management who are accustomed to an autonomous working environment.
(CMA adapted)
(CMA adapted)
Reality Check
63. Variable production cost would be appropriate when the selling division has idle capacity and the buying division has
marginal opportunities to use such idle capacity. Thus, whenever it is important that the total variable cost of production be computed so that marginal cost can be compared to marginal benefit, a variable cost transfer price is most beneficial. Such marginal analysis is usually associated with short-run decision making.
Full absorption costing is a better cost base than
variable cost for long-run pricing. The full absorption cost makes the buying division aware of the total cost that must be covered in the long run to be profitable.
A cost-based transfer price is most appropriate when there is either no external supplier of the material or
component that is involved in the internal transfer, or there is no external market for such a component. When neither of these conditions is met, an external market price may be superior to cost-based transfers. The market-based transfer price provides incentive for both the buying and selling
divisions to be efficient, and it is determined outside of the firm and is therefore a less biased number than other price bases.
64. a. The main advantage that Precision Regulator might have is a cost advantage. It is likely, because the division sells mainly internally, that the division incurs lower marketing and promotion costs than other divisions. By selling mainly internally, the division has no
requirement to maintain the same marketing capability as other divisions that sell their products externally. In addition, the division may reap substantial savings on distribution costs because it does not have to ship most of its output to other customer locations.
b. Because the division sells mainly internally, it would be possible to make the Precision Regulator Division a cost center. Then, output of the division could be
transferred to other internal divisions at full or
65. The new Ireland division’s transfer pricing scheme must be developed in consideration of the following factors: • Ireland is considered a tax haven country. A transfer
pricing scheme should consider the benefits of using legal means to shift profit from higher tax jurisdictions to the Ireland operations.
• The transfer pricing mechanism must provide incentives to the management of the Ireland operation to make transfers that are consistent with the overall objectives and goals of the organization.
• Currency fluctuations can affect the profitability of
global operations. The transfer price must be set to help manage this risk.
• The transfer pricing scheme must provide the incentives to apportion the output appropriately between sales in the European Union and to internal divisions in the United States.
• Top management must establish appropriate performance
measures to encourage the management of the Irish division to maximize its profit contribution to the overall
corporation.
• Controllable factors must be distinguishable from
noncontrollable factors in performance measurement. In a global setting, more factors are noncontrollable, e.g., currency rate fluctuations, local inflation.
66. a. The ethical problems are created when short-run gains can be maximized by doing what is unethical rather than what is ethical. This situation is created by the company's incentive system. By narrowly focusing performance evaluation on profit-related measures, the firm is ignoring other important critical success factors. By measuring achievement across a broader set of critical success factors, the company could induce the managers to behave in a more ethically acceptable manner. The
managers are merely reacting, albeit in an ethically
questionable way, to the incentives that have been put in place by the company.
b. By refocusing the performance evaluation measures on a broader set of critical success factors, top managers can induce lower managers to behave more ethically. Top
managers need to develop performance measures that are more long term; focus on customer satisfaction, product quality, and social responsibility; and provide
