Decentralisation & Transfer Pricing Flashcards
What is decentralisation
The delegation of decision-making authority. More responsibility is passed down, the more decentralised authority is.
Advantages of Decentralisation:
- Top management free to concentrate on strategy
- Lower-level managers gain experience, have better info & can respond to change in business environment quickly.
- Increases job satisfaction
Disadvantages of Decentralisation:
- Lack of co-ordination amongst autonomous managers
- Lower-level managers cannot see “bigger picture”, and objectives may not align with organisations
- Difficult to spread innovative ideas in organisation
What are the 4 types of Responsibility Centres?
- Cost Centre
- Revenue Centre
- Profit Centre
- Investment Centre
What is a Cost Centre?
- Manager control costs.
- Responsible for production of goods/services at minimum costs.
- Performance evaluated by comparing actual costs with amount costs should have been for their actual level of production (flexible budget).
What is a Revenue Centre?
- Responsible for generating the target level of revenue.
- Also accountable for selling expenses (salaries/bonuses).
- Not accountable for cost of goods or services sold.
What is a Profit Centre?
- Managers control inputs & outputs revenue to attain required level of profitability.
- Managers set selling prices, choose market to target, prioritise products/services.
- Evaluated by profit/profit-related performance measures.
What is an Investment Centre?
- Managers assigned responsibilities of profit centres, and working capital & investment capital decisions.
- Evaluated on ROI or residual income.
- Higher level of autonomy than managers in cost/revenue/profit centres.
What is Transfer Price?
Price charged when one responsibility centre of an organisation provides goods/services to another responsibility centre with the same organisation.
Main Purpose of Transfer Pricing:
- Motivate managers to act in best interest of overall company by creating market within organisation to gain advantage over competition.
- Divisional autonomy.
- Shift profits across locations for tax and other purposes.
- Minimise other transaction-based taxes
Types of Transfer Pricing:
- Market-based transfer prices
- Cost-based transfer prices
- Negotiated transfer prices
- Dual rate pricing
Non-market-based TP valuable when intermediate product market prices are difficult/impossible to get.
What are the Benefits of Arm’s Length Trading?
Both parties act in their own self-interest and are not subject to pressure from the other party.
Fair market value, (ensures correct taxes paid for MNEs).
What is Cost Based Transfer Pricing?
Method of setting prices when selling products to divisions within the same company.
Standard/Marginal Cost –
Company’s division record all parts to make product and it adds variable overhead.
Actual/Full Production Cost Plus –
Company adds fixed OH expenses to the cost of each item.
What are Negotiated Transfer Pricing?
Company representatives negotiate prices themselves, not based purely on market prices.
* Seller’s perspective…
Transfer price >/= cost of production per unit
* Purchaser’s perspective…
Transfer price </= cost of buying from outside supplier
Issues with Negotiated Transfer Pricing:
- Total profit doesn’t change (zero sum endgame = one side wins, other side losses)
- Opportunity cost of management time
- Group priority may lead to resolution cost (2 sides dissatisfied)
- Group priority may lead to inefficiencies being maintained in companies in transfer pricing scheme (invariably seller)
- Quality issues
