Cost Chapter 22: Management Control Systems, Transfer Pricing, and Multinational Considerations

Management Control System

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.

Formal Management Control System

includes explicit rules, procedures, performance measures, and incentive plans that guide the behavior of its managers and other employees.

The formal control system is composed of several systems such as:

1. The management accounting system for information about the firm's costs, revenues, and income.
2. The human resources system for information about the recruiting and training of employees, absenteeism, and accidents.
3. The quality system for informati

Informal Management Control System

includes the shared values, loyalties, and mutual commitments among members of the organization, the company's culture, and the unwritten norms about acceptable behavior for managers and other employees.

the firm's strategies and goals
(Also be designed to support the organizational responsibilities of individual managers)

To be effective, MCS's should be closely aligned to...

Motivation

the desire to attain a selected goal (goal-congruence aspect) combined with the resulting pursuit of that goal (effort aspect).

1. Goal congruence
2. Effort

2 Aspects of Motivation

Goal Congruence

exists when individuals and groups work toward achieving the organization's goals.

Effort

the extent to which managers strive or endeavor in order to achieve a goal. Effort goes beyond physical exertion to include mental actions as well.

Decentralization

is an organizational structure that gives managers at lower levels the freedom to make decisions.

Autonomy

the degree of freedom to make decisions. The greater the freedom, the greater the autonomy.

Subunit

refers to any part of an organization. It may be a large division or a small group.

1. Creates greater responsiveness to the needs of a subunit's customers, suppliers, and employees.
2. Leads to gains from faster decision making by subunit managers.
3. Assists management development and learning.
4. Sharpens the focus of subunit managers

Benefits of Decentralization

Incongruent decision making (dysfunctional decision making)

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.

1. Incongruent decision making
2. Leads to unhealthy competition.
3. Results in duplication of output.
4. Results in duplication of activities.

Costs of Decentralization

decentralized level

Decisions related to product mix and advertising and made most frequently at the

decentralized level

Decisions related to the type and source of long-term financing are made least frequently at the

optimize across subunits by offsetting the income in one subunit with losses in others.

Centralizing its income tax strategies allows an organization to

decentralized because centralized control of a company with subunits around the world is often physically and practically impossible.

Multinational firms are often

knowledge of local business and political conditions and to deal with uncertainties in their individual environments

Decentralization enables managers in different countries to make decisions that exploit their

loss or lack of control and the resulting risks

The biggest drawback to international decentralization is

measure and monitor the performance of divisions.

Multinational corporations that implement decentralized decision making usually design their management control systems to

Responsibility center

segment or subunit of the organization whose manager is accountable for a specified set of activities.

1. Cost
2. Revenue
3. Profit
4. Investment

4 Types of Responsibility Centers

Transfer Price

is the price one subunit (department or division) charges for a product or service supplied to another subunit of the same organization.

Individual subunits

In a decentralized organization, much of the decision-making power resides in

Revenues; purchase costs

The transfer price creates ________________ for the selling subunit and_______________ for the buying subunit affecting each subunit's operating income.

evaluate the subunits performances and to motivate their managers

Operating income can be used to

Intermediate Product

product or service transferred between subunits of an organization.

1. Promote goal congruence so that division managers acting in their own interest will take actions that are aligned with the objectives of top management.
2. Induce managers to exert a high level of effort.
3. Help top managers evaluate the performance o

Transfer Prices should meet 4 criteria:

1. Market-based transfer prices.
2. Cost-based transfer prices.
3. Hybrid transfer prices.

3 Transfer Pricing Methods

Market Based Transfer Prices

Top managers may choose to use the price of a similar product or service that is publicly available. Sources of prices include trade associations, competitors, and so on.
Or, they may select the external price a subunit charges outside customers.

1. The market for the intermediate product is perfectly competitive.
2. The interdependencies of subunits are minimal.
3. There are no additional costs or benefits to the company as a whole from buying or selling in the external market instead of transact

Transferring products or services at market prices generally leads to optimal decisions when three conditions are satisfied.

Perfectly competitive market

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.

distress pricing

Market based pricing should not be used if the market if currently in a state of

Cost-based Transfer Pricing

Top managers choose a transfer price based on the costs of producing the intermediate product.

Useful when market prices are unavailable, inappropriate, or too costly to obtain, such as when markets are not perfectly competitive, when the product is specialized or when the internal product is different from the products available externally in term

When is cost-based transfer pricing used?

1. They represent relevant costs for long-run decisions.
2. They facilitate external pricing based on variable and fixed costs.
3. They are the least costly to administer.

Full cost based

1. How are the subunit's indirect costs allocated to products?
2. Have the correct activities, cost pools, and cost-allocation bases been identified?
3. Should the chosen fixed-cost rates be actual or budgeted?

Full cost based issues:

Hybrid transfer pricing

Top management may set the prices by specifying a transfer price that is an average of the cost of producing and transporting the product internally and the market price for comparable products.

1. Prorating the difference between maximum and minimum transfer prices.
2. Negotiated pricing. (Most common hybrid type.)
3. Dual pricing.

Types of Hybrid Transfer Prices

Negotiated Transfer Prices

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

Negotiated Transfer Prices

Used when market prices are volatile

Negotiated Transfer Prices

Represents the outcome of a bargaining process between the selling and buying subunits

Dual Pricing

uses two separate transfer-pricing methods to price each transfer from one subunit to another.

Incremental Cost per unit incurred up to the point of transfer + Opportunity Cost per unit to the selling subunit

Minimum Transfer Price=

Incremental Cost

the additional cost of producing and transferring the product or service.

Opportunity Cost

the maximum contribution margin forgone by the selling subunit if the product or service is transferred internally.

payroll taxes, customs duties, tariffs, sales taxes, value-added taxes, environment-related taxes, and other government levies.

Transfer prices affect not just income taxes, but..