Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for...

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith

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Chapter 12

Financial performance reports and transfer pricing


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Decentralisation and responsibility accounting• Decentralisation

– The restructuring of the organisation into smaller sub-units, such as divisions and departments, each with specific operations and decision-making responsibilities

• Responsibility accounting– Assign responsibility to managers to run particular sub-

units of the organisation– Helps to reinforce the advantages of decentralisation

• Goal congruence helps ensure that decentralised organisations are effective

– Consistency between managers’ personal goals and the goals of the organisation


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Decentralisation

• Benefits– Managers of sub-units have better local information

about markets and operations to enable them to manage their areas more effectively

– Provides managerial training for future higher-level managers

– May lead to greater motivation and job satisfaction for sub-unit managers

– Allows corporate managers more time for strategic issues– Allows the organisation to react more quickly to

opportunities and problems as they arise

continued


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Decentralisation

• Negative consequences– Managers may focus too narrowly on their own sub-unit’s

performance rather than on attaining the organisation’s overall goals

– Some tasks and services may be duplicated unnecessarily

• Goal congruence: a behavioural challenge– Goal congruence may be difficult to achieve in a

decentralised organisation– Performance measures and reward systems may provide

direction and incentives to achieve wider organisational goals


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Responsibility centres

• A responsibility centres is a sub-unit of an organisation where the manager is held accountable for the sub-unit’s activities and performance

– Investment centre– Profit centre– Cost centre– Revenue centre

continued


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Responsibility centres

• Terminology used in practice– Cost centre is commonly used– Revenue centre seldom used– Profit centre may refer to both profit centres and

investment centres– Strategic business unit (SBU) often used to refer to

investment centres and, sometimes, profit centres which have their own distinct markets and strategies


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New developments in organisational structuring• Shared services

– The concentration of some support services that are typically spread across a decentralised organisation into a separate unit to service multiple internal customers

– May focus on non-strategic areas, such as accounts payable, payroll, finance, information technology

– Capture the best aspects of centralised and decentralised structures

– Business units may choose to use a shared service unit or an outside provider, so there is an incentive for shared service units to deliver high quality service to internal customers

continued


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New developments in organisational structuring

• Team-based structures– Firms have moved away from hierarchical structures

towards flatter structures that involve fewer levels of management

– Self-managed work teams may be used to manage all aspects of a process

– In the production area, team responsibilities may include Production planning, ordering materials, liaising with

suppliers and customers, all aspects of the production process, cost budgets and performance management

continued


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New developments in organisational structuring• Team-based structures

– Teams may manage some processes more effectively– Teams may promote employee satisfaction, improved

customer satisfaction and productivity Greater empowerment may result from the transfer of

decision-making responsibility from middle managers to teams

– Teams are often set up as cost centres Non-financial measures may be more important in

managing a team than cost measures


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Financial performance reports

• A financial performance report shows key financial results appropriate for the types of responsibility centre

• Segmented profit statements may show profits for major responsibility centres and the entire organisation

• A contribution margin format may be used in these reports to provide more useful information for managers

continued


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• Performance of sub-units and sub-unit managers may differ

– A manager’s performance may be based on revenues and costs that the manager can control or significantly influence

To prevent good managers who are managing poor units from being penalised

– In evaluating the economic performance of a sub-unit, focus on revenues and costs that are attributable to that sub-unit

– Not everyone agrees this distinction is warranted

continued


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• Cost allocation in performance reports– Some costs attributable to a sub-unit may be incurred

outside of that sub-unit, so need to be allocated to the sub-unit

Causal allocation bases may be used to charge the costs of services to the sub-units that used the services

– Common costs result from activities that are performed for the benefit of more than one responsibility centre

Arbitrary allocation of common cost to sub-units may not provide useful information in reports

continued


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• A hierarchy of financial performance reports may be prepared

