The questions will be focused like they were on the first exam, but the "solution" depends on your view of the problem.
Responsibility accounting becomes increasingly important as the firm becomes more and more decentralized.
└── Terri (Owner of Terri's Amazing Restaurant)
├── Jackson (Manages Location 1)
│ ├── Food
│ ├── Menu
│ └── Staff
└── Jason (Manages Location 2)
├── Food
├── Menu
└── Staff
└── Terri (Owner of Terri's Amazing Restaurant) <--- CENTRALIZED
├── Jackson (Manages Location 1)
│ ├── Food
│ ├── Menu
│ └── Staff
└── Jason (Manages Location 2)
├── Food
├── Menu
└── Staff
└── Terri (Owner of Terri's Amazing Restaurant)
├── Jackson (Manages Location 1) <--- DECENTRALIZED
│ ├── Food
│ ├── Menu
│ └── Staff
└── Jason (Manages Location 2) <--- DECENTRALIZED
├── Food
├── Menu
└── Staff
The performance of these responsibility centers is evaluated on the basis of various accounting numbers, such as:
Notice that each of these measures is incomplete w.r.t. to the effect of the center's impact on other parts of the firm.
In each case there is an incentive to shift costs to other departments.
One function of the management accounting system therefore is to attach a dollar figure to transactions between different responsibility centers.
The transfer price is the price that one division of a company charges another division of the same company for a product transferred between the two divisions.
Like an internal sale price.
There are two main reasons for instituting a transfer pricing scheme:
In both cases the price is communicating information, just as it does in competitive markets.
If intra-company transactions are accounted for at prices in excess of cost, appropriate elimination entries should be made for external reporting purposes. Examples of items to be eliminated for consolidated financial statements include:
When the outside market for the good is well-defined, competitive, and stable, firms often use the market price as an upper bound for the transfer price.
Market-Based Transfer Pricing Terms:
Market-Based Transfer Pricing Terms:
External prices may not have the information we need.
Here, the firm does not specify rules for the determination of transfer prices.
In the absence of an established market price many companies base the transfer price on the production cost of the supplying division.
The most common methods are:
Each of these methods is outlined below.
The transfer price is equal to the full cost of producing the good or service by the supplying department.
Transfer Price = (Full Cost)x
Transfer Price = VC + X
In order to motivate the buying division to make appropriate purchasing decisions, the transfer price could be set equal to (standard) variable cost plus a lump-sum periodical charge covering the supplying division's related fixed costs.
Why this is important will be a topic of a whole lecture later in the semester.
Also know as the Minimum Transfer Price:
Minimum Transfer Price = Incremental Cost + Opportunity Cost.
Requires the consuming department to be at least as productive as the supplier's outside option.
For internal decision making purposes, a transfer price should be at least as large as the sum of:
Sub-optimal decisions can result from the natural inclination of the manager of an autonomous buying division to view a mix of variable and fixed costs of a selling division plus, possibly, a mark-up as variable costs of his buying division.
In this case costs that are not avoidable for the firm, appear avoidable to the manager.
Dual transfer pricing can address this problem, although it introduces the complexity of using different prices for different managers.
To avoid some of the problems associated with the above schemes, some companies adopt a dual transfer pricing system. For example: