Lektion 5 - Transfer pricing and shared service centers Flashcards
What is transfer pricing?
’Value placed on a transfer of goods or services in transaction in which at least one of the two parties involved is a profit- or investment centre’’
Dependencies:
- Company type
- Environment
- PLC
- Strategic mentality
(!) What are the objectives of transfer pricing?
Provide business unit with information needed to determine optimum trade-off between company costs and revenues
Should induce goal-congruent decisions (Decisions that improve responsible centres should also improve company profit)
Should help measure financial performance of the individual responsibility centres
System should be simple to understand and easy to administer.
System should be acceptable to the tax authorities (Even if located in two different tax jurisdictions)
(Should be less than external sales minus external costs poss.)
What is meant by ‘‘arms length’’?
Transfer prices should be similar to the prices that would be charged if the products were sold to outside customers or purchased from outside vendors
Comes from length of handshake between two independent business partners
What is the difference between a transfer pricing decision and a sourcing decision?
Transfer price decision:
- Price for product transferred between profit/investments centres
Sourcing decision:
- Production inside company or purchasing from outside vendor
Which conditions makes the a market price-based transfer price closer to induce goal congruence?
Perfectly competitive market
Homogeneous product
Equivalent buying and selling prices not affected by individual buyers or sellers
Full information
Freedom to source: Alternatives should exist and
managers should have permission to choose source in own best interest
Market price: Ideal transfer price bases on a well-established, normal market price reflecting the same conditions
Competent people
Good atmosphere
Negotiation
(!) How can a competitive price be determined?
Available published market prices:
- Has to be prices actually paid
- Has to be under the same conditions
___________
Market price set by bids:
- Only if low bidders has chance of obtaining business
- Only if the bids is not to obtain competitive price
___________
Selling of similar products in outside market:
- Price on the basis of outside price
___________
Buying similar products in outside market:
- Price on the basis of outside price
What is implied by cost-based transfer prices?
The cost basis
- The usual basis is standard costs: Not actual costs
- Calculation: Full (absorption)- or activity based costing
The profit mark-up:
- Basis: Percentage of costs or percentage of investment
- Level of profit allowed: Should approximate rate-of-return achievable on outside markets
Which methods can be used against the problem of reluctant to reducing own profit to optimize company profit?
Agreement among business units:
- Formal mechanism
____________
Two step pricing:
General:
- Two charges: Standard variable cost + fixed costs
- One charge should include a profitmargin
- Buying party should compensate selling party for risk of holding capacity
Considerations:
- Monthly charge should be negotiated periodically
- Question about accuracy of cost & investment allocation
- Manufacturing units profit performance not affected by sales volume on final unit
- Conflict interest between manufacturing unit & company
- Method similar to ‘’take-or-pay’’ pricing
- Might have an incentive to reserve a lower capacity at the beginning
____________
Profit sharing:
- Product transferred to marketing unit at standard variable cost and when sold the business unit share the contribution earned
- Useful if demand is highly fluctuating
Considerations:
- How contribution is divided between profit centre
- Dividing the profit does not give information about profitability of each unit
- Manufacturing unit contribution depends on marketing units ability to sell and selling price
____________
Two sets of prices:
- Dual-rate transfer pricing
- Outside price for manufacturing unit
- Standard cost for selling unit
- Used when conflicts between seller and buyer
Considerations:
- Sum of unit profits higher than actual total profit
- Illusive feeling of making money
- Might motivate to focus on internal sales
- Additional bookkeeping
- May reduce important conflicts
Describe the ways to resolve a conflict
Avoidance:
- Forcing
- Smoothing
Resolution:
- Bargaining
- Problem solving
What is meant by class 1 and 2 in classification of products?
Class 1:
- Products to control sourcing
- Large volume products
- Make or buy decision: Make
- Products where no outside source exist
- Manufacturing with quality and secrecy reasons to maintain control
- Sourcing only changed by permission of central management
__________
Class 2:
- Other products
- Small volume products
- Make or buy decision: Buy
- General purpose equipment
- Transferred at market price
- Sourcing determined by business units involved
- Production outside company without significant disruption to present operations
(!) Describe what is meant by a shared service center
General:
- A subset of ‘non-core’ business functions are concentrated into a new business unit
- Support services structured into a separate unit
- Not the same as centralized service units
- Intention to capture best aspects of both centralization and decentralization
____________
Pros:
- Economies of scale
- Customer focus and quality
- Employees build up specialized knowledge
- Can become an independent, outside, service form
- Improves clarity about strategic alignment through simpler structures: Units can focus on their core business
Cons:
- Customer demand for variety will suffer
- Sometimes instead of redesign current service flow
- Many shared service center projects fail or costs more than planned
(!) What is relevant for the shared service center in terms of management control systems?
Free and independent
Must be flexible
Allow organization to maintain control
Operates as either expense or profit centre
Often operating on break-even basis
Strategic direction from top management and relationships with business units
Hard to decide
Changes over time
Service level agreement
What is the role of top management in terms of shared service centers?
Differentiate between core- vs non-core activities
Explain and justify clearly why shared service center are implemented
Decision whether outside sourcing and service provision is allowed
What is a service level agreement?
Formally stated internal contract
____________
Written contract including type and scope of services negotiated between shared service center and internal customers/business units
____________
Contract specifies service levels, cost, quality, deadlines
____________
Determines balance between service quality & cost:
- Costs
- Quality: Accessibility, responsiveness, timeliness and accuracy
____________
Negotiated between shared service centre and business unit
____________
Defines performance measures:
- Financial
- Non financial
Describe the pros and cons for cost allocation of corporate services
Pros:
- Allocation enables the calculation of accurate cost prices of goods and services produced in the decentralized unit
- Allocation raises managers awareness of the service provided
- Allocation creates a healthy tension between central and non-central managers
Cons:
- Allocation of non controllable costs may be perceived as a type of corporate tax
- Sometimes quite broad allocation bases
