8 Flashcards
What is a management control system?
A management control system is a way to gather and use information to help managers plan, control, and make decisions. It guides the behavior of managers and employees by providing financial (e.g., profits, costs) and non-financial data (e.g., customer response times).
What are important elements of effective management control systems?
Effective systems include:
Motivation: Drives employees to achieve goals.
Goal Congruence: Ensures individuals and teams align with organizational goals.
Effort: Encourages consistent actions toward objectives. Systems also offer rewards (monetary and non-monetary) tied to performance
What are the benefits and costs of decentralization?
Benefits:
Faster Decisions: Managers closer to operations can act quickly without waiting for higher approval.
Local Responsiveness: Divisions can tailor decisions to meet local market needs.
Improved Manager Motivation: Greater autonomy empowers managers and boosts morale.
Better Learning Opportunities: Managers gain hands-on experience, developing decision-making skills.
Sharper Focus on Goals: Divisions focus on their specific objectives, driving accountability.
Costs:
Risk of Suboptimal Decisions: Divisions may prioritize their own profits over company-wide goals.
Duplication of Efforts: Separate divisions may repeat similar tasks, increasing inefficiency.
Increased Information Costs: Collecting and sharing data between divisions can be time-consuming and costly.
Misalignment of Goals: Decisions made at the divisional level might conflict with overall organizational strategies.
What is Decentralization?
Decentralization is when decision-making authority is delegated from top management to lower levels or divisions in an organization. It gives managers in specific areas more autonomy to make decisions relevant to their operations, improving responsiveness and efficiency.
What are the three methods of determining transfer prices?
Market-Based: Uses the external market price for a similar product.
Cost-Based: Sets prices based on production costs (e.g., full cost or cost-plus).
Negotiated: Divisions agree on a price through negotiation.
How do market-based transfer prices promote goal congruence?
Fairness: Divisions are treated as if they are independent businesses dealing with external customers.
Aligned Goals: If each division makes decisions based on the market price, their actions will also benefit the overall company.
Efficiency: Using market prices encourages divisions to operate efficiently, as they must stay competitive.
his forces the division to:
Control Costs: If their costs are too high, they won’t make a profit selling at the market price.
Use Resources Wisely: They need to manage resources carefully to remain competitive with outside suppliers.
Why Might a Transfer Price Lead to Suboptimal Decisions?
A transfer price can cause divisions to prioritize their own profits instead of the overall company’s goals. For instance, if a cost-based transfer price is too high, the buying division might prefer sourcing externally, even when internal sourcing would save costs for the company as a whole. Similarly, a selling division might refuse to sell internally at a price that doesn’t cover all their fixed costs, even if doing so benefits the organization overall. This misalignment can result in inefficiencies and lost opportunities.
What Range Is Used to Negotiate Transfer Prices with Excess Capacity?
What Range Is Used to Negotiate Transfer Prices with Excess Capacity?
When there is excess capacity, the range for transfer prices is:
Minimum Price: The variable cost (incremental cost) of the selling division, since there’s no lost opportunity to sell to external customers.
Maximum Price: The price the buying division would pay to purchase the product from an external supplier.
Key Point: With excess capacity, the selling division’s opportunity cost is zero, so the minimum price equals the cost of producing one additional unit. This ensures both divisions benefit from the transaction.
How do income tax considerations affect transfer pricing?
Companies can use transfer pricing to allocate more profits to divisions in low-tax countries, reducing their overall tax burden. For example, setting a high transfer price for goods sold to a high-tax country shifts more profit to the low-tax country. However, tax laws and international regulations (e.g., OECD guidelines) often limit these practices to prevent tax avoidance and ensure fair tax contributions across jurisdictions.
What is the general guideline for determining the minimum transfer price?
If there is excess capacity, opportunity cost is zero, and the minimum price equals variable costs.
What is dual pricing in transfer pricing?
Dual pricing uses two different transfer prices for the same transaction: the selling division is credited at a higher price, such as full cost-plus, while the buying division is debited at the market price. This approach balances goal congruence and subunit autonomy, ensuring the selling division is motivated to produce and the buying division makes decisions aligned with overall company goals. However, it is rarely used due to its complexity in tracking and evaluating two prices for the same transaction.
What is goal congruence in transfer pricing?
Goal congruence means that decisions made by divisions align with the overall goals of the organization. Proper transfer pricing ensures that divisions prioritize what is best for the entire company, not just their own profits.
What is a suboptimal decision in transfer pricing?
Suboptimal decisions occur when transfer prices cause divisions to act in ways that harm the company overall, such as refusing to trade internally or purchasing externally at a higher cost.
What are the drawbacks of market-based transfer prices?
Market prices may not be available for unique products, and in imperfect markets, prices might not reflect true value. This can lead to unfair evaluations or inefficiencies.
How do income tax regulations affect transfer pricing?
Tax laws require companies to use arm’s-length pricing, which means that internal transfer prices between divisions must match the price that would be charged between unrelated companies in the open market. This ensures fairness and prevents companies from artificially shifting profits to low-tax countries to reduce their tax liability.
Key Point: If a company fails to comply with these rules, it can face penalties, fines, or additional tax assessments from tax authorities. This is especially important for multinational companies operating in different tax jurisdictions.
