Cost Accounting

Foundations and Evolutions

Kinney, Prather, Raiborn

Chapter 13
Responsibility Accounting
and Transfer Pricing
in Decentralized Organizations
 Learning Objectives (1 of 2)

• Explain the organizational characteristics used

to determine if a firm should be centralized or
decentralized
• Clarify the relationship between responsibility
accounting and decentralization
• Contrast the four types of responsibility
centers
 Learning Objectives (2 of 2)
• Explain why and how service department
costs are allocated to revenue-producing
departments
• Explain why transfer prices are used and
describe the types of transfer prices
• Explain the difficulties that multinational
companies may encounter when using
transfer prices
 Decentralization Continuum
Factor Centralized Decentralized
Age of firm Young Mature
Size of firm Small Large
Stage of product
development Stable Growth
Growth rate Slow Rapid
Impact on profits
of incorrect decisions High Low
Management’s
confidence in
subordinates Low High
Degree of control Tight Moderate/loose
 Decentralization Continuum
Factor Centralized Decentralized
Geographic
diversity Local Widespread
Cost of communications Low High
Ability to resolve
conflicts Easy Difficult
Level of employee
motivation Low Moderate to high
Level of organizational
flexibility Low High
Response time to
changes Slow Rapid
 Advantages of Decentralization
• Personnel
– train and screen aspiring managers
– develop leadership qualities, problem-solving
abilities, and decision-making skills
– compare managers’ results
– increase job satisfaction and job enrichment
• Effective means of achieving organizational goals
• Reduces decision-making time
• Allows management by exception
 Disadvantages of Decentralization
• Lack of goal congruence
• Suboptimization
– pursuing the subunit manager’s goals instead of the
company’s goals
• Requires more effective communication skills
• Managers must relinquish control
• Expensive
– train managers in decision-making skills
– absorb cost of poor decisions
– requires a sophisticated planning and reporting system
 Responsibility Reports

• Monetary and nonmonetary

• Adjusted for the planning, controlling, and
decision-making needs of each unit
manager
• Separates costs as controllable or
noncontrollable by the unit manager
 Nonmonetary Measures
• Capacity measures • Reduction of non-value-
• Target ROI added time
• Desired/actual market share • Employee suggestions
• Throughput received/implemented
• Defects • Unplanned production
• Backorders interruptions
• Complaints • Schedule changes
• On-time delivery • Engineering changes
• Manufacturing cycle • Safety violations
efficiency • Absenteeism
 Control Process Steps

Compare Plan
Gather
actual
Managerial data
influence
Compare
 Responsibility Accounting

• Upward flow of information

– from operations to top management
• Unit level reports are detailed
• Upper-level reports are summarized
• Encourages management by exception
– Major deviations are highlighted
 Responsibility Accounting
• Disadvantages of responsibility accounting
include
– Important details may not be visible at upper
management levels
– Managers might “promote” their unit while
“blaming” their competitor units
– Departmental interdependencies might not be
visible
 Responsibility Centers
• Responsibility accounting systems identify,
measure, and report on activities in
responsibility centers
– Cost center
– Revenue center
– Profit center
– Investment center
Service Cost Allocation Methods

• Direct method
• Step method
– Benefits-provided ranking
• Algebraic method
– Simultaneous equations
 Service Cost Allocation
• Allocated service department costs are
included in the overhead application rate for
the revenue-producing areas
• Service department costs are allocated to
products or jobs through normal overhead
assignment procedures
 Transfer Pricing
Internal charges for the exchange of goods or
services within the organization
• Promote goal congruence
• Make performance evaluation among segments
more comparable
• Transform a cost center into a pseudo- profit
center
• For internal use only
– Eliminated on external financial reports
• Encourages managers to be
entrepreneurial
 Transfer Pricing Systems
• May cause disagreement among managers
• Add costs and take time
• May not work for all departments
• May cause dysfunctional behavior
• May cause underutilization or
overutilization of services
• Complicate tax planning
for multinationals
 Multinational Transfer Pricing

Internal Objectives External Objectives

• Better goal • Less taxes and tariffs
congruence • Less foreign exchange
• Better performance risks
evaluations • Better competitive
• More motivated positions
managers • Better relations with
• Better cash government
management
 Multinational Transfer Pricing
• Develop guidelines that are followed on a
consistent basis
• Set transfer prices that reflect an arm’s-
length transaction
• Be prepared for transfer pricing audits
• Consider Advance Pricing Agreements –
binding contracts between a company and
taxing authorities that set an acceptable
transfer pricing methodology
 Questions

• What are some advantages and

disadvantages of decentralization?
• What are the four types of responsibility
centers?
• Why are transfer prices used?