Chapter 13: Responsibility Accounting, Support Department Cost Allocations, and Transfer Pricing

1. Chapter 13: Responsibility Accounting, Support Department Cost Allocations, and Transfer Pricing Cost Accounting Principles, 9e Raiborn ● Kinney

2. 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?

3. 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

4. Decentralization Continuum Factor Centralized Decentralized Age of firm Young Mature Size of firm Small Large Stage of product development Stable Growth Growth rate Slow Rapid Impact on profits of incorrect decisions High Low Management’s confidence in subordinates Low High Degree of control Tight Moderate/loose

5. Decentralization Continuum Factor Centralized Decentralized Geographic diversity Local Widespread Cost of communications Low High Ability to resolve conflicts Easy Difficult Level of employee motivation Low Moderate to high Level of organizational flexibility Low High Response time to changes Slow Rapid

6. 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

7. 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

8. 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

9. 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 Nonmonetary Measures

10. Control Process Steps • Plan • Gather actual data • Compare • Exert managerial influence • Compare • Plan

11. 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

12. 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

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

14. Service Cost Allocation Methods • Direct method • Step method • Benefits-provided ranking • Algebraic method • Simultaneous equations

15. 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

16. 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

17. 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 Multinational Transfer Pricing

18. 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

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

20. 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