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 Market Prices?
Benefits of arm’s length trading are…
* Full commercial value passed to supplier
* Inefficiencies are avoided in receiver
* Market price includes profit
* Distress pricing (price below costs)
What is Cost Based Transfer Pricing?
Standard cost (Marginal/Full Absorption) plus –
This is compatible with a responsibility accounting system. Variances in each process will be highlighted and appropriate responsible people can be identified.
Actual cost plus –
All efficiencies and inefficiencies of a process passed onto subsequent process. There is no incentive for manager of transferring process to control costs and manager of receiving department has no control over the input costs.
What are Negotiated Transfer Pricing?
Opportunity Cost –
* Seller’s perspective…
Transfer price >/= (variable cost per unit) + total contribution margin on lost sales (sold to outside customers) / No. units transferred
* 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
