1. Chapter 12 Financial performance reports and transfer pricing
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

2. Decentralisation and responsibility accounting
The restructuring of the organisation into smaller sub-units, such as divisions and departments, each with specific operations and decision-making responsibilities
Responsibility accounting
Assign responsibility to managers to run particular sub-units of the organisation
Helps to reinforce the advantages of decentralisation
Goal congruence helps ensure that decentralised organisations are effective
Consistency between managers’ personal goals and the goals of the organisation
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

3. Decentralisation Benefits
Managers of sub-units have better local information about markets and operations to enable them to manage their areas more effectively
Provides managerial training for future higher-level managers
May lead to greater motivation and job satisfaction for sub-unit managers
Allows corporate managers more time for strategic issues
Allows the organisation to react more quickly to opportunities and problems as they arise
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

4. Decentralisation Negative consequences
Managers may focus too narrowly on their own sub-unit’s performance rather than on attaining the organisation’s overall goals
Some tasks and services may be duplicated unnecessarily
Goal congruence: a behavioural challenge
Goal congruence may be difficult to achieve in a decentralised organisation
Performance measures and reward systems may provide direction and incentives to achieve wider organisational goals
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

5. Responsibility centres
A responsibility centres is a sub-unit of an organisation where the manager is held accountable for the sub-unit’s activities and performance
Investment centre
Profit centre
Cost centre
Revenue centre
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

6. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

7. Responsibility centres
Terminology used in practice
Cost centre is commonly used
Revenue centre seldom used
Profit centre may refer to both profit centres and investment centres
Strategic business unit (SBU) often used to refer to investment centres and, sometimes, profit centres which have their own distinct markets and strategies
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

8. New developments in organisational structuring
Shared services
The concentration of some support services that are typically spread across a decentralised organisation into a separate unit to service multiple internal customers
May focus on non-strategic areas, such as accounts payable, payroll, finance, information technology
Capture the best aspects of centralised and decentralised structures
Business units may choose to use a shared service unit or an outside provider, so there is an incentive for shared service units to deliver high quality service to internal customers
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

9. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

10. New developments in organisational structuring
Team-based structures
Firms have moved away from hierarchical structures towards flatter structures that involve fewer levels of management
Self-managed work teams may be used to manage all aspects of a process
In the production area, team responsibilities may include
Production planning, ordering materials, liaising with suppliers and customers, all aspects of the production process, cost budgets and performance management
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

11. New developments in organisational structuring
Team-based structures
Teams may manage some processes more effectively
Teams may promote employee satisfaction, improved customer satisfaction and productivity
Greater empowerment may result from the transfer of decision-making responsibility from middle managers to teams
Teams are often set up as cost centres
Non-financial measures may be more important in managing a team than cost measures
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

12. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

13. Financial performance reports
A financial performance report shows key financial results appropriate for the types of responsibility centre
Segmented profit statements may show profits for major responsibility centres and the entire organisation
A contribution margin format may be used in these reports to provide more useful information for managers
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

14. Financial performance reports
Performance of sub-units and sub-unit managers may differ
A manager’s performance may be based on revenues and costs that the manager can control or significantly influence
To prevent good managers who are managing poor units from being penalised
In evaluating the economic performance of a sub-unit, focus on revenues and costs that are attributable to that sub-unit
Not everyone agrees this distinction is warranted
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

15. Financial performance reports
Cost allocation in performance reports
Some costs attributable to a sub-unit may be incurred outside of that sub-unit, so need to be allocated to the sub-unit
Causal allocation bases may be used to charge the costs of services to the sub-units that used the services
Common costs result from activities that are performed for the benefit of more than one responsibility centre
Arbitrary allocation of common cost to sub-units may not provide useful information in reports
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

16. Financial performance reports
A hierarchy of financial performance reports may be prepared
To reflect the organisational structure
Budgets and variance reports may be included in performance reports
Allocated costs should be included in performance reports, when relevant
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

