Chapter 13Responsibility Accounting

and Transfer Pricing in Decentralized Organizations

Cost AccountingFoundations and Evolutions

Kinney, Prather, Raiborn

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

Age of firm Young MatureSize of firm Small LargeStage of product development Stable GrowthGrowth rate Slow RapidImpact on profits of incorrect decisions High LowManagement’s confidence in subordinates Low HighDegree of control Tight Moderate/loose

Factor Centralized Decentralized

Decentralization Continuum

Geographic diversity Local WidespreadCost of communications Low HighAbility to resolve conflicts Easy DifficultLevel of employee motivation Low Moderate to highLevel of organizational flexibility Low HighResponse time to changes Slow Rapid

Factor Centralized Decentralized

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• Target ROI• Desired/actual market share• Throughput• Defects• Backorders• Complaints• On-time delivery• Manufacturing cycle

efficiency

• Reduction of non-value-added time

• Employee suggestions received/implemented

• Unplanned production interruptions

• Schedule changes• Engineering changes• Safety violations• Absenteeism

Control Process Steps

Compare

Compare

Plan

GatheractualdataManagerial

influence

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 PricingInternal 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• Better goal congruence• Better performance

evaluations• More motivated

managers• Better cash

management

External Objectives• Less taxes and tariffs• Less foreign exchange

risks• Better competitive

positions• Better relations with

government

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?