Design and use of cost systems, responsibility accounting and transfer pricing
18 important questions on Design and use of cost systems, responsibility accounting and transfer pricing
Cost center - knowledge
- Central manager knows optimal production quantity and budget
- Cost center manager knows how to optimally mix inputs
Cost center - decision rights
Cost center - measurement
- Minimize total cost for a fixed output
- Maximize output for a fixed budget
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Cost center - problems
- Minimizing average costs does not necessariliy maximize profits. Cost centers have an incentive to product more units to spreak fixed costs over a large number of units.
- Quality of products produced by costs center must be monitored.
Profit Center - knowledge
Profit Center - decision rights
- Can chose input mix, product mix and selling prices
- Given fixed capital budget
Profit Center - measurement
- Actual profits
- Actual profits compared to budget
Profit Center - problems
- Setting appropriate transfer prices on goods and services transferred within the firm
- How to allocate corporate overhead costs to responsibility centers
- Profit centers that focus onlu on their own profits often ignore how their actions affect other responsibility centers.
Investment center - knowledge
Investment center - decision rights
- Ratify and monitor decisions of cost and profit centers
- Decide amount of capital invested or disposed
Drawbacks of controllability principle
What are multiple effects on firm value from transfer pricing?
- Performance measurement: reallocate total company profits among business segments and influence decision making by purchasing, production, marketing and investment managers.
- Rewards and punishments: compensation for divisional managers
- Partitioning decision rights: disputes over determining TP
What would be ideal TP?
Cost-based transfer pricing
- Standard cost (engineered)
- Profit mark-up
- Danger: double marginalization
Upstream fixed costs & profits
- Agreement among BU's
- Two-step pricing: variable cost unit basis + fixed costs and profits lump sum
Incentive Effects: Discourage Cooperation
Incentive effects: mutual monitoring
Incentive effects: satisficing
Satisficing behavior: managers have incentives to achieve standard but go no further.
However, the firm value would increase if managers attempted 1) continuous improvement beyond standard and 2) innovate to meet competitive threats.
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