Slide AKT202 Chapter 22
Management-Control Systems,
Transfer Pricing,
and Multinational Considerations
© 2009 Pearson Prentice Hall. All rights
reserved.
Management Control
Systems
Management Control Systems are a means of
gathering and using information to aid and
coordinate the planning and control decisions
throughout an organization and to guide the
behavior of its managers and other employees
© 2009 Pearson Prentice Hall. All rights
reserved.
Management Control
Systems
Many management control systems contain
some or all of the balanced scorecard
perspectives:
1. Financial
2. Customer
3. Internal Business Process
4. Learning and Growth
© 2009 Pearson Prentice Hall. All rights
reserved.
Management Control
Systems
Consist of Formal and Informal control
systems:
Formal systems include explicit rules,
procedures, performance measures, and
incentive plans that guide the behavior of its
managers and other employees
Informal systems include shared values,
loyalties, and mutual commitments among
members of the company, corporate culture,
and unwritten norms about acceptable behavior
© 2009 Pearson Prentice Hall. All rights
reserved.
Evaluating
Management Control Systems
To be effective, management control systems
should be closely aligned to the firm’s
strategies and goals
Systems should be designed to fit the
company’s structure and decision-making
responsibility of individual managers
© 2009 Pearson Prentice Hall. All rights
reserved.
Evaluating
Management Control Systems
Effective management control systems should
also motivate managers and their employees
Motivation is the desire to attain a selected
goal (goal-congruence) combined with the
resulting pursuit of that goal (effort)
© 2009 Pearson Prentice Hall. All rights
reserved.
Two Aspects of Motivation
Goal Congruence exists when individuals and
groups work toward achieving the
organization’s goals – managers working in
their own best interest take actions that align
with the overall goals of top management
Effort is exertions toward reaching a goal,
including both physical and mental actions
© 2009 Pearson Prentice Hall. All rights
reserved.
Organization Structure and
Decentralization
Decentralization is the freedom for managers
at lower levels of the organization to make
decisions
Autonomy is the degree of freedom to make
decisions. The greater the freedom, the
greater the autonomy
© 2009 Pearson Prentice Hall. All rights
reserved.
Decentralization vs.
Centralization
Total decentralization means minimum
constraints and maximum freedom for managers
at the lowest levels of an organization to make
decisions
Total centralization means maximum constraints
and minimum freedom for managers at the
lowest levels of an organization to make
decisions
Companies structures generally fall somewhere
in between these two extremes, as each has
benefits and costs. Structure chosen cost vs.
benefit analysis
© 2009 Pearson Prentice Hall. All rights
reserved.
Benefits of Decentralization
Creates greater responsiveness to local needs
Leads to gains from faster decision making
Increases motivation of subunit managers
Assists management development and
learning
Sharpens the focus of subunit managers
© 2009 Pearson Prentice Hall. All rights
reserved.
Costs of Decentralization
Leads to Suboptimal Decision Making, which
arises when a decision’s benefit to one
subunit is more than offset by the costs or
loss of benefits to the organization as a whole.
Also called Incongruent Decision Making or
Dysfunctional Decision Making
© 2009 Pearson Prentice Hall. All rights
reserved.
Costs of Decentralization
Focuses manger’s attention on the subunit
rather than the company as a whole
Increases costs of gathering information
Results in duplication of activities
© 2009 Pearson Prentice Hall. All rights
reserved.
Decentralization and
Multinational Firms
Multinational firms – companies that operate in
multiple countries – are often decentralized
because centralized control of a company with
subunits around the world is often physically and
practically impossible
Decentralization enables managers in different
countries to make decisions that exploit their
knowledge of local business and political
conditions and to deal with uncertainties in their
individual environments
Biggest Drawback to International
Decentralization: Loss or lack of control
© 2009 Pearson Prentice Hall. All rights
reserved.
Choices About
Responsibility Centers
Regardless of the degree of decentralization,
management control systems uses one or a
mix of the four types of responsibility centers:
Cost Center
Revenue Center
Profit Center
Investment Center
© 2009 Pearson Prentice Hall. All rights
reserved.
Transfer Pricing
Transfer Price – the price one subunit
(department or division) charges for a product
or service supplied to another subunit of the
same organization
Management control systems use transfer
prices to coordinate the actions of subunits
and to evaluate their performance
© 2009 Pearson Prentice Hall. All rights
reserved.
Transfer Pricing
The transfer price creates revenues for the
selling subunit and purchase costs for the
buying subunit affecting each subunit’s
operating income
Intermediate Product – the product or service
transferred between subunits of an
organization
© 2009 Pearson Prentice Hall. All rights
reserved.
Three Transfer Pricing
Methods
1. Market-based Transfer Prices
2. Cost-based Transfer Prices
3. Negotiated Transfer Prices
© 2009 Pearson Prentice Hall. All rights
reserved.
Market-Based Transfer Prices
Top management chooses to use the price of
similar product or service that is publicly
available. Sources of prices include trade
associations, competitors, etc.
© 2009 Pearson Prentice Hall. All rights
reserved.
Market-Based Transfer Prices
Lead to optimal decision-making when three
conditions are satisfied:
1. The market for the intermediate product is
perfectly competitive
2. Interdependencies of subunits are minimal
3. There are no additional costs or benefits to
the company as a whole from buying or
selling in the external market instead of
transacting internally
© 2009 Pearson Prentice Hall. All rights
reserved.
Market-Based Transfer Prices
A perfectly competitive market exists when
there is a homogeneous product with buying
prices equal to selling prices and no individual
buyer or seller can affect those prices by their
own actions
Allows a firm to achieve goal congruence,
motivating management effort, subunit
performance evaluations, and subunit autonomy
Perhaps should not be used if the market is
currently in a state of “distress pricing”
© 2009 Pearson Prentice Hall. All rights
reserved.
Cost-Based Transfer Prices
Top management chooses a transfer price
based on the costs of producing the
intermediate product. Examples include:
Variable Production Costs
Variable and Fixed Production Costs
Full Costs (including life-cycle costs)
One of the above, plus some markup
Useful when market prices are unavailable,
inappropriate, or too costly to obtain
© 2009 Pearson Prentice Hall. All rights
reserved.
Cost-Based Transfer Pricing
Alternatives
Prorating the difference between the
maximum and minimum cost-based transfer
prices
Dual-Pricing – using two separate transferpricing methods to price each transfer from
one subunit to another. Example: selling
division receives full cost pricing, and the
buying division pays market pricing
© 2009 Pearson Prentice Hall. All rights
reserved.
Negotiated Transfer Prices
Occasionally, subunits of a firm are free to
negotiate the transfer price between
themselves and then to decide whether to
buy and sell internally or deal with external
parties
May or may not bear any resemblance to
cost or market data
Often used when market prices are volatile
Represent the outcome of a bargaining
process between the selling and buying
subunits
© 2009 Pearson Prentice Hall. All rights
reserved.
Comparison of TransferPricing Methods
© 2009 Pearson Prentice Hall. All rights
reserved.
Transfer Pricing Illustration
© 2009 Pearson Prentice Hall. All rights
reserved.
Transfer
Pricing
Illustrati
on
© 2009 Pearson Prentice Hall. All rights
reserved.
Minimum Transfer Price
The minimum transfer price in many
situations should be:
Incremental cost is the additional cost of
producing and transferring the product or
service
Opportunity cost is the maximum contribution
margin forgone by the selling subunit if the
product or service is transferred internally
© 2009 Pearson Prentice Hall. All rights
reserved.
Multinational Transfer Pricing and
Tax Considerations
Transfer prices often have tax implications
Tax factors include income taxes, payroll
taxes, customs duties, tariffs, sales taxes,
value-added taxes, environment-related taxes
and other government levies
© 2009 Pearson Prentice Hall. All rights
reserved.
Multinational Transfer Pricing and
Tax Considerations
Section 482 of the US Internal Revenue Code
governs taxation of multinational transfer
pricing
Section 482 requires that transfer prices
between a company and its foreign division or
subsidiary equal the price that would be
charged by an unrelated third party in a
comparable transaction
Transfer price could be market-based or “cost-plus”
based
© 2009 Pearson Prentice Hall. All rights
reserved.