– To reflect the organisational structure

• Budgets and variance reports may be included in performance reports

• Allocated costs should be included in performance reports, when relevant

continued


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• Real-time reporting– Involves managers having access to up-to-date

information whenever they require it– Gaining a competitive advantage may rely on having

latest information on company performance readily availability

– The difficulties in achieving a virtual close may prevent real-time reporting

– A virtual close can be achieved by reducing the complexity of end-of-period closing of accounts

Focus on critical performance data Implement ERP systems Re-engineer the reporting system


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Transfer pricing

• A transfer price is the internal selling price used when goods and services are transferred between profit centres and investment centres in a divisionalised organisation

– Becomes the revenue of the selling division and the cost of the buying division

– Allows the selling division to record revenue and earn profit to reflect their effort in producing the product

continued


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Transfer pricing

• Allows the buying division to record the cost of that product to match against the revenue when it is eventually sold to external customers

• The transfer price should– Result in divisional profits that are a reliable and accurate

measure of divisional performance– Preserve and encourage divisional autonomy– Encourage goal-congruent behaviour

continued


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Transfer pricing

• Who sets the transfer prices?– Managers of profit centres and investment centres

usually have considerable autonomy in deciding whether to accept or reject orders for goods or services and where to source their materials

– They may also have autonomy on whether to set and accept transfer prices

– Direct intervention by corporate managers to establish transfer prices may be inconsistent with the philosophy of decentralisation

– Corporate management may set a general policy for transfer pricing

continued


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Transfer pricing

• Transfer pricing methods– Market-based prices– Cost-plus prices– Negotiated prices

• Market-based prices– Need competitive external markets for a product

• Cost-plus prices– Where there is no external market price– Intermediate products have no market outside the

company, and are processed further to become final products

continued


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Transfer pricing

• Cost-plus prices– Standard variable cost plus markup allows supplying

division to show a contribution margin on the transferred product

– Standard absorption cost may lead to overpricing of products and possible dysfunctional decisions

– Standard costs should always be used in favour of actual costs, to prevent cost inefficiencies being passed onto buying division

continued


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Transfer pricing

• Negotiated prices– Market price may form the starting point, and cost may be

the lower boundary

• The issue of whether or not the supplying division has excess capacity can influence the appropriate level of transfer price

continued


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Transfer pricing

• General transfer pricing rule– Provides guidance on the appropriate transfer price– Represents a minimum transfer price– May guide divisional manager to make goal-congruent

decisions

division supplying theto

unitper cost y opportunit

division supplyingby incurred

unitper costsoutlay additionalpriceTransfer


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Transfer pricing under different scenarios

1. An external market and excess capacity in the supplying division– Where there is excess capacity, a transfer of product

gives the supplying division additional profits that it would not otherwise make

– The two divisions may negotiate a transfer price less than market to provide an incentive for the buying division to purchase from the supplying division

continued


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2. An external market and no excess capacity in the supplying division– When there is no excess capacity, the supplying division

will need to account for the opportunity cost of lost profits on sales due to the transfer

3. External market and limited capacity in the supplying division– Where capacity is limited, an opportunity cost needs to

be accounted for in the transfer price

continued


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4. No external market and excess capacity in the supplying division– There is no opportunity cost associated with the transfer,

so the transfer price may be based on cost-plus

5. No external market and no excess capacity in the supplying division– The transfer price will need to account for opportunity

cost on lost sales due to the transfer


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Transfer pricing: the impact of taxation

• The influence of taxation– Transfer pricing is used by many companies to transfer

profits between business units in different countries– This moves profits between different tax jurisdictions – International tax considerations will influence the transfer

prices that are used for domestic purposes

• Service firms and not-for-profit firms may also use transfer pricing when services are transferred between business units


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Transfer pricing and service level agreements

• A service level agreement (SLA) is a contract between two sub-units

– establish the nature of the service that will be provided by one unit to the other

– outline the responsibilities of each party– price, quality and timing of service delivery, performance

targets, problem-solving arrangements, ways in which the agreement can be changed or terminated

– the price of the service is a transfer price, and can be determined using similar methods to those used for the transfer of goods

Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for...

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Transcript of Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for...