profit centres and transfer price

1. PRESENTED BY:
NEETU.P.S
2K13068

2.  Profit centre is a segment of an organization
in which financial performance is measured
on the basis of profit.
 It is a responsibility centre in which inputs
are measured in terms of expenses and
outputs are measured in terms of revenues.
 In simple words, Profit centre is a division or
sub unit of an organization in which financial
performance is measured on the basis of
profit, that is, revenues less costs.

3.  For purposes of profit centre performance,
revenue represents a monetary measure of
the output of a profit centre in a given
accounting period whether or not the firm
actually realizes the revenue in that period.
 The test is that a department has output
(goods & services) which are amenable to
monetary measurement.
 It is possible to measure the effectiveness
and efficiency of performance in financial
terms.

4.  It provides a powerful tool for measuring
how well the profit centre or manager of the
profit centre has performed.
 It resembles a business in miniature.
 It makes decentralized organization possible
 Provides a broader & more inclusive
measurement of performance than the
expense centres.

5.  Criterion for profit centres
 Measurement of expenses
 Transfer prices

6.  It is a monetary amount of interdivisional
exchanges/transfer of goods and services.
 It is a price used to measure the value of
goods and services furnished by a profit
centre to other responsibility centres within a
company.
 It should be objectively determinable & equal
to the value of the intermediate products
being transferred & compactible with the
policy that maximizes attainment of company
goals.

7. Two general approaches to the determination:
 Cost-based
 Market-based
Based on these, there are six types:
 Cost
 Cost plus a normal mark-up
 Incremental cost
 Market price
 Negotiated price
 Dual[Two-way] prices

8.  Companies using the transfer-at-cost approach
recognize that sales by international affiliates
contribute to corporate profitability by
generating scale economies in domestic
manufacturing operations. This approach
assumes lower costs lead to better affiliate
performance, which ultimately benefits the entire
organization.
 The transfer-at-cost method helps keep duties at
a minimum. Companies using this approach have
no profit expectation on transfer sales; rather,
the expectation is that the affiliate will generate
the profit by subsequent resale.

9.  Companies that follow the cost-plus pricing
method are taking the position that profit
must be shown for any product or service at
every stage of movement through the
corporate system. While cost-plus pricing
may result in a price that is completely
unrelated to competitive or demand
conditions in international markets, many
exporters use this approach successfully.

10.  The entire production of the selling division
is transferred & there are no independent
outside customers.
 In this case, it includes all variable cost plus
any fixed costs directly
 When there are outside customers for the
goods & the division is unable to produce the
full demand , it would be revenue lost on
sales to such customers & it will be equal to
market price.

11.  A market-based transfer price is derived from
the price required to be competitive in the
international market. The constraint on this price
is cost. However, there is a considerable degree
of variation in how costs are defined. Since costs
generally decline with volume, a decision must be
made regarding whether to price on the basis of
current or planned volume levels. To use market-based
transfer prices to enter a new market that
is too small to support local manufacturing,
third-country sourcing may be required. This
enables a company to establish its name or
franchise in the market without investing in
bricks and mortar.

12.  The interdivisional exchange pricing can also
be based on a price mutually agreed upon by
the buying as well as the selling departments,
through negotiation.
 Advantageous to both the divisions as well
as the entire organization
 Limitation is that, that it can be applied only
when a selling division has a choice of
customers & purchasing division has a
choice of suppliers

13.  According to this method of pricing for
segment performance evaluation, the
transferring division is credited with one price
but acquiring division is charged at different
price.
 This method eliminates the possibility of
conflict caused by a single transfer price, in
which case one segment receives relatively
less contribution of profit because the price
setting process entitles the segment to
receive relatively more.

14.  Sales & other major revenues
 Controllable variable cost
 controllable contribution margin
 Controllable fixed costs
 Controllable segment margin
 Attributable segment costs
 Segment profit contribution
 Common firm-wide cost
 Segment net income