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CHAPTER 22MANAGEMENT CONTROL SYSTEMS, TRANSFER PRICING,

AND MULTINATIONAL CONSIDERATIONS

22-4 The chapter cites five benefits of decentralization:

1. Creates greater responsiveness to local needs2. Leads to gains from faster decision making3. Increases motivation of subunit managers

. !ids management development and learning". #harpens the focus of subunit managers

The chapter cites four costs of decentralization:1. Leads to suboptimal decision making2. $esults in duplication of activities3. %ocuses managers& attention on the subunit rather than the compan' as a (hole

. Increases costs of gathering information

22-7 The three general methods for determining transfer prices are:1. )arket*based transfer prices2. Cost*based transfer prices3. +egotiated transfer prices

22-11 ,ne potential limitation of full*cost*based transfer prices is that the' can lead tosuboptimal decisions for the compan' as a (hole. !n e-ample of a conflict bet(een divisionalaction and overall compan' profitabilit' resulting from an inappropriate transfer*pricing polic' is

bu'ing products or services outside the compan' (hen it is beneficial to overall compan' profitabilit' to source them internall'. This situation often arises (here full*cost*based transfer prices are used. This situation can make the fi-ed costs of the suppl'ing division appear to bevariable costs of the purchasing division. !nother limitation is that the suppl'ing division ma'not have sufficient incentives to control costs if the full*cost*based transfer price uses actualcosts rather than standard costs.

The purchasing division sources e-ternall' if market prices are lo(er than full costs.%rom the vie(point of the compan' as a (hole the purchasing division should source fromoutside onl' if market prices are less than variable costs of production not full costs of

production.

22-16 /2" min.0 Decentr !"# t"$n, re%&$n%"'"!"t( center% .

1. The manufacturing plants in the )anufacturing ivision are cost centers. #enior management determines the manufacturing schedule based on the uantit' of each t'pe of lighting product specified b' the sales and marketing division and detailed studies of the timeand cost to manufacture each t'pe of product. )anufacturing managers are accountable onl' for costs. The' are evaluated based on achieving target output (ithin budgeted costs.

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2a. If manufacturing and marketing managers (ere to directl' negotiate the prices for manufacturing various products uinn should evaluate manufacturing plant managers as profitcenters4revenues received from marketing minus the costs incurred to produce and sell output.

2b. uinn Corporation (ould be better off decentralizing its marketing and manufacturingdecisions and evaluating each division as a profit center. ecentralization (ould encourage plant

managers to increase total output to achieve the greatest profitabilit' and motivate plantmanagers to cut their costs to increase margins. )anufacturing managers (ould be motivated todesign their operations according to the criteria that meet the marketing managers& approvalthereb' improving cooperation bet(een manufacturing and marketing.

5nder uinn6s e-isting s'stem manufacturing managers had ever' incentive not toimprove. )anufacturing managers6 incentives (ere to get as high a cost target as possible so thatthe' could produce output (ithin budgeted costs. !n' significant improvements could result inthe target costs being lo(ered for the ne-t 'ear increasing the possibilit' of not achieving

budgeted costs. 7' the same line of reasoning manufacturing managers (ould also tr' to limittheir production so that production uotas (ould not be increased in the future. ecentralizingmanufacturing and marketing decisions overcomes these problems.

22-1) /3" min.0 M*!t"n t"$n ! tr n%+er &r"c"n , e++ect $+ !tern t" e tr n%+er-&r"c"n .et/$0%, !$' ! "nc$.e t ."n"."# t"$n

1. This is a three*countr' three*division transfer*pricing problem (ith three alternativetransfer*pricing methods. #ummar' data in 5.#. dollars are:

China Plant

8ariable costs: 1 999 uan ; < uan per = > =12" per subunit%i-ed costs: 1 =22" per subunit

South Korea Plant

8ariable costs: 3?9 999 @on ; 1 299 @on per = > =399 per unit%i-ed costs: = 99 per unit

U.S. Plant

8ariable costs: > =199 per unit%i-ed costs: > =299 per unit

)arket prices for private*label sale alternatives:China Alant: 3 ?99 uan ; < uan per = > = "9 per subunit#outh Borea Alant: 1 "?9 999 @on ; 1 299 @on per = > =1 399 per unit

The transfer prices under each method are:a. )arket price

China to #outh Borea > = "9 per subunit#outh Borea to 5.#. Alant > =1 399 per unit

b. 299D of full costsChina to #outh Borea

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2.9 /=12" E =22"0 > =F99 per subunit#outh Borea to 5.#. Alant 2.9 /=F99 E =399 E = 990 > =2

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2. ivision net income:M r et

Pr"ce255 $+

F*!! C$%t%55 $+

8 r" '!e C$%t

China ivision#outh Borea ivision

5.#. ivision5ser %riendl' Computer Inc.

= ?9129

1 129=1 399

= 2191 129

F9=1 99

= 1".99F?9.99

?12 ."9=1 3

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Se!! % R : L*.'er Se!! % F"n"%/e0 L*.'er$a( Lumber ivision

ivision revenuesivision variable costsivision operating income

%inished Lumber ivisionivision revenuesTransferred*in costs

ivision variable costsivision operating income

=299 199=199

= 9 4

= 9

=119199

= 19

=2F"119

12"= 9

The $a( Lumber ivision (ill ma-imize reported division operating income b' selling ra(lumber (hich is the action preferred b' the compan' as a (hole. The %inished Lumber ivision(ill ma-imize division operating income b' selling finished lumber (hich is contrar' to theaction preferred b' the compan' as a (hole.

3. Transfer price at market price > =299 per 199 board feet.

Se!! % R : L*.'er Se!! % F"n"%/e0 L*.'er$a( Lumber ivision

ivision revenuesivision variable costsivision operating income

%inished Lumber ivisionivision revenues

Transferred*in costsivision variable costsivision operating income

=299 199=199

= 9

4 4= 9

=299 199=199

=2F"

299 12"= /"9 0

The $a( Lumber ivision (ill ma-imize division operating income b' selling ra( lumber(hich is the action preferred b' the compan' as a (hole. %inished Lumber ivision (illma-imize division operating income b' not further processing ra( lumber not further

processing is preferred b' the compan' as a (hole.

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22-27 /29H39 min.0 Pert"nent tr n%+er &r"ce

This problem e-plores the Jgeneral transfer*pricing guidelineJ discussed in the chapter.

1. +o transfers should not be made to ivision 7 if there is no e-cess capacit' in ivision !.

!n incremental /outla'0 cost approach sho(s a positive contribution for the compan' as a(hole.#elling price of final product =399Incremental costs in ivision ! =129Incremental costs in ivision 7 1"9 2F9Contribution = 39

Ko(ever if there is no e-cess capacit' in ivision ! an' transfer (ill result in diverting products from the market for the intermediate product. #ales in this market result in a greater contribution for the compan' as a (hole. ivision 7 should not assemble the bic'cle since theincremental revenue uropa can earn =199 per unit /=399 from selling the final product H =299from selling the intermediate product0 is less than the incremental costs of =1"9 to assemble the

bic'cle in ivision 7. !lternativel' put uropa&s contribution margin from selling theintermediate product e-ceeds uropa&s contribution margin from selling the final product.

#elling price of intermediate product =299Incrementral /outla'0 costs in ivision ! 129Contribution = E

> =129 E /=299 H =1290> =299 (hich is the market price

The market price is the transfer price that leads to the correct decision that is do not transfer toivision 7 unless there are e-tenuating circumstances for continuing to market the final product.

Therefore 7 must either drop the product or reduce the incremental costs of assembl' from =1"9 per bic'cle to less than =199.

2. If /a0 ! has e-cess capacit' /b0 there is intermediate e-ternal demand for onl' =129 (hich is the incremental or outla' costs for the first 299 units. 7 (ould bu' 299

units from ! at a transfer price of =129 because 7 can earn a contribution of =39 per unit M=399 H /=129 E =1"90N. In fact 7 (ould be (illing to bu' units from ! at an' price up to =1"9 per unit because an' transfers at a price of up to =1"9 (ill still 'ield 7 a positive contributionmargin.

+ote ho(ever that if 7 (ants more than 299 units the minimum transfer price (ill be=299 as computed in re uirement 1 because ! (ill incur an opportunit' cost in the form of lost

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contribution of =

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%i-ed costs:Karvesting 1 999 P =9. 9 = 99Arocessing "99 P =9.?9 399

Total fi-ed costs F99,perating income =1 299

2 150% of Full Cost Karvesting ivision to Arocessing ivision> 1." /=9.29 E =9. 90 > =9.G9 per pound of ra( tuna

' ar!et Pri"eKarvesting ivision to Arocessing ivision> =1.99 per pound of ra( tuna

Met/$0 A Met/$0 3 Intern ! Intern !

Tr n%+er% Tr n%+er% t 1;5 $+ t M r et

F*!! C$%t% Pr"ce1. #una $arvestin Division

ivision revenues =9.G9 =1 P 1 999 pounds of ra( tuna = G99 =1 999

educt:ivision variable costs =9.29 P 1 999

pounds of ra( tuna 299 299ivision fi-ed costs =9. 9 P 1 999

pounds of ra( tuna 99 99

ivision operating income = 399 = 99

2. #una Pro"essin Divisionivision revenues =" P "99 pounds of processed tuna =2 "99 =2 "99

educt:Transferred*in costs =9.G9 =1 P 1 999

pounds of processed tuna G99 1 999ivision variable costs =9.

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Met/$0 AIntern ! Tr n%+er%t 1;5 $+ F*!! C$%t%

Met/$0 3Intern ! Tr n%+er%

t M r et Pr"ce%Karvesting ivision manager&s bonus/19D P =399 19D P = 990 =39 = 9

Arocessing ivision manager&s bonus/19D P =G99 19D P =

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+et costs =/239 999 0 =/1G9 9990 =/2"9 999022- /Cont&d.0

!t a price of =3F per cassette deck the net cost of =1G9 999 is less than the net cost of =239 999 if #ather Corporation made the cassette decks inhouse. Kence #ather Corporationshould outsource to Rohnson.

!t a price of = 3 per cassette deck the net cost of =2"9 999 is greater than the net cost of =239 999 if #ather Corporation made the cassette decks inhouse. Kence #ather Corporationshould reSect Rohnson&s offer.

2. %or the Cassette eck ivision and the !ssembl' ivision to take actions that are optimalfor #ather Corporation as a (hole the transfer price should be set at = 1 calculated as follo(s:

The Cassette eck ivision can manufacture at most 12 999 cassette decks and is currentl'operating at capacit'. The incremental costs of manufacturing a cassette deck are =2" per deck.The opportunit' cost of manufacturing cassette decks for the !ssembl' ivision is /10 the

contribution margin of =19 /selling price =3" minus incremental costs =2"0 that the Cassetteeck ivision (ould forgo b' not selling cassette decks in the outside market and /20 thecontribution margin of =? /selling price =1< minus incremental costs =120 that the Cassette

eck ivision (ould forgo b' not being able to sell the cassette*head mechanism to outsidesuppliers of cassette decks /such as Rohnson0. Thus the total opportunit' cost of the Cassette

eck ivision of suppl'ing cassette decks to !ssembl' is =19 E =? > =1? per unit.

5sing the general guideline

)inimum transfer price per cassette deck > divisionselling

thedeck tocassette per costs',pportunit

transfer of point

thetoupdeckcassette per costlIncrementa

+

> =2" E =1? > = 1

+ote that at a price of = 1 #ather is indifferent bet(een manufacturing cassette decksinhouse or purchasing them from an outside supplier. ach results in a net cost of =239 999. %or an outside price per cassette deck belo( = 1 the !ssembl' ivision (ould prefer to purchasefrom outside above it the !ssembl' ivision (ould prefer to purchase from the Cassette eck

ivision.

@hen selling prices are uncertain the transfer price should be set at the minimum

acceptable transfer price. %or e-ample if the transfer price (ere set above the minimum transfer price at = 2 per cassette deck sa' and an outside supplier offered to suppl' the cassette decks at= 1."9 per unit the !ssembl' ivision (ould purchase the cassette deck from the outsidesupplier. In fact as the follo(ing calculations sho( #ather Corporation as a (hole (ould be

better off had the !ssembl' ivision purchased the cassette decks from the Cassette eck ivision. The net cost to #ather Corporation if the Cassette eck ivision transfers 19 999

cassette decks to the !ssembl' ivision is =239 999 as calculated in Column 1 of the table

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presented in re uirement 1. If an outside supplier supplies cassette decks at = 1."9 each (esimpl' substitute = 1."9 19 999 > = 1" 999 for the incremental costs of bu'ing 19 999 cassette

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22- /Cont&d.0

decks in column 2 or 3 and leave ever'thing else unchanged. This gives a higher net cost of =23" 999 to #ather Corporation as a (hole.

It is onl' if the price charged b' the outside supplier falls belo( = 1 that #ather Corporation as a (hole is better off purchasing from the outside market. #etting the transfer

price at = 1 per unit achieves goal congruence.

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