Learning Objective 1
Lead to rewards
Monetary
Nonmonetary
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Learning Objective 2
Organization Structure
Total decentralization
Total centralization
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Benefits of Decentralization
Creates greater responsiveness to local needs Leads to gains from quicker decision making
Costs of Decentralization
Suboptimal decision making may occur Focuses the managers attention on the subunit rather than the organization as a whole Increases the costs of gathering information Results in duplication of activities
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Responsibility Centers
Cost center Revenue center
Profit center
Investment center
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Learning Objective 3
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Transfer Pricing
A transfer price is the price one subunit charges for a product or service supplied to another subunit of the same organization. Intermediate products are the products transferred between subunits of an organization.
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Transfer Pricing
Transfer pricing should help achieve a companys strategies and goals. fit the organizations structure promote goal congruence promote a sustained high level of management effort
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Learning Objective 4
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Transfer-Pricing Methods
Market-based transfer prices
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$ 2 3 $ 5
$ 8 4 $12
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$23 per barrel What is the cost-based transfer price at 112% of full costs?
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$13 2 3 $18
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What is the Refining Division operating income using the full cost price?
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Learning Objective 5
Illustrate how market-based transfer prices promote goal congruence in perfectly competitive markets.
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Learning Objective 6
Avoid making suboptimal decisions when transfer prices are based on full cost plus a markup.
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Learning Objective 7
Understand the range over which two divisions negotiate the transfer price when there is unused capacity.
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Prorating
Lomas & Co. may choose a transfer price that splits on some equitable basis the difference between the maximum transfer price and the minimum transfer price. $23 $19 = $4
Suppose that variable costs are chosen as the basis to allocate this $4 difference.
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Prorating
The Transportation Divisions variable costs are $2 1,000 = $2,000. The Refining Divisions variable costs to refine 1,000 of crude oil into 500 barrels of gasoline are $8 500 = $4,000.
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Prorating
The Transportation Division gets to keep $2,000 $6,000 $4 = $1.33. The Refining Division gets to keep $4,000 $6,000 $4 = $2.67. What is the transfer price from the Transportation Division? $17.00 + $2.00 + $1.33 = $20.33
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Dual Pricing
An example of dual pricing is for Lomas & Co. to credit the Transportation Division with 112% of the full cost transfer price of $24.64 per barrel of crude oil. Debit the Refining Division with the market-based transfer price of $23 per barrel of crude oil.
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Learning Objective 8
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Comparison of Methods
Achieves Goal Congruence
Market Price: Yes, if markets competitive
Cost-Based:
Negotiated:
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Comparison of Methods
Useful for Evaluating Subunit Performance
Market Price: Yes, if markets competitive Cost-Based: Negotiated:
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Comparison of Methods
Motivates Management Effort
Market Price: Yes
Cost-Based: Negotiated:
Yes, if based on budgeted costs; less incentive if based on actual cost Yes
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Comparison of Methods
Preserves Subunit Autonomy
Market Price: Yes, if markets competitive
Cost-Based:
Negotiated:
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Comparison of Methods
Other Factors
Market Price: No market may exist Cost-Based: Negotiated:
Useful for determining full-cost; easy to implement Bargaining takes time and may need to be reviewed
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General Guideline
Minimum transfer price = Incremental costs per unit incurred up to the point of transfer + Opportunity costs per unit to the selling division
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General Guideline
Assume a perfectly competitive market, with no idle capacity. Transportation Division can sell all the crude oil it transports to the external market in Seattle for $23 per barrel. What is the minimum transfer price? ($19 + $4) or ($13 + $2 + $8) = $23 = Market price
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General Guideline
Assume that an intermediate market exists that is not perfectly competitive, and the selling division has idle capacity. If the Transportation Division has idle capacity, its opportunity cost of transferring the oil internally is zero. What is the minimum transfer price?
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General Guideline
It would be $15 per barrel for oil purchased under the long-term contract, or... $19 per barrel for oil purchased and transported from the independent supplier in Alaska.
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Learning Objective 9
IRC Section 482 requires that transfer prices for both tangible and intangible property between a company and its foreign division be set to equal the price that would be charged by an unrelated third party in a comparable transaction.
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