INTRODUCTION

 Organization
– association of
men organized to produced
results

 BusinessOrganization –
association of men in business
Men are best managed when motivated, when
there is a clear definition of:
Structure – open coordination flows and avoid communication
problems w/ defined scope of authority, responsibility, and
accountability
Standards – set of expectations, order, discipline, normalcy
Plans – form an effective and efficient utilization of resources,
develop blueprint, guideposts, compass
Controls – make on-line monitoring, end-of-line monitoring,
variance investigation, corrective measures, feedback
analysis, adjustments
Performance Evaluation – give recognition, rewards,
adjustments, merits, promotions and the like
 Basic foundation of managing organizations

 Must be developed based on the best

organizational plan

 Organizational design is affected by the:

◦ External environment –governance, practices,
socio-cultural dynamics
◦ Internal environment – aspirations, cravings,
philosophies, objectives, goals, credo, culture
Objectives:
1. Channel of motivational activities
2. Clarity
3. Openness (transparency)
4. Speed
5. Trust
6. Responsibility
Objectives:
1. Channel of motivational activities
2. Clarity
3. Openness (transparency)
4. Speed
5. Trust
6. Responsibility
 Centralization Decentralization

•Decisions rests •Power to make

exclusively to top decision is
management entrusted to
operating managers
•Autonomous
responsibility
centers
 Centralization
•Advantages:
•Lower managers may not have the
required skills in making excellent
decisions
•Top management decisions are
geared towards presenting favorable
overall corporate performance that
leads to goal congruence
Decentralization
•Advantages:
•Responsibility center managers are
authorized to decide on operational
matters within their technical
expertise and control
•Decisions are made quicker
•Constant interaction w/ and feedback
from customers w/ lower managers
would lead to an excellent service
•Employees are more involved and
committed
•People trated as responsible:
unfolding of potentials
 Centralization
•Disdvantages:
•Responsibility center managers note
empowered to decide
•Results to slower decisions
•Infrequent interaction w/ and feedback
from customers w/ top management would
lead to inferior service
•Employees less involved and less motivated
•People treated as irresponsible
•Decisions are less guided by the invaluable
worth of technical expertise and hands-on
experience
Decentralization
•Disadvantages:
•Lower managers who have the required
skills in making excellent decisions are
untapped
•Operating managers are inclined to decide
in favor of presenting a favorable results of
their responsibility center’s performance
over that of the organizational performance,
this leads to suboptimization
 Organizational segments are classified into
responsibility centers headed by a manager who
is assigned a corresponding authority,
responsibility, and accountability in business
operations

 Responsibility Centers – any segment,

department, unit, section or division in a
business organization headed by a manager who
has been delegated authority, responsibility, and
accountability to mange a business segment
 Autonomy – independence, the power to decide
on its own affairs without being operationally
subservient to the influences of the mother unit

 Alliance – interdependence, relation among

independent entities or units

 Goal Congruence – objective of management

control: as people work to achieve their own
goals, they also work to achieve the goals of the
company
 Authority – power to give orders, to give
command, to give instructions, or to make
decisions

 Responsibility – duty to do or not to do an

activity, the obligation to produce or not to
produce results

 Accountability – answerability on the

consequences of what has been done or not done
Cost Center Revenue Center Profit Center Investment
•Cost incurrence •Revenue •Revenues and
Center
or nonincurrence generation or Costs incurrence •Investment of
•Cost variance nongeneration or nonincurrence organizational
analysis •Revenue variance •Segment margin resources
analysis analysis • ROI, residual income,
economic value
added (EVA), equity
spread, total SH
return, market value
added
 Cost variance analyses (standard costing)
 Revenue variance analyses (gross profit
variation)
 Segment Margin
◦ Contribution Margin xx
◦ Less: Controllable direct fixed costs & exp xx
◦ Controllable Margin xx
◦ Less: Noncontrollable direct fixed costs & exp xx
◦ Segment Margin xx
Investment Center Manager’s Performance
 Return on Investment (ROI) or
Return on Asset (ROA)
 ROI = Segment Income / Investment
 ROI = (Segment Income / Net Sales) x
(Net Sales / Investment)
 ROI = Return on Sales (ROS) x Asset Turnover (ATO)