17. Financial performance reports
Real-time reporting
Involves managers having access to up-to-date information whenever they require it
Gaining a competitive advantage may rely on having latest information on company performance readily availability
The difficulties in achieving a virtual close may prevent real-time reporting
A virtual close can be achieved by reducing the complexity of end-of-period closing of accounts
Focus on critical performance data
Implement ERP systems
Re-engineer the reporting system
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

18. Transfer pricing
A transfer price is the internal selling price used when goods and services are transferred between profit centres and investment centres in a divisionalised organisation
Becomes the revenue of the selling division and the cost of the buying division
Allows the selling division to record revenue and earn profit to reflect their effort in producing the product
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

19. Transfer pricing
Allows the buying division to record the cost of that product to match against the revenue when it is eventually sold to external customers
The transfer price should
Result in divisional profits that are a reliable and accurate measure of divisional performance
Preserve and encourage divisional autonomy
Encourage goal-congruent behaviour
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

20. Transfer pricing Who sets the transfer prices?
Managers of profit centres and investment centres usually have considerable autonomy in deciding whether to accept or reject orders for goods or services and where to source their materials
They may also have autonomy on whether to set and accept transfer prices
Direct intervention by corporate managers to establish transfer prices may be inconsistent with the philosophy of decentralisation
Corporate management may set a general policy for transfer pricing
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

21. Transfer pricing Transfer pricing methods Market-based prices
Cost-plus prices
Negotiated prices
Need competitive external markets for a product
Where there is no external market price
Intermediate products have no market outside the company, and are processed further to become final products
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

22. Transfer pricing Cost-plus prices
Standard variable cost plus markup allows supplying division to show a contribution margin on the transferred product
Standard absorption cost may lead to overpricing of products and possible dysfunctional decisions
Standard costs should always be used in favour of actual costs, to prevent cost inefficiencies being passed onto buying division
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

23. Transfer pricing Negotiated prices
Market price may form the starting point, and cost may be the lower boundary
The issue of whether or not the supplying division has excess capacity can influence the appropriate level of transfer price
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

24. Transfer pricing General transfer pricing rule
Provides guidance on the appropriate transfer price
Represents a minimum transfer price
May guide divisional manager to make goal-congruent decisions
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

25. Transfer pricing under different scenarios
An external market and excess capacity in the supplying division
Where there is excess capacity, a transfer of product gives the supplying division additional profits that it would not otherwise make
The two divisions may negotiate a transfer price less than market to provide an incentive for the buying division to purchase from the supplying division
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

26. Transfer pricing under different scenarios
An external market and no excess capacity in the supplying division
When there is no excess capacity, the supplying division will need to account for the opportunity cost of lost profits on sales due to the transfer
External market and limited capacity in the supplying division
Where capacity is limited, an opportunity cost needs to be accounted for in the transfer price
continued
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

27. Transfer pricing under different scenarios
No external market and excess capacity in the supplying division
There is no opportunity cost associated with the transfer, so the transfer price may be based on cost-plus
No external market and no excess capacity in the supplying division
The transfer price will need to account for opportunity cost on lost sales due to the transfer
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

28. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

29. Transfer pricing: the impact of taxation
The influence of taxation
Transfer pricing is used by many companies to transfer profits between business units in different countries
This moves profits between different tax jurisdictions
International tax considerations will influence the transfer prices that are used for domestic purposes
Service firms and not-for-profit firms may also use transfer pricing when services are transferred between business units
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith

30. Transfer pricing and service level agreements
A service level agreement (SLA) is a contract between two sub-units
establish the nature of the service that will be provided by one unit to the other
outline the responsibilities of each party
price, quality and timing of service delivery, performance targets, problem-solving arrangements, ways in which the agreement can be changed or terminated
the price of the service is a transfer price, and can be determined using similar methods to those used for the transfer of goods
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e
Slides prepared by Kim Langfield-Smith