Chapter 13 Responsibility Accounting and Transfer Pricing in Decentralized Organizations Cost Accounting Foundations and Evolutions Kinney, Prather, Raiborn

Learning Objectives (1 of 2) Explain the organizational characteristics used to determine if a firm should be centralized or decentralized Clarify the relationship between responsibility accounting and decentralization Contrast the four types of responsibility centers

Learning Objectives (2 of 2) Explain why and how service department costs are allocated to revenue-producing departments Explain why transfer prices are used and describe the types of transfer prices Explain the difficulties that multinational companies may encounter when using transfer prices

Decentralization Continuum Age of firmYoungMature Size of firmSmallLarge Stage of product developmentStableGrowth Growth rateSlowRapid Impact on profits of incorrect decisionsHighLow Management’s confidence in subordinates LowHigh Degree of controlTightModerate/loose Factor Centralized Decentralized

Decentralization Continuum Geographic diversity Local Widespread Cost of communications LowHigh Ability to resolve conflictsEasyDifficult Level of employee motivationLowModerate to high Level of organizational flexibilityLowHigh Response time to changesSlowRapid Factor Centralized Decentralized

Advantages of Decentralization Personnel –train and screen aspiring managers –develop leadership qualities, problem-solving abilities, and decision-making skills –compare managers’ results –increase job satisfaction and job enrichment Effective means of achieving organizational goals Reduces decision-making time Allows management by exception

Disadvantages of Decentralization Lack of goal congruence Suboptimization –pursuing the subunit manager’s goals instead of the company’s goals Requires more effective communication skills Managers must relinquish control Expensive –train managers in decision-making skills –absorb cost of poor decisions –requires a sophisticated planning and reporting system

Responsibility Reports Monetary and nonmonetary Adjusted for the planning, controlling, and decision-making needs of each unit manager Separates costs as controllable or noncontrollable by the unit manager

Nonmonetary Measures Capacity measures Target ROI Desired/actual market share Throughput Defects Backorders Complaints On-time delivery Manufacturing cycle efficiency Reduction of non-value- added time Employee suggestions received/implemented Unplanned production interruptions Schedule changes Engineering changes Safety violations Absenteeism

Control Process Steps Compare Plan Gather actual data Managerial influence

Responsibility Accounting Upward flow of information –from operations to top management Unit level reports are detailed Upper-level reports are summarized Encourages management by exception –Major deviations are highlighted

Responsibility Accounting Disadvantages of responsibility accounting include –Important details may not be visible at upper management levels –Managers might “promote” their unit while “blaming” their competitor units –Departmental interdependencies might not be visible

Responsibility Centers Responsibility accounting systems identify, measure, and report on activities in responsibility centers –Cost center –Revenue center –Profit center –Investment center

Service Cost Allocation Methods Direct method Step method –Benefits-provided ranking Algebraic method –Simultaneous equations

Service Cost Allocation Allocated service department costs are included in the overhead application rate for the revenue-producing areas Service department costs are allocated to products or jobs through normal overhead assignment procedures

Transfer Pricing Internal charges for the exchange of goods or services within the organization Promote goal congruence Make performance evaluation among segments more comparable Transform a cost center into a pseudo- profit center For internal use only –Eliminated on external financial reports Encourages managers to be entrepreneurial

Transfer Pricing Systems May cause disagreement among managers Add costs and take time May not work for all departments May cause dysfunctional behavior May cause underutilization or overutilization of services Complicate tax planning for multinationals

Multinational Transfer Pricing Internal Objectives Better goal congruence Better performance evaluations More motivated managers Better cash management External Objectives Less taxes and tariffs Less foreign exchange risks Better competitive positions Better relations with government

Multinational Transfer Pricing Develop guidelines that are followed on a consistent basis Set transfer prices that reflect an arm’s- length transaction Be prepared for transfer pricing audits Consider Advance Pricing Agreements – binding contracts between a company and taxing authorities that set an acceptable transfer pricing methodology

Questions What are some advantages and disadvantages of decentralization? What are the four types of responsibility centers? Why are transfer prices used?