 Inc in ROI = Inc in Segment Income / Decrease in

Investment
 Inc in ROI = Inc in ROS x Increase in ATO

◦ ROI – expressed on percentage and has an inherent limitation of

disregarding the peso value performance of a business segment and
its manager
Investment Center Manager’s Performance
◦ Segment Income xx
◦ Less: Minimum Income xx
◦ Residual Income (RI) xx
Segment Income – income before income tax
Minimum Income – investment times imputed income rate
Investment – those resources assigned and operationally used by a
business segment
Imputed Income Rate – desired income rate; implied income rate;
minimum income rate; prevailing market rate from which the
business can generate income w/o accepting a high risk
-----------------------
Sometimes: imputed rate = cost of capital
Positive RI = performance is above standard, favorable
RI is superior than ROI bec. it is determined in absolute peso amount,
not in rate
Investment Center Manager’s Performance
◦ EBIT (1-Tax) xx
◦ Less: Minimum Retun on long-term equity
◦ (TA – CL) x WACOC xx
◦ Economic Value Added (EVA) xx

WACOC – weighted average of cost of capital

EVA – represents the business unit’s true economic profit because a
change in the cost of equity capital is implicit in the COC; more
specific version of residual income
- measures the marginal benefit obtained by using resources in
relation to the business of increasing shareholders value
MNO, a division of Aeon Manufacturing, has assets of P450,000
and an operating income of P110,000.

a. What is the division’s ROI?

b. If the minimum rate of return is 12%, what is the division’s
residual income?

Solution:
a. ROI = Operating Income/ Total Assets
= P110,000/P450,000
= 24.44%

b. Operating Income P110,000

Less: Minimum Required Return
(12% x P450,000) 54,000
Residual Income P 56,000
Consider the following:
Division A Division B
Operating Assets P5,000 P12,500
Operating Income P1,000 P 2,250
ROI 20% 18%

a. Which is the more successful division in terms of ROI?

b. Using 16 percent as the minimum required rate of return,
compute the residual income for each division. Which
division is more successful under this rate?

Solution:
a. Based on the information above, the more successful
division in terms of ROI is division A.
Solution:
a. Based on the information above, the more successful
division in terms of ROI is division A.

b. Division A Division B
Operating Income P1,000 P2,250
Less: Min. Required Return
(16% x P5,000) 800
(16% x P12,500) 2,000
Residual Income P 200 P 250

Division B is more successful in terms of residual income

The following data were taken from the records of Combo
Corporation, a division of Great Food Corp. for the year
ended December 31, 2014:
Sales P12,000,000
Less: Variable Costs and Expenses 8,000,000
Contribution Margin P 4,000,000
Less: Direct Fixed Costs and Expenses 1,000,000
Segment Income P 3,000,000
The company uses an average assets of P8M in 2014. The cost
of capital is 12%.

Required:
a. Determine: 1) Return on Sales 2) Asset Turnover
3) Return on Investment 4) Residual Income
b. The president of Combo Corporation wants to double its ROI
in 2015 by increasing its return on sales by 80%. What is
the expected assets turnover in 2015?
Solution:
a. ROS = Segment Income/Net Sales = P3M/P12M = 25%
ATO = Net Sales/Average Assets = P12M/P8M = 1.5x
ROI = Segment Income/Average Assets = P3M/P8M = 37.5%
ROI = ROS x ATO = 25% x 1.5 = 37.5%

