22 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Management Control Systems,Transfer Pricing, and
Multinational Considerations
Chapter 22
22 - 2©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 1
Describe a managementcontrol system and itsthree key properties.
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Management Control Systems
A management control system is a meansof gathering and using information.
It guides the behavior of managers and employees.
22 - 4©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Management Control Systems
Financial data
Formal control system
Nonfinancial data
Informal control system
22 - 5©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Evaluating ManagementControl Systems
Motivation Goal congruence Effort
Lead to rewards
Monetary Nonmonetary
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Learning Objective 2
Describe the benefits andcosts of decentralization.
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Organization Structure
Total decentralization
Total centralization
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Benefits of Decentralization
Creates greater responsiveness to local needsLeads to gains from quicker decision making
Increases motivation of subunit managersAssists management development and learning
Sharpens the focus of subunit managers
22 - 9©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Costs of Decentralization
Suboptimal decision making may occurFocuses the manager’s attention on the subunit
rather than the organization as a wholeIncreases the costs of gathering information
Results in duplication of activities
22 - 10©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Decentralization inMultinational Companies
Decentralization enables country managers tomake decisions that exploit their knowledge
of local business and political conditions.Multinational corporations often rotate
managers between foreign locationsand corporate headquarters.
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Responsibility Centers
Costcenter
Revenuecenter
Investmentcenter
Profitcenter
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Learning Objective 3
Explain transfer prices and fourcriteria used to evaluate them.
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Transfer Pricing
A transfer price is the price one subunit chargesfor a product or service supplied to another
subunit of the same organization.Intermediate products are the products
transferred between subunits of an organization.
22 - 14©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer Pricing
Transfer pricing should help achievea company’s strategies and goals.– fit the organization’s structure
– promote goal congruence– promote a sustained high level
of management effort
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Learning Objective 4
Calculate transfer prices usingthree different methods.
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Transfer-Pricing Methods
Market-based transfer prices
Cost-based transfer prices
Negotiated transfer prices
22 - 17©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
Lomas & Co. has two divisions:Transportation and Refining.
Transportation purchasescrude oil in Alaska and
sends it to Seattle.
Refining processescrude oil
into gasoline.
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Transfer-PricingMethods Example
External market price for supplyingcrude oil per barrel: $13 Transportation Division:Variable cost per barrel of crude oil $ 2Fixed cost per barrel of crude oil 3Total $ 5The pipeline can carry 35,000 barrels per day.
22 - 19©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
External purchase price forcrude oil per barrel: $23 Refining Division:Variable cost per barrel of gasoline $ 8Fixed cost per barrel of gasoline 4Total $12The division is buying 20,000 barrels per day.
22 - 20©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
The external market price to outsideparties is $60 per barrel.
The Refining Division is operatingat 30,000 barrels capacity per day.
22 - 21©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
What is the market-based transfer pricefrom Transportation to Refining?
$23 per barrel
What is the cost-based transfer priceat 112% of full costs?
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Transfer-PricingMethods Example
Purchase price of crude oil $13Variable costs per barrel of crude oil 2Fixed costs per barrel of crude oil 3Total $18
1.12 × $18 = $20.16 What is the negotiated price?
Between $20.16 and $23.00 per barrel.
22 - 23©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
Assume that the Refining Division buys1,000 barrels of crude oil from the
Transportation Division.The Refining Division converts these 1,000
barrels of crude oil into 500 gallons ofgasoline and sells them.
What is the Transportation Division operatingincome using the market-based price?
22 - 24©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
Transportation Division:Revenues: ($23 × 1,000) $23,000Deduct costs: ($18 × 1,000) 18,000Operating income $ 5,000What is the Refining Division’s operating
income using the market-based price?
22 - 25©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
Refining Division:Revenues: ($60 × 500) $30,000Deduct costs:
Transferred-in ($23 × 1,000) 23,000Division variable ($8 × 500) 4,000Division fixed ($4 × 500) 2,000
Operating income $ 1,000
22 - 26©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
What is the operating income of bothdivisions together?
Transportation Division $5,000Refining Division 1,000Total $6,000
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Transfer-PricingMethods Example
What is the Transportation Division’s operatingincome using the 112% of full cost price?
Transportation Division:Revenues: ($20.16 × 1,000) $20,160Deduct costs: ($18.00 × 1,000) 18,000Operating income $ 2,160
What is the Refining Division operatingincome using the full cost price?
22 - 28©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
Refining Division:Revenues ($60 × 500) $30,000Deduct costs:
Transferred-in ($20.16 × 1,000) 20,160Division variable ($8.00 × 500) 4,000Division fixed ($4.00 × 500) 2,000
Operating income $ 3,840
22 - 29©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Transfer-PricingMethods Example
What is the operating income of bothdivisions together?
Transportation Division $2,160Refining Division 3,840Total $6,000
22 - 30©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 5
Illustrate how market-basedtransfer prices promote goal
congruence in perfectlycompetitive markets.
22 - 31©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Market-Based Transfer Prices
By using market-based transfer pricesin a perfectly competitive market, acompany can achieve the following:
Goal congruenceManagement effort
Subunit performance evaluationSubunit autonomy
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Market-Based Transfer Prices
Market prices also serve to evaluate theeconomic viability and profitability
of divisions individually.
22 - 33©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Market-Based Transfer Prices
When supply outstrips demand, market pricesmay drop well below their historical average.
