Responsibility accounting

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COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan Chapter 10 Decentralization: Responsibility Accounting, Performance Evaluation, and Transfer Pricing COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning Cengage Learning and South-Western are trademarks used herein under license Study Objectives Define responsibility accounting, and describe the four types of responsibility centers Explain why firms choose to decentralize Compute and explain return on investment (ROI), residual income (RI), and economic value added (EVA) Discuss methods of evaluating and rewarding managerial performance Explain the role of transfer pricing in a decentralized firm Discuss the methods of setting transfer prices Responsibility Accounting Responsibility accounting – measures the results of each responsibility center – compares those results with some measure of expected or budgeted outcome Responsibility Accounting Types of Responsibility Centers – – – – Cost center: only responsible for costs Revenue center: only responsible for revenues Profit center: responsible for both revenues and costs Investment center: responsible for revenues, costs, and investments Decentralization Reasons for Decentralization – – – – – – Better access to local information More timely response Focusing of central management Training and evaluation of segment managers Motivation of segment managers Enhanced competition Measuring the Performance of Investment Centers Return on investment (ROI) the most common measure of performance for an investment center ROI = Operating income ÷ Average operating assets = (Operating income ÷ Sales) × (Sales ÷ Average operating assets) = Operating income margin × Operating asset turnover Margin: portion of sales available for interest, taxes and profit  Operating income   ÷ Sales   Turnover: how productively assets are being used to generate sales   Sales  ÷  Average operating assets  Measuring the Performance of Investment Centers Measuring the Performance of Investment Centers Measuring the Performance of Investment Centers Advantages of the ROI measure – Helps managers focus on the relationship between sales, expenses and investment – Encourages cost efficiency – Discourages excessive investment in operating assets Disadvantages of the ROI measure – Discourages managers from investing in projects decreasing divisional ROI but increasing profitability of the company overall – Encourages managers to focus on the short-term at the expense of the long-term Measuring the Performance of Investment Centers Residual income the difference between operating income and the minimum dollar return required on a company’s operating assets ( Residual = Operating - Minimum rate of return Income Income × Operating assets ) 10 Transfer Pricing Opportunity cost approach identifies – The minimum price that a selling division would be will to accept Floor: leaves the selling division no worse off for having sold to an internal division – The maximum price that the buying division would be willing to pay Ceiling: leaves the buying division no worse off for having purchased from an internal division 26 Transfer Pricing 27 Setting Transfer Prices A good should be transferred internally whenever the opportunity cost (minimum price) of the selling division is less than the opportunity cost (maximum price) of the buying division 28 Setting Transfer Prices • Commonly used policies – Market price • Price in an outside, perfectly competitive, market – Negotiated transfer prices • Agreed to only if the opportunity cost of the selling division is less than the opportunity cost of the buying division – Cost-based transfer prices • Variable cost • Full (absorption cost) 29 Setting Transfer Prices Negotiated transfer prices Example 1: Avoidable Distribution Costs 30 Setting Transfer Prices Negotiated transfer prices Example 1: Avoidable Distribution Costs 31 Setting Transfer Prices Negotiated transfer prices Example 1: Avoidable Distribution Costs 32 Setting Transfer Prices Negotiated transfer prices Example 2: Excess Capacity 33 Setting Transfer Prices Negotiated transfer prices Example 2: Excess Capacity 34 Setting Transfer Prices • Negotiated Transfer Prices – Disadvantages • Time consuming – Advantages • Negotiation helps ensure goal congruence • Comparable negotiating skills support motivation and accurate performance measures 35 Setting Transfer Prices • Cost-Based Transfer Prices – Forms • Full-cost transfer pricing • Full cost plus markup • Variable cost plus fixed fee – Propriety of use • Impact on divisional profit is negligible • Ease of cost measurement is beneficial • Result of negotiations 36 Setting Transfer Prices • Transfer Pricing and the MNC – Performance evaluation – Optimal determination of income taxes • Shift costs to high-tax countries • Shift revenues to low-tax countries 37 Setting Transfer Prices 38 Setting Transfer Prices • IRS Code §482 – Requires arms’-length transactions – Allowable pricing methods • Comparable uncontrolled price method • Resale price method • Cost-plus method • Negotiated between the company and the IRS • Income taxes are universal – Market-based transfer prices 39 COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan End Chapter 10 COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning Cengage Learning and South-Western are trademarks used herein under license 40
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