Segment Income P3,000,000

Less: Min. Required Return
(12% x P8) 960,000
Residual Income P2,040,000

b. Desired ROI = 37.5% x 2 = 75%

New ROS = 25% x 180% = 45%
if ROI = ROS x ATO, then,
ATO = ROI/ROS = 75%/45% = 1.67x
An excerpt from the records of South Star Corporation revealed
the following information:
EBIT P 30,000,000
Average Total Assets 100,000,000
Average Current Liabilities 20,000,000
Weighted Average Cost of Capital 18%
Tax Rate 32%

Required: Economic value added

Solution:
EBIT (1-Tax) 30M (1-.32) 21,040,000
Less: Minimum Retun on long-term equity
◦ (TA – CL) x WACOC (100M-20M) x 18% 14,400,000
Economic Value Added (EVA) 6,640,000
Following are data about Cameron Company’s two service
departments and two operating departments.
Service Depts. Operating Depts.
A B X Y
Direct Costs P400 P600 P2,000 P3,000
Service Performed
by Dept. A 30% 30% 40%
by Dept. B 20% 70% 10%

Required: Find the total cost that will be allocated to each of

the operating departments using:
a. Direct Method
b. Step Down Method
c. Reciprocal Method
Direct Method – allocation of cost directly to the operating dept.
Operating Depts.
X Y
by Dept. A 400 x 3/7 171
x 4/7 229
by Dept. B 600 x 7/8 525
x 1/8 75
1,000 696 304
Step-Down Method – allocation of cost to recipient dept.
(first highest) Service Depts. Operating Depts.
A B X Y
400 600
by Dept. A (400) 120 120 160
-0- 720
by Dept. B (720) 630 90
-0- 750 250
Reciprocal Method – highly mathematical allocation method;
allocation made to all recipients

Service Depts. Operating Depts.

A B X Y
400 600
by Dept. A (553) 166 166 221
(153) 766
by Dept. B 153 (766) 536 77
-0- -0- 702 298
A = 400 + .2B
B = 600 + .3A
By using substitution:
A = 553
B = 766
 Occurs when two or more affiliated
companies transact with one another in an
arm’s length nature involving goods or
services in the ordinary course of business
operations

 Transfer Price:
◦ REVENUE selling unit
◦ COST buying unit
 Goal congruence or optimization: when the overall goal of
the organization prevails that of the divisional goals

 Suboptimization: when the individual goal of investment

managers prevails over that of the overall organization’s
goals

 Managerial effort: extent to which a manager attempts to

accomplish a goal

 Techniques of Managerial Motivation:

goal congruence – desire to attain a specific goal
managerial effort – commitment to accomplish the goal
The best transfer price is market price.
Cost-based price = cost + markup percentage
o Cost may either be:

 standard (has the advantage of isolating variances) or

 actual (gives little incentive to control costs; may not
promote long-term efficiencies)
Negotiated market price
o occur when segments are free to determine the prices at which
they buy and sell internally
o appropriate when market prices are subject to rapid
fluctuations
o best bargain price acceptable to the selling and buying
divisions w/o adversely sacrificing respective interests
Arbitrary Transfer Pricing
o set by the management in the corporate headquarters

o anchored on the premise that the entire corporate organization

has to promote its overall goals over and above that of the
division’s goals
o contrary to the principle of decentralization

Dual Pricing
o used when the divisions, selling and buying, use different
prices in recording their inter-company transfers
Transfer Pricing Policy
o normally set by top management

o Factors to consider:
o Overall goal
o Segment goals
o Excess capacity
o Opportunity cost of the transfer
o International tax issues
o Other international issues (i.e foreign exchange rate fluctuations and
limitations on transfer of profits outside the host country)

When capacities are considered, transfer price may be computed

as the sum of the incremental cost plus the opportunity costs
from the alternative use of capacity.
1. Minimum Transfer Price (lower limit-seller)

2. Market-based Transfer Price (upper limit-buyer)

3. Cost-based Transfer Price

a. Variable cost
b. Full Cost
C. Alternative Cost Measures

4. Negotiated Transfer Price

LOWER LIMIT (seller)

