© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 13: Responsibility Accounting, Support Department Cost Allocations, and Transfer Pricing Cost Accounting Principles, 9e Raiborn ● Kinney

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objectives Which factors determine whether a firm should be decentralized or centralized? How are decentralization and responsibility accounting related? What are the four primary types of responsibility centers, and what distinguishes them from each other? How are revenue variances computed? Why and how are support department costs allocated to operating departments? What types of transfer prices are used in organizations, and why are such prices used? What difficulties can be encountered by multinational companies using transfer prices?

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Degree of centralization Centralization – a single individual (usually the company owner or president) makes all major decisions and retains full authority and responsibility for the organization’s activities Decentralization – a transfer of authority, responsibility, and decision-making rights from the top to the bottom of the organizational structure

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Decentralization Continuum Age of firmYoung Mature Size of firmSmallLarge Stage of product developmentStableGrowth Growth rateSlowRapid Impact on profits of incorrect decisionsHighLow Management’s confidence in subordinates LowHigh Degree of controlTight Moderate/loose Factor Centralized Decentralized

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Decentralization Continuum Geographic diversity Local Widespread Cost of communications LowHigh Ability to resolve conflictsEasyDifficult Level of employee motivation LowModerate to high Level of organizational flexibilityLowHigh Response time to changesSlowRapid Factor Centralized Decentralized

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Control Process Steps Plan Gather actual data Compare Exert managerial influence Compare Plan

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Responsibility Accounting Disadvantages of responsibility accounting:  Important details may not be visible at upper management levels  Managers might “promote” their unit while “blaming” their competitor units  Could lead to lack of goal congruence  Departmental interdependencies might not be visible

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Responsibility Centers Responsibility accounting systems identify, measure, and report on activities in responsibility centers  Cost center  Revenue center  Profit center  Investment center

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Service Cost Allocation Methods Direct method Step method  Benefits-provided ranking Algebraic method  Simultaneous equations

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Transfer Pricing Internal charges for the exchange of goods or services within the organization Promote goal congruence Ensure optimal resource allocation Promote operational efficiency 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 Encourage managers to be entrepreneurial

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Transfer Pricing Systems May cause disagreement among managers Adds costs and takes time May not work for all departments May cause underutilization or overutilization of services May cause dysfunctional organizational behavior Causes a need for year-end entries to eliminate transfer prices

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Multinational Transfer Pricing Internal Objectives Better goal congruence Better performance evaluations More motivated managers Better cash management External Objectives Fewer taxes and tariffs Fewer foreign exchange risks Better competitive positions Better relations with government

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Questions What are some advantages and disadvantages of decentralization? What are the four types of responsibility centers? Why are transfer prices used?

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Potential Ethical Issues Managers who make decisions to benefit themselves but not always the firm Burying important details in responsibility reports Allocating costs using “ability-to-bear” criterion Shifting support department costs to inappropriate departments Not allowing managers to buy or sell externally in a transfer pricing situation Using transfer pricing to shift costs to low- or no-tax locations