1. CHAPTER 22 Management-Control Systems, Transfer Pricing,
and Multinational Considerations
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2. Management Control Systems
Management Control Systems are a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and other employees
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3. Management Control Systems
Many management control systems contain some or all of the balanced scorecard perspectives:
Financial
Customer
Internal Business Process
Learning and Growth
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4. Management Control Systems
Consist of Formal and Informal control systems:
Formal systems include explicit rules, procedures, performance measures, and incentive plans that guide the behavior of its managers and other employees
Informal systems include shared values, loyalties, and mutual commitments among members of the company, corporate culture, and unwritten norms about acceptable behavior
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5. Evaluating Management Control Systems
To be effective, management control systems should be closely aligned to the firm’s strategies and goals
Systems should be designed to fit the company’s structure and decision-making responsibility of individual managers
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6. Evaluating Management Control Systems
Effective management control systems should also motivate managers and their employees
Motivation is the desire to attain a selected goal (goal-congruence) combined with the resulting pursuit of that goal (effort)
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7. Two Aspects of Motivation
Goal Congruence exists when individuals and groups work toward achieving the organization’s goals – managers working in their own best interest take actions that align with the overall goals of top management
Effort is exertions toward reaching a goal, including both physical and mental actions
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8. Organization Structure and Decentralization
Decentralization is the freedom for managers at lower levels of the organization to make decisions
Autonomy is the degree of freedom to make decisions. The greater the freedom, the greater the autonomy
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9. Decentralization vs. Centralization
Total decentralization means minimum constraints and maximum freedom for managers at the lowest levels of an organization to make decisions
Total centralization means maximum constraints and minimum freedom for managers at the lowest levels of an organization to make decisions
Companies structures generally fall somewhere in between these two extremes, as each has benefits and costs. Structure chosen cost vs. benefit analysis
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10. Benefits of Decentralization
Creates greater responsiveness to local needs
Leads to gains from faster decision making
Increases motivation of subunit managers
Assists management development and learning
Sharpens the focus of subunit managers
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11. Costs of Decentralization
Leads to Suboptimal Decision Making, which arises when a decision’s benefit to one subunit is more than offset by the costs or loss of benefits to the organization as a whole.
Also called Incongruent Decision Making or Dysfunctional Decision Making
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12. Costs of Decentralization
Focuses manger’s attention on the subunit rather than the company as a whole
Increases costs of gathering information
Results in duplication of activities
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13. Decentralization and Multinational Firms
Multinational firms – companies that operate in multiple countries – are often decentralized because centralized control of a company with subunits around the world is often physically and practically impossible
Decentralization enables managers in different countries to make decisions that exploit their knowledge of local business and political conditions and to deal with uncertainties in their individual environments
Biggest Drawback to International Decentralization: Loss or lack of control
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14. Choices About Responsibility Centers
Regardless of the degree of decentralization, management control systems uses one or a mix of the four types of responsibility centers:
Cost Center
Revenue Center
Profit Center
Investment Center
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15. Transfer Pricing
Transfer Price – the price one subunit (department or division) charges for a product or service supplied to another subunit of the same organization
Management control systems use transfer prices to coordinate the actions of subunits and to evaluate their performance
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16. Transfer Pricing
The transfer price creates revenues for the selling subunit and purchase costs for the buying subunit affecting each subunit’s operating income
Intermediate Product – the product or service transferred between subunits of an organization
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17. Three Transfer Pricing Methods
Market-based Transfer Prices
Cost-based Transfer Prices
Negotiated Transfer Prices
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18. Market-Based Transfer Prices
Top management chooses to use the price of similar product or service that is publicly available. Sources of prices include trade associations, competitors, etc.
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19. Market-Based Transfer Prices
Lead to optimal decision-making when three conditions are satisfied:
The market for the intermediate product is perfectly competitive
Interdependencies of subunits are minimal
There are no additional costs or benefits to the company as a whole from buying or selling in the external market instead of transacting internally
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20. Market-Based Transfer Prices
A perfectly competitive market exists when there is a homogeneous product with buying prices equal to selling prices and no individual buyer or seller can affect those prices by their own actions
Allows a firm to achieve goal congruence, motivating management effort, subunit performance evaluations, and subunit autonomy
Perhaps should not be used if the market is currently in a state of “distress pricing”
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21. Cost-Based Transfer Prices
Top management chooses a transfer price based on the costs of producing the intermediate product. Examples include:
Variable Production Costs
Variable and Fixed Production Costs
Full Costs (including life-cycle costs)
One of the above, plus some markup
Useful when market prices are unavailable, inappropriate, or too costly to obtain
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22. Cost-Based Transfer Pricing Alternatives
Prorating the difference between the maximum and minimum cost-based transfer prices
Dual-Pricing – using two separate transfer-pricing methods to price each transfer from one subunit to another. Example: selling division receives full cost pricing, and the buying division pays market pricing
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23. Negotiated Transfer Prices
Occasionally, subunits of a firm are free to negotiate the transfer price between themselves and then to decide whether to buy and sell internally or deal with external parties
May or may not bear any resemblance to cost or market data
Often used when market prices are volatile
Represent the outcome of a bargaining process between the selling and buying subunits
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24. Comparison of Transfer-Pricing Methods
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25. Transfer Pricing Illustration
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26. Transfer Pricing Illustration
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27. Minimum Transfer Price
The minimum transfer price in many situations should be:
Incremental cost is the additional cost of producing and transferring the product or service
Opportunity cost is the maximum contribution margin forgone by the selling subunit if the product or service is transferred internally
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28. Multinational Transfer Pricing and Tax Considerations
Transfer prices often have tax implications
Tax factors include income taxes, payroll taxes, customs duties, tariffs, sales taxes, value-added taxes, environment-related taxes and other government levies
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29. Multinational Transfer Pricing and Tax Considerations
Section 482 of the US Internal Revenue Code governs taxation of multinational transfer pricing
Section 482 requires that transfer prices between a company and its foreign division or subsidiary equal the price that would be charged by an unrelated third party in a comparable transaction
Transfer price could be market-based or “cost-plus” based
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