W. Bentz A&MIS 525 1

Agenda – Session19Agenda – Session19

• Go over Devon Companies

• Outline transfer pricing issues

• Go over HFD C22 P20

• Review Artic Delights and CDE Co.

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Profit CentersProfit Centers

• Responsibility elements

–Sales prices

–Sales volumes

–Sales mix

–Promotional activities

–Other terms of sale

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Profit Centers (Cont.)Profit Centers (Cont.)

• Direct cost elements– Production activity costs

– Order-getting costs

– Order-filling costs

– Marketing expenses

– Support activity costs

– Costs associated with other terms of sale

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Profit Centers (Cont.)Profit Centers (Cont.)

• Other possible responsibility elements

–Receivables

–Inventories

–Plant & equipment

• Examples?

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Investment CentersInvestment Centers

• Profit centers with additional responsibility elements

–Investment in current operating assets

–Investment in plant & equipment

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Investment CentersInvestment Centers

• Challenges–Allocation of common assets

• Cash• Receivables• Warehouse space• Transportation resources

–Valuation of investment• Inflation and currency effects

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Invest.Centers (Cont.)Invest.Centers (Cont.)

• Examples–Lazarus store in City Center

Mall

–Marysville Honda plant

–EDS processing centers

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DivisionsDivisions

• Divisions are investment centers whose managers have the broad decision-making authority associated with decentralized management systems

• Divisions may have a variety of legal forms (corporations, unincorporated, etc.)

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DivisionsDivisions

• Divisions vary greatly in size

• Financial controls dominate since the decision-making is decentralized

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Transfer PricingTransfer Pricing

• A transfer price is the price at which a product or service is transferred from one entity to another entity within the same firm. Typically when products are moved from one cost center to another within a manufacturing system, the transfer price is the cumulative cost of the product to date.

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Transfer PricingTransfer Pricing

• In a standard cost system, when products are transferred out of a cost center, they are transferred at their standard cost. The difference between the standard cost credited (received) for the product transferred, and the cost of the resources that are allowed by the standards for the production achieved, are the cost variances.

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Manufacturing Process 1Manufacturing Process 1

Support Manufacturing

Process 1

Inputs Outputs at Standard CostMaterials

Labor

Support

Manufacturing Process 2

Difference between cost of inputs and standard cost of outputs = variances

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Support ServiceSupport Service

When a support service is charged to other entities at a predetermined price, that amounts to a transfer price. If the transfer price is a budgeted cost, as in the previous slides, the difference between the budgeted prices of the services provided to others, and the cost of resources used by the entity, are cost variances.

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Services in GeneralServices in General

When a service is provided to other entities in the same firm at a predetermined price, that amounts to a transfer price. If the transfer price were a budgeted cost, then like the previous slides, the difference between the budgeted cost of the services provided and the cost of resources actually used to provide those services would be cost variances.

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Therefore,Therefore,

We have dealt with transfer prices in the context of cost centers. The transfers between cost centers can be made at budgeted, standard, or actual cost. The objective of a cost center is to create a positive difference between the actual costs incurred and the budgeted cost allowance for the output levels achieved.

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Revenue CentersRevenue Centers

In the case of revenue centers, we are tracking revenues by responsibility center, where the emphasis in on generating revenues. Normally, there are no transfers involved with revenue centers.

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Profit & Investment CentersProfit & Investment Centers

Profit centers and investment centers have profit responsibility--usually in the form of the control of both revenues and costs. Therefore, transferring goods and services out of a profit center at cost is inconsistent with the idea of having profit responsibility. Normally, for true profit centers, there should be a meaningful “profit” component.

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Pricing Goods and ServicesPricing Goods and Services

In a market economy, prices determine economic activity. Prices determine what resources are offered, and how they are used to produce which products and services. Activities cease when they are no longer “economic”; but persist when they are “economic.” Economic activity is the result of independent decisions made based on available prices.

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Pricing Goods and ServicesPricing Goods and Services

Large, decentralized organizations simulate market economies by allowing internal (transfer) prices to guide intra-firm economic activity. Ideally, managers would be free to price transfers of goods and services at a mutually agreed upon price, as in a market economy. Divisions would buy from the best sources and sell to maximize their own profitability.

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Decentralization PurposesDecentralization Purposes

• Decentralize managerial responsibilities to local managers.

• Provide managerial incentives to operating executives

• Isolate economic efficiency by responsible entity

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Decentralization PurposesDecentralization Purposes

• Distribute overall profitability among contributing entities

• Distribute overall profitability among taxing entities

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Transfer Pricing MethodsTransfer Pricing Methods

• Transfer pricing methods that include a profit element include:– Marginal cost (economic theory)– Administered prices– Cost-plus prices– Negotiated prices– Market prices

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Transfer Price = Internal PriceTransfer Price = Internal Price

Primary or inter-mediate producer

Intermediate Producer or Distributor

External Customer

Transfer price

Final price

Corporate Entity

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Note!!Note!!

• The selling division’s “price” is the buying division’s cost for divisional performance measurement purposes.

• Production mix and volume decisions are incremental analysis-type decisions in a multi-entity context.

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