Transfer Price
= Differential Costs + Lost CM
per unit per unit
(usually VC)
If selling division has sufficient idle capacity,
NO OPPORTUNITY COST
Lowest acceptable transfer price = VC
UPPER LIMIT (buyer)
- price at which goods are sold on the open market
- best transfer price (profit center concept)

Transfer Price
= price used for outside customer

If selling division has no idle capacity,

THERE IS OPPORTUNITY COST

In using market price as transfer price,

o selling division manager will not lose anything
o buying division manager will get correct signal how much it really
costs the company for the transfer to take place
Useful in highly decentralized organizations

As a general rule, this policy should contain the following

guidelines:
1. The buying division must purchase internally so long
as the selling division meets all bona fide outside
prices and wants to sell internally.
2. The selling division must be free to reject internal
business if it prefers to sell outside.
3. If the selling division does not meet all bona fide
outside prices, then buying division is free to
purchase outside.
4. As independent and impartial body must be
established to settle disagreements between divisions
over transfer prices.
Variable Cost Transfer Price

Transfer Price
= Variable Costs + Differential Costs
per unit per unit

Variable costs – usually approximate differential costs

but when fixed costs increase because of a transfer of
goods between segments, they are differential costs and
therefore, should be included
Full Cost Transfer Price

Transfer Price
= Variable Costs + Fixed Costs
per unit per unit
plus portions of marketing and administrative costs

Not suitable for companies with decentralized structures that

measure the profitability of autonomous units
Departs from goal congruence
Standard full cost may also be use instead of the historical
average cost
Alternative Cost Measures:

a. Full Absorption Cost-based transfer price

- only manufacturing costs (variable and fixed)

b. Cost-Plus transfer price

- based on either variable costs or full absorption costs
with a normal markup to costs as a substitute for market
prices when intermediate market prices are not available
Managers are permitted to negotiate the price for
internally transferred goods and services

An attempt to simulate an arm’s length transaction

between supplying and buying segment.

Major advantage: preserve the autonomy of the

division managers

Disadvantage: very time consuming and require

frequent reexamination and revision of prices
Steps in setting transfer price for services:
1. Identify the different departments contributing
various services.
2. Evaluate the corresponding skill and expertise of
personnel involved in delivering services.
3. Estimate the cost involved in providing the service.
Factors such as time requirements, qualifications,
cost of the facilities needed to provide the service
should be considered.
4. Adopt one or any the principles applied to the
transfer of products discussed.
The Lewis Company has two divisions, Production and
Marketing. Production manufactures pants, which it sells to
both the Marketing Division and to other retailers (to the
latter under a different brand name). Marketing operates
numerous pants stores, and it sells both Lewis pants and
other brands. The following facts also pertain to the Lewis
Company:
o Sales price to retailers if sold by Production: P380 per pair
o Variable Cost to produce: P190 per pair
o Fixed Costs: P2,000,000 per month
o Production is operating far below its capacity.
o Sales price to customers if sold by Marketing: P500 per pair
o Variable marketing costs: 5% of sales price

Marketing has decided to reduce the sales price of Lewis pants.

The company’s variable manufacturing and marketing costs
are differential to this decision, whereas fixed
manufacturing and marketing costs are not.
Required:

a. What is the minimum price that can be charged for the

pants and still cover differential manufacturing and
marketing costs?
b. What is the appropriate transfer price for this decision?
c. What if the transfer price were set at P380? What effect
would this have on the minimum price set by the marketing
manager?
d. How would you answer to questions a and b change if the
Production Division had been operating at full capacity?
Required:

a. What is the minimum price that can be charged for the

pants and still cover differential manufacturing and
marketing costs? P200 X = 190 + .05X
b. What is the appropriate transfer price for this decision?
P190 VC: production is operating below capacity
c. What if the transfer price were set at P380? What effect
would this have on the minimum price set by the marketing
manager? P400 X = 380 + .05X
d. How would you answer to questions a and b change if the
Production Division had been operating at full capacity?
a. P400 X = 380 + .05X
b. P380 Selling Price used by Production