2. Learning Objectives (1 of 2)
• Explain why decentralization is appropriate
for some companies but not for others
• Clarify the relationship between responsibility
accounting and decentralization
• List and describe the four types of
responsibility centers
3. Learning Objectives (2 of 2)
• Explain why and how service department
costs are allocated to producing departments
• Explain why transfer prices are used
• List the advantages and disadvantages of
each type of transfer price
• Describe how multinational companies use
transfer prices
5. 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
6. Advantages of Decentralization
• Personnel
– train and screen aspiring managers
– develop leadership qualities, problem-solving
abilities, and decision-making skills
– compare managers’ results
– job satisfaction
• Effective means of achieving organizational
goals
• Allows management by exception
7. Disadvantages of Decentralization
• Lack of goal congruence
• Suboptimization
• 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
9. Responsibility Accounting
• Reporting system
– provides information about subunits
– allows management to measure subunit
performance
• Consistent with
– Standard costing (variances)
– Activity-based costing (reduced allocations)
10. 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
15. 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
16. Responsibility Reporting System
Dept R Costs
Itemized
Total for Dept
Dept Q Costs
Itemized
Total for Dept
Division A
Dept Q Totals
Dept R Totals
Total for Division
17. Responsibility Reporting System
Division B
Dept X Totals
Dept Y Totals
Total for Division
Division A
Dept Q Totals
Dept R Totals
Total for Division
To President
Division A Total
Division B Total
Total for Company
19. Cost Centers
• Authority to incur costs
• Evaluated on how well costs are controlled
• Revenues
– do not exist - university placement center
– exist but cannot be measured - R&D center
– exist but are not under manager’s control - public
libraries
• Focus on variances outside acceptable range
20. Revenue Centers
• Responsible for generating revenue
• No control of selling price or costs
• Individual sales departments in retail stores
• Revenue and Limited Cost Center
– some involvement in planning and controlling
costs
• Evaluate on sales mix and volume variance
21. Profit Centers
• Responsible for generating revenues - set
selling prices
• Responsible for controlling expenses -
allowed to purchase at most economical price
• Goal is to maximize profit
• Independent units - bank branches, 18-
wheelers, educational divisions
• Evaluate on profit variance
22. Investment Centers
• Responsible for generating revenues and
planning and controlling expenses
• Responsible for plant assets
• Goal is maximize rate of return on assets
• Divisions or subsidiaries
• Evaluate on rate of return on assets and
other performance measures
23. Microprofit Centers
• Convert cost or revenue center to microprofit
center
• Responsible for revenue and costs
• Affects behavior - sense of ownership,
improved managerial skills, continuous
improvement
• Microprofit Center - output has market value
• Pseudo Microprofit Center - output measured
using surrogate market value
25. Service Department Cost Allocation
• Service departments
provide functional
tasks for other internal
units
– Purchasing
– Maintenance
– Engineering
– Security
– Warehousing
• Administrative
departments provide
management activities
for the organization
– Personnel
– Legal
– Payroll
– Insurance
26. Allocating Service Costs
Full Cost Objective
• Full Cost
– Traceable material
– Traceable labor
– Traceable manufacturing overhead
– Allocated service costs
27. Allocating Service Costs
Full Cost Objective
Reasons for
• Cost recovery
• Awareness of support
costs
• “Fair share” of costs
• Regulations in some
pricing instances
Reasons against
• Managers cannot
control costs
• Arbitrary costs not
useful in decision
making
• Confuses costing and
pricing issues
28. Allocating Service Costs
Motivate Managers Objective
Reasons for
• Awareness of support
costs in production
managers
• Relates unit’s profit to
total company profits
• Reflects usage of
services
• Encourages cost control
• Encourages usage of
certain services
Reasons against
• Distorts profits with
subjective allocations
• Managers cannot
control costs
• Not material to profits
• Creates ill will
• Not cost beneficial
29. Allocating Service Costs
Compare Alternatives Objective
Reasons for
• Relevant information
helps compare
alternatives
• Provides best cost
estimates when
comparing alternatives
Reasons against
• Unnecessary if costs
do not change among
alternatives
• Arbitrary allocations
distort cash flow and
profits for alternatives
Future differential costs important when
making decisions about capacity utilization
30. Allocation Bases for
Service Department Costs
• Rational and systematic base
– Benefit received by revenue-producing
department
– Causal relationship
– Fairness or equity of the allocations
– Ability of revenue-producing department to
bear the allocated cost
35. Service Cost Allocations
Step
• Partially recognizes
relationships among
service departments
• Does not recognize the
two-way exchange of
services between
service departments
Algebraic
• Recognizes all
interrelationships
among departments
36. 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 profit center
• For internal use only
37. Setting the Transfer Price
• Maximum - no greater than the lowest market
price
• Minimum - no less than the sum of
– selling segment’s incremental costs
– the opportunity cost of the facilities used
• Ease of determining the transfer price
• Managers should understand how to
compute and evaluate the transfer price
39. Cost-Based Transfer Prices
• Definition of cost
– variable cost vs. absorption cost
– actual vs. standard
• Standard cost is superior to actual cost
– actual costs vary according to season
– actual costs vary according to production
volume
– variances are attributed to selling division
– standard costs are stable measures of
production costs
40. Market-Based Transfer Prices
• Potential problems when the market
determines transfer price
– No exact counterpart in the external market
– Ignores internal cost savings
– Market price varies
• current depressed price v.s. long-run market price
– Different prices, discounts, and credit terms for
different buyers
41. Negotiated Transfer Prices
• Below market purchase price
• Above the incremental and opportunity
costs of the selling unit
• If negotiation fails
– managers can purchase on the market
– arbitration by top management
42. Dual Pricing
• Seller transfers at market or negotiated price
• Buyer records transfer at cost-based amount
• Eliminates need to artificially divide profits
• Provides relevant information for decision
making and performance evaluation
• Promotes goal congruency
• Eases tension between segments
43. Transfer Pricing System
• Permits evaluation of segment performance
• Allows for rational acquisition of goods and
services between corporate divisions
• Is flexible to respond to changes
• Encourages and rewards goal congruence
44. Service Transfer Prices
• Allocate service costs using direct, step, or
algebraic method, or
• Sell service costs using transfer price
• Transfer price useful when distinct, measurable
benefits provided
• Transfer price useful when services provided
have a specific cause-and-effect relationship
• Transfer price depends on
– cost and volume of service
– comparable substitutes
45. Service Transfer Prices
• Market-based - common, standardized
services that are high-cost, high volume
• Negotiated transfer price - customized
services that are high-cost, high volume
• Cost-based or dual - low-cost, low volume
46. Service Transfer Prices
Advantages
• Encourage involvement between service
departments and their users
• Promote cost consciousness and elimination
of waste
• Provide information for performance
evaluations - controllable service
department cost
47. Service Transfer Prices
Disadvantages
• Disagreement among unit managers about
transfer price
• Implementation requires additional costs
and employee time
• Does not work equally well for all segments
• May cause dysfunctional behavior or cause
some services to be under- or overutilized
• Complex tax regulations
48. Transfer Pricing in Multinational
Settings
Differences in
• Tax systems
• Customs duties
• Freight and insurance costs
• Import/export regulations
• Foreign-exchange controls
49. Multinational Transfer Pricing
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
50. Multinational Transfer Pricing
Do transfer prices positively
affect the performance of
multinational enterprises?
Do managers feel they
are being fairly
evaluated and rewarded?
IRS
Advance
Pricing
Agreements
51. Questions
• What are the four types of responsibility
centers?
• Why and how are service department costs
allocated to producing departments?
• Why are transfer prices used?