Presentation on theme: "Accounting Costing 3 Prof. Clive Vlieland-Boddy Academic Year"— Presentation transcript:
1 Accounting Costing 3 Prof. Clive Vlieland-Boddy Academic Year
2 Dr. Clive Vlieland-Boddy FCA FCCA MBA Costing 3Dr. Clive Vlieland-BoddyFCA FCCA MBA
3 Management use it Effectively Costing & HowManagement use it Effectively
4 The Functions of Management StrategyEvaluationForecastingPlanning – Choosing goals and deciding how to achieve themActing – carry out planControlling – evaluating results by comparing the actual results to the plan.You work for Baskin Robins – one of its goals is to increase operating incomeHow do you do it?Incr sales priceIncr sales volumeLower costsThe accounting system, by tracking costs, helps managers evaluate performanceFeedback
5 Objectives Make, Buy & Sell Decisions Transfer Pricing Balanced Score CardThe Value ChainManagement Motivation
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 priceSet transfer price using either:1. Variable Cost, or2. Full (Absorption) CostSet transfer price at market price
13 Transfer PricingWhen 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 batteriesSelling price to outsiders $40Variable cost per battery $18Fixed 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 $40OutsideSuppliersOutsideCustomers
16 Transfer Pricing Situation 1: The battery division operates at full capacity (i.e., sells presently 300,000 batteries tooutside customers).Transfer Price = $18 + ($40 - $18) = $40No transfer will happen since the vehicle divisioncan buy batteries for $39 on the outside market.
17 Transfer PricingSituation 2: The battery division operates at full capacity(i.e., sells presently 300,000 batteries to outsidercustomers), but can avoid $4 in variable costs (e.g.,sales commissions) on sales to the vehicle division.Transfer Price = ($18 - $4) + ($40 - $18) = $36Transfer will happen if the transfer price is setbetween $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, andA revenue to the supplying divisionSo the price set will affectthe 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 affectthe 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), andAn 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 PricesThe Actual Transfer Price falls anywhere between the Lower and Higher LimitLowest Limit (Seller’s Perspective) – Supplying Division Transfer Price ³ Variable Cost + Total Cont. Margin on lost sales Number of units transferredHighest Limit (Purchaser's Perspective)- Receiving DivisionTransfer Price £ Cost of buying from outside supplier
25 Negotiated transfer prices AdvantagesAutonomy DecentralisationBetter 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 decisionsTime - consumingDivisional 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 assetsControlling costsGenerating revenuesAll of the aboveAnswer:d. All of the above
28 Question 1 An investment center is responsible for: Answer: Investing in long term assetsControlling costsGenerating revenuesAll of the aboveAnswer:d. All of the above
29 Question 1 An investment center is responsible for: Answer: Investing in long term assetsControlling costsGenerating revenuesAll of the aboveAnswer:d. All of the above
30 Question 1 An investment center is responsible for: Answer: Investing in long term assetsControlling costsGenerating revenuesAll of the aboveAnswer:d. All of the above
31 Question 1 An investment center is responsible for: Answer: Investing in long term assetsControlling costsGenerating revenuesAll of the aboveAnswer:d. All of the above