Distress prices are the drop in pricesexpected to be temporary.
22 - 34©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 6
Avoid making suboptimaldecisions when transferprices are based on full
cost plus a markup.
22 - 35©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost-Based TransferPrices Example
The Refining Division of Lomas & Co. ispurchasing crude oil locally for $23 a barrel.
The Refining Division located an independentproducer in Alaska that is willing to sell 20,000
barrels of crude oil per day at $17 per barreldelivered to the pipeline (Transportation Division).
22 - 36©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost-Based TransferPrices Example
The Transportation Division has excesscapacity and can transport the crude oil
at its variable costs of $2 per barrel.Should Lomas purchase from the
independent supplier?Yes.
There is a reduction in total costs of $80,000.
22 - 37©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost-Based TransferPrices Example
Alternative 1:Buy 20,000 barrels from the
local supplier at $23 per barrel.The total cost to Lomas is:20,000 × $23 = $460,000
22 - 38©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost-Based TransferPrices Example
Alternative 2:Buy 20,000 barrels from the independentsupplier in Alaska at $17 per barrel andtransport it to Seattle at $2 per barrel.
The total cost to Lomas is:20,000 × $19 = $380,000
22 - 39©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost-Based TransferPrices Example
Suppose the Transportation Division’stransfer price to the Refining Division
is 112% of full cost.What is the cost to the Refining Division?
22 - 40©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost-Based TransferPrices Example
Purchase price of crude oil $17Variable costs per barrel of crude oil 2Fixed costs per barrel of crude oil 3Total $22
1.12 × $22 = $24.64$24.64 × 20,000 = $492,800
22 - 41©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost-Based TransferPrices Example
What is the maximum transfer price?It is the price that the Refining Division can
pay in the local external market ($23).What is the minimum transfer price?
The minimum transfer price is $19 per barrel.
22 - 42©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 7
Understand the range overwhich two divisions negotiate
the transfer price whenthere is unused capacity.
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Prorating
Lomas & Co. may choose a transfer pricethat splits on some equitable basis the
difference between the maximum transferprice and the minimum transfer price.
$23 – $19 = $4Suppose that variable costs are chosen as
the basis to allocate this $4 difference.
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Prorating
The Transportation Division’s variablecosts are $2 × 1,000 = $2,000.
The Refining Division’s variable costs torefine 1,000 of crude oil into 500 barrels
of gasoline are $8 × 500 = $4,000.
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Prorating
The Transportation Division gets to keep$2,000 ÷ $6,000 × $4 = $1.33.
The Refining Division gets to keep$4,000 ÷ $6,000 × $4 = $2.67.
What is the transfer price from theTransportation Division?
$17.00 + $2.00 + $1.33 = $20.33
22 - 46©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Dual Pricing
An example of dual pricing is for Lomas & Co.to credit the Transportation Division with
112% of the full cost transfer price of $24.64per barrel of crude oil.
Debit the Refining Division with the market-basedtransfer price of $23 per barrel of crude oil.
22 - 47©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Negotiated Transfer Prices
Negotiated transfer prices arise from theoutcome of a bargaining process between
selling and buying divisions.
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Learning Objective 8
Construct a general guidelinefor determining a minimum
transfer price.
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Comparison of Methods
Achieves Goal Congruence
Market Price: Yes, if markets competitiveCost-Based: Often, but not alwaysNegotiated: Yes
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Comparison of Methods
Useful for Evaluating Subunit Performance
Market Price: Yes, if markets competitive
Cost-Based: Difficult, unless transferprice exceeds full cost
Negotiated: Yes
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Comparison of Methods
Motivates Management Effort
Market Price: Yes
Cost-Based:Yes, if based on budgetedcosts; less incentive ifbased on actual cost
Negotiated: Yes
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Comparison of Methods
Preserves Subunit Autonomy
Market Price: Yes, if markets competitiveCost-Based: No, it is rule basedNegotiated: Yes
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Comparison of Methods
Other Factors
Market Price: No market may exist
Cost-Based: Useful for determiningfull-cost; easy to implement
Negotiated: Bargaining takes time andmay need to be reviewed
22 - 54©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
General Guideline
Minimum transfer price= Incremental costs per unit incurred
up to the point of transfer+ Opportunity costs per unit to the selling division
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General Guideline
Assume a perfectly competitive market,with no idle capacity.
Transportation Division can sell all the crude oilit transports to the external market in Seattle
for $23 per barrel.What is the minimum transfer price?
($19 + $4) or ($13 + $2 + $8) = $23 = Market price
22 - 56©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
General Guideline
Assume that an intermediate market existsthat is not perfectly competitive, and the
selling division has idle capacity.If the Transportation Division has idle
capacity, its opportunity cost of transferringthe oil internally is zero.
What is the minimum transfer price?
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General Guideline
It would be $15 per barrel for oil purchasedunder the long-term contract, or...
$19 per barrel for oil purchased andtransported from the independent
supplier in Alaska.
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Learning Objective 9
Incorporate income taxconsiderations in
multinationaltransfer pricing.
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Multinational Transfer Pricing
IRC Section 482 requires that transfer prices forboth tangible and intangible property between acompany and its foreign division be set to equalthe price that would be charged by an unrelated
third party in a comparable transaction.
22 - 60©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
End of Chapter 22