Financial performance reports and transfer pricing

Chapter 12Financial performance reports and transfer pricing12-1Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithOutlineDecentralisation and responsibility accountingResponsibility centresNew developments in organisational structuringTeam-based structures and shared servicesFinancial performance reportsTransfer pricing12-2Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithDecentralisation and responsibility accountingDecentralisationThe restructuring of the organisation into units, such as units and departments, each with specific operations and decision-making responsibilitiesResponsibility accountingAssigning responsibility to managers to run particular units of the organisationHelps to reinforce the advantages of decentralisationGoal congruence helps ensure that decentralised organisations are effectiveConsistency between managers’ personal goals and the goals of the organisation12-3Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithDecentralisationBenefitsManagers of units have better local information about markets and operations to enable them to manage their areas more effectivelyProvides managerial training for future higher-level managersMay lead to greater motivation and job satisfaction for unit managersAllows corporate managers more time for strategic issuesDelegation allows the organisation to react more quickly to opportunities and problems as they arise12-4(cont.)Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithDecentralisation (cont.)Negative consequencesManagers may focus too narrowly on their own unit’s performance rather than on attaining the organisation’s overall goalsSome tasks and services may be duplicated unnecessarilyGoal congruence: a behavioural challengeGoal congruence may be difficult to achieve in a decentralised organisationPerformance measures and reward systems may provide direction and incentives to achieve wider organisational goals12-5Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithResponsibility centresA responsibility centres is a unit of an organisation where the manager is held accountable for the unit’s activities and performanceInvestment centreProfit centreCost centreRevenue centre12-6Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)12-7Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithResponsibility centres (cont.)Terminology used in practiceCost centre is commonly usedRevenue centre seldom usedProfit centre may refer to both profit centres and investment centresStrategic business unