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Responsibility Accounting, Performance Measurement, And Transfer Pricing
I. Overview
A responsibility accounting system.
To harmonize the measures used to evaluate managers with the measures used in top management’s decision models.
- Assigning responsibilities activities.
- Delegating the authority to do necessary tasks.
- Establishing accounting and the degree of control.
- Measuring and evaluating performance.
- Responsibility is the obligation to perform.
- Authority is the power to direct and require performance from others.
Accountability.
Controllability.
Only on the basis of factors controllable by the manager.
Responsibility centers.
Examples: cost center, revenue center, and profit center.
Investment center.
Fixed costs are less controllable than variable costs; therefore, a contribution margin (sales-variable costs) is fairer than a gross margin (sales – cost of sales).
- Such costs are allocated to remind managers that such costs exist.
- They would incur the costs if their operations were independent.
- Earnings must cover some amount of support costs.
- Center services need to be used appropriately.
- Managers who bear the costs of services they do not control may exert on those who do.
Residual income.
Return on investment.
Economic value added.
Performance measurements
Balance scorecard.
Critical success factors?
Strengths, Weaknesses, Opportunities, and Threats (SWOT) analysis.
Strengths and Weaknesses.
Opportunities and Threats.
Core competencies.
A price charge by one segment of an entity for goods and services it provides to another segment.
- Variable cost.
- Full costs.
- Market price.
- Negotiation.
To determine a price that motivates the seller and the buyer to achieve the same goals.
It is the sum of the incremental cost of producing the unit and the opportunity cost of selling it internally.
An external market for the product exists, and the seller has excess capacity.
II. Basis Of A Responsibility System
Management effort and goal congruence.
Because the entity may lack or have no incentive to minimize cost.
Specific, objective, and verifiable.
The manager may be knowledgeable about the activities and the potential for behavioral change.
The service center.
Variance analysis.
To motivate management to perform in a manner consistent with overall company objectives.
Investment center.
The proper delegation of responsibility and authority.
Authority to make decisions affecting the major determinants of profits, including the power to choose its markets and sources of supply and significant controls over the amount of invested capital.
III. Responsibility Accounting
Management by exception.
Because it facilitates evaluation of company management by providing data on particular segments.
Because depreciation on the equipment is ordinarily not controllable by the manager of an assembly line and should not appear on his or her performance report.
Note: Costs are classified as controllable and uncontrollable to assign responsibility, implying that some revenue and cost can be changed through effective management.
Because a fixed cost is directly attributed to a segment, it is not controllable by the manager.
- Corporate administrative costs are allocated on the basis of net segment sales.
- Personnel department costs are assigned on the basis of the number of employees in each segment.
- Fixed computer facility costs are divided equally among each segment.
- Depreciation for a fax machine and allocation to each segment equally.
Cause and effect.
Because fairness is an objective rather than a criterion, and moreover, fairness may be interpreted differently by different managers.
When a cause-effect relationship cannot be feasibly identified.
When one segment takes an action that benefits itself but not the entity as a whole.
Maximization.
Throughput time.
To evaluate the performance of a manufacturing system.
Because managers are likely to maximize the measures in the performance evaluation model.
- Profitability.
- Customer satisfaction.
- Innovation.
- Efficiency, quality, and time.
The use of different accounting methods impairs compatibility.
- Greater centralization.
- Lack of long-term planning.
- Reduced innovation.
- Scapegoating.
- Resistance to change.
- High turnover of competent leaders.
- Low morale.
- Nonprioritized downsizing.
- Conflict.
- Turnover of employees.
- Employee participation in setting budgets.
- The number of suppliers.
The segment margin.
The point at which discounted cumulative cash inflows on a project equal discounted total cash outflows.
- Income taxes.
- Interest.
- Entity-wide R&D expense.
- Central administrative cost.
- Corporate officers’ salaries.
IV. Profit Center Performance
- Total asset available.
- Total assets employed.
- Working capital plus other assets.
- Shareholders equity.
Shareholders’ equity.
Total assets available.
Totaled assets employed.
Residual income concentrates on maximizing absolute dollars of income rather than a percentage return as with ROI.
- Turnover of operating assets.
- Gross profit margin.
- Return on equity.
Target return on investment set by the company’s management.
V. Decentralization and Transfer Pricing
The extent of freedom of decision-making by many levels of management.
Because the local manager can make more informed decisions than a centralized manager.
- A tendency to focus on the short-run results to the detriment of the long-term health of the entity.
- An increased risk of loss of control by top management.
- The increased difficulty of coordinating interdependent units.
- Less cooperation and communication among competing decentralized unit managers.
- Duplication of effort and lack of goal congruence.
- Encourages the development of lower-level managers.
- More tasks are delegated to lower-level employees.
- Top managers make fewer operating decisions.
- Greater responsiveness to the needs of local customers, suppliers, and employees.
- Local managers are more knowledgeable about local markets and the needs of customers.
- Respond flexibly and quickly to changing conditions.
- Greater authority enhances managerial morale and development.
Transfer price.
The profit center.
Management effort.
Goal congruence.
The price is equal to the supplier’s cash outflows plus the supplier’s contribution from an outside sale.
The price is set by charging for variable costs plus lump sum or an additional markup, but less than full markup.
The price is usually set by an absorption-costing calculation.
It can lead to suboptimal decisions for the company as a whole.
Note: Setting the transfer price based on actual costs rather than standard costs gives the sellers little incentive to control costs.
It should be set at a point that has the most desirable economic effect on the firm as a whole but motivates the management of every division to perform efficiently.
Standard variable cost.
- When the market is competitive.
- Interdivisional dependency is low.
- Buying in the market involves no marginal costs or benefits.
- Provide information allowing central management to evaluate divisions with respect to total entity profit and each division’s contribution to profit.
- Stimulate each manager’s efficiency without losing each division’s autonomy.
- Motivate each divisional manager to archive his or her own profit goal in a way that contributes to the entity’s success.
Because it only covers selling subunit costs, and it may pay more than is necessary to produce goods and services internally by ignoring relevant alternative market prices.
It will motivate both divisions as estimated profits are shared.