© 2009 Pearson Prentice Hall. All rights
reserved.
Transfer Pricing,
and Multinational Considerations
© 2009 Pearson Prentice Hall. All rights
reserved.
Management Control
Systems
Management Control Systems are a means of
gathering and using information to aid and
coordinate the planning and control decisions
throughout an organization and to guide the
behavior of its managers and other employees
© 2009 Pearson Prentice Hall. All rights
reserved.
Management Control
Systems
Many management control systems contain
some or all of the balanced scorecard
perspectives:
1. Financial
2. Customer
3. Internal Business Process
4. Learning and Growth
© 2009 Pearson Prentice Hall. All rights
reserved.
Management Control
Systems
Consist of Formal and Informal control
systems:
Formal systems include explicit rules,
procedures, performance measures, and
incentive plans that guide the behavior of its
managers and other employees
Informal systems include shared values,
loyalties, and mutual commitments among
members of the company, corporate culture,
and unwritten norms about acceptable behavior
© 2009 Pearson Prentice Hall. All rights
reserved.
Evaluating
Management Control Systems
To be effective, management control systems
should be closely aligned to the firm’s
strategies and goals
Systems should be designed to fit the
company’s structure and decision-making
responsibility of individual managers
© 2009 Pearson Prentice Hall. All rights
reserved.
Evaluating
Management Control Systems
Effective management control systems should
also motivate managers and their employees
Motivation is the desire to attain a selected
goal (goal-congruence) combined with the
resulting pursuit of that goal (effort)
© 2009 Pearson Prentice Hall. All rights
reserved.
Two Aspects of Motivation
Goal Congruence exists when individuals and
groups work toward achieving the
organization’s goals – managers working in
their own best interest take actions that align
with the overall goals of top management
Effort is exertions toward reaching a goal,
including both physical and mental actions
© 2009 Pearson Prentice Hall. All rights
reserved.
Organization Structure and
Decentralization
Decentralization is the freedom for managers
at lower levels of the organization to make
decisions
Autonomy is the degree of freedom to make
decisions. The greater the freedom, the
greater the autonomy
© 2009 Pearson Prentice Hall. All rights
reserved.
Decentralization vs.
Centralization
Total decentralization means minimum
constraints and maximum freedom for managers
at the lowest levels of an organization to make
decisions
Total centralization means maximum constraints
and minimum freedom for managers at the
lowest levels of an organization to make
decisions
Companies structures generally fall somewhere
in between these two extremes, as each has
benefits and costs. Structure chosen cost vs.
benefit analysis
© 2009 Pearson Prentice Hall. All rights
reserved.
Benefits of Decentralization
Creates greater responsiveness to local needs
Leads to gains from faster decision making
Increases motivation of subunit managers
Assists management development and
learning
Sharpens the focus of subunit managers
© 2009 Pearson Prentice Hall. All rights
reserved.
Costs of Decentralization
Leads to Suboptimal Decision Making, which
arises when a decision’s benefit to one
subunit is more than offset by the costs or
loss of benefits to the organization as a whole.
Also called Incongruent Decision Making or
Dysfunctional Decision Making
© 2009 Pearson Prentice Hall. All rights
reserved.
Costs of Decentralization
Focuses manger’s attention on the subunit
rather than the company as a whole
Increases costs of gathering information
Results in duplication of activities
© 2009 Pearson Prentice Hall. All rights
reserved.
Decentralization and
Multinational Firms
Multinational firms – companies that operate in
multiple countries – are often decentralized
because centralized control of a company with
subunits around the world is often physically and
practically impossible
Decentralization enables managers in different
countries to make decisions that exploit their
knowledge of local business and political
conditions and to deal with uncertainties in their
individual environments
Biggest Drawback to International
Decentralization: Loss or lack of control
© 2009 Pearson Prentice Hall. All rights
reserved.
Choices About
Responsibility Centers
Regardless of the degree of decentralization,
management control systems uses one or a
mix of the four types of responsibility centers:
Cost Center
Revenue Center
Profit Center
Investment Center
© 2009 Pearson Prentice Hall. All rights
reserved.
Transfer Pricing
Transfer Price – the price one subunit
(department or division) charges for a product
or service supplied to another subunit of the
same organization
Management control systems use transfer
prices to coordinate the actions of subunits
and to evaluate their performance
© 2009 Pearson Prentice Hall. All rights
reserved.
Transfer Pricing
The transfer price creates revenues for the
selling subunit and purchase costs for the
buying subunit affecting each subunit’s
operating income
Intermediate Product – the product or service
transferred between subunits of an
organization
© 2009 Pearson Prentice Hall. All rights
reserved.
Three Transfer Pricing
Methods
1. Market-based Transfer Prices
2. Cost-based Transfer Prices
3. Negotiated Transfer Prices
© 2009 Pearson Prentice Hall. All rights
reserved.
Market-Based Transfer Prices
Top management chooses to use the price of
similar product or service that is publicly
available. Sources of prices include trade
associations, competitors, etc.
© 2009 Pearson Prentice Hall. All rights
reserved.
Market-Based Transfer Prices
Lead to optimal decision-making when three
conditions are satisfied:
1. The market for the intermediate product is
perfectly competitive
2. Interdependencies of subunits are minimal
3. There are no additional costs or benefits to
the company as a whole from buying or
selling in the external market instead of
transacting internally
© 2009 Pearson Prentice Hall. All rights
reserved.
Market-Based Transfer Prices
A perfectly competitive market exists when
there is a homogeneous product with buying
prices equal to selling prices and no individual
buyer or seller can affect those prices by their
own actions
Allows a firm to achieve goal congruence,
motivating management effort, subunit
performance evaluations, and subunit autonomy
Perhaps should not be used if the market is
currently in a state of “distress pricing”
© 2009 Pearson Prentice Hall. All rights
reserved.
Cost-Based Transfer Prices
Top management chooses a transfer price
based on the costs of producing the
intermediate product. Examples include:
Variable Production Costs
Variable and Fixed Production Costs
Full Costs (including life-cycle costs)
One of the above, plus some markup
Useful when market prices are unavailable,
inappropriate, or too costly to obtain
© 2009 Pearson Prentice Hall. All rights
reserved.
Cost-Based Transfer Pricing
Alternatives
Prorating the difference between the
maximum and minimum cost-based transfer
prices
Dual-Pricing – using two separate transferpricing methods to price each transfer from
one subunit to another. Example: selling
division receives full cost pricing, and the
buying division pays market pricing
© 2009 Pearson Prentice Hall. All rights
reserved.
Negotiated Transfer Prices
Occasionally, subunits of a firm are free to
negotiate the transfer price between
themselves and then to decide whether to
buy and sell internally or deal with external
parties
May or may not bear any resemblance to
cost or market data
Often used when market prices are volatile
Represent the outcome of a bargaining
process between the selling and buying
subunits
© 2009 Pearson Prentice Hall. All rights
reserved.
Comparison of TransferPricing Methods
© 2009 Pearson Prentice Hall. All rights
reserved.
Transfer Pricing Illustration
© 2009 Pearson Prentice Hall. All rights
reserved.
Transfer
Pricing
Illustrati
on
© 2009 Pearson Prentice Hall. All rights
reserved.
Minimum Transfer Price
The minimum transfer price in many
situations should be:
Incremental cost is the additional cost of
producing and transferring the product or
service
Opportunity cost is the maximum contribution
margin forgone by the selling subunit if the
product or service is transferred internally
© 2009 Pearson Prentice Hall. All rights
reserved.
Multinational Transfer Pricing and
Tax Considerations
Transfer prices often have tax implications
Tax factors include income taxes, payroll
taxes, customs duties, tariffs, sales taxes,
value-added taxes, environment-related taxes
and other government levies
© 2009 Pearson Prentice Hall. All rights
reserved.
Multinational Transfer Pricing and
Tax Considerations
Section 482 of the US Internal Revenue Code
governs taxation of multinational transfer
pricing
Section 482 requires that transfer prices
between a company and its foreign division or
subsidiary equal the price that would be
charged by an unrelated third party in a
comparable transaction
Transfer price could be market-based or “cost-plus”
based
© 2009 Pearson Prentice Hall. All rights
reserved.
© 2009 Pearson Prentice Hall. All rights
reserved.