1. Accounting Costing 3 Prof. Clive Vlieland-Boddy Academic Year

2. Dr. Clive Vlieland-Boddy FCA FCCA MBA
Costing 3
Dr. Clive Vlieland-Boddy
FCA FCCA MBA

3. Management use it Effectively
Costing & How
Management use it Effectively

4. The Functions of Management
Strategy
Evaluation
Forecasting
Planning – Choosing goals and deciding how to achieve them
Acting – carry out plan
Controlling – evaluating results by comparing the actual results to the plan.
You work for Baskin Robins – one of its goals is to increase operating income
How do you do it?
Incr sales price
Incr sales volume
Lower costs
The accounting system, by tracking costs, helps managers evaluate performance
Feedback

5. Objectives Make, Buy & Sell Decisions Transfer Pricing
Balanced Score Card
The Value Chain
Management Motivation

6. Make Buy or Sell

7. Decision Making Sunk - irrelevant Opportunity Costs
Incremental / Differential

8. DECISIONS Make or buy decisions Close department
Accept or reject order
Conversion cost pricing

9. Transfer Pricing

10. What is transfer pricing?
Transfer pricing is a set of rules an organisation uses to assign prices to products transferred between internal responsibility centres.
A transfer price is the price charged when one segment of a company provides goods or services to another segment of the company.

11. Transfer Pricing Fundamental Objective:
Setting transfer prices to motivate the managers to act in the
“best interest of the overall company”

12. Three Common Approaches:
Managers negotiate their own transfer price
Set transfer price using either:
1. Variable Cost, or
2. Full (Absorption) Cost
Set transfer price at market price

13. Transfer Pricing
When division managers work well together, a negotiated transfer price is an excellent solution to the transfer pricing problem. The following formula, representing the minimum transfer price, provides a good starting point in determining the appropriate transfer price:
Transfer Price = Variable cost per unit +
Lost contribution margin on outside sales

14. Transfer Pricing EXAMPLE: The battery division of a company makes
a standard 12-volt battery.
Production capacity 300,000 batteries
Selling price to outsiders $40
Variable cost per battery $18
Fixed costs per battery $ 7 (based on capacity)
The company’s vehicle division could use this battery in its forklift trucks. The vehicle division is now buying 100,000 batteries per year from an outside supplier at $39 per battery.

15. Transfer Pricing Battery Transfer Price? Vehicle Division Division $39
$40
Outside
Suppliers
Outside
Customers

16. Transfer Pricing Situation 1: The battery division operates at full
capacity (i.e., sells presently 300,000 batteries to
outside customers).
Transfer Price = $18 + ($40 - $18) = $40
No transfer will happen since the vehicle division
can buy batteries for $39 on the outside market.

17. Transfer Pricing
Situation 2: The battery division operates at full capacity
(i.e., sells presently 300,000 batteries to outsider
customers), but can avoid $4 in variable costs (e.g.,
sales commissions) on sales to the vehicle division.
Transfer Price = ($18 - $4) + ($40 - $18) = $36
Transfer will happen if the transfer price is set
between $36 and $39.

18. So the price set will affect the profitability of each division!
What is the effect on divisional profitability of transfer prices for goods or services that are transferred from one division to another?
The ‘transfer price’ will be:
A cost to the receiving division, and
A revenue to the supplying division
So the price set will affect
the profitability of each division!

19. What about the overall company? The ‘transfer price’ will have:
No direct effect on the entire company’s reported profit.
It is like taking money out of one pocket and putting it into the other.
So the price set will NOT affect
the profitability of overall company!

20. What are the purposes of transfer pricing?
1. To provide information that motivates divisional managers to make good economic decisions.
2. To provide information that is useful for evaluating the managerial and economic performance of the divisions.
3. To ensure that divisional autonomy is not undermined.
4. To intentionally move profits between divisions or locations.

21. Basic Principle in Setting Transfer Prices:
How do we price goods or services that are transferred from one division to another? (contd…)
Basic Principle in Setting Transfer Prices:
Motivate the divisional managers to act in the best interests of the overall company.
If not, sub-optimization can occur.

22. Market-based Transfer Price (Contd…)
Market price works well when there is no idle capacity.
However, it is more difficult to apply when there is idle capacity.

23. 3. Negotiated Transfer Prices
A negotiated transfer price is a transfer price that is agreed on between the supplying and receiving divisions.
Generally speaking, we cannot predict the exact transfer they will agree to.
For any given proposed transfer, the transfer price has both:
A lower limit (determined by the situation of the supplying division), and
An upper limit (determined by the situation of the receiving division).
These limits determine the range of acceptable transfer prices.

24. 3. Negotiated Transfer Prices (contd…)
Range of Acceptable Transfer Prices
The Actual Transfer Price falls anywhere between the Lower and Higher Limit
Lowest Limit (Seller’s Perspective) – Supplying Division Transfer Price ³ Variable Cost + Total Cont. Margin on lost sales Number of units transferred
Highest Limit (Purchaser's Perspective)- Receiving Division
Transfer Price £ Cost of buying from outside supplier

25. Negotiated transfer prices
Advantages
Autonomy  Decentralisation
Better information about costs and benefits
• Most appropriate where there are market imperfections for the intermediate product and when managers have equal bargaining power.
• To be effective managers must understand how to use cost and revenue information.
• Limitations:
Can lead to sub-optimal decisions
Time - consuming
Divisional profitability may be strongly influenced by the bargaining skills and powers of the divisional managers.

26. Tax and transfer pricing
International companies can make use of tax havens to strip out profit by transfer pricing.
However, most governments are well aware of this.

27. Question 1 An investment center is responsible for: Answer:
Investing in long term assets
Controlling costs
Generating revenues
All of the above
Answer:
d. All of the above

28. Question 1 An investment center is responsible for: Answer:
Investing in long term assets
Controlling costs
Generating revenues
All of the above
Answer:
d. All of the above

29. Question 1 An investment center is responsible for: Answer:
Investing in long term assets
Controlling costs
Generating revenues
All of the above
Answer:
d. All of the above

30. Question 1 An investment center is responsible for: Answer:
Investing in long term assets
Controlling costs
Generating revenues
All of the above
Answer:
d. All of the above

31. Question 1 An investment center is responsible for: Answer:
Investing in long term assets
Controlling costs
Generating revenues
All of the above
Answer:
d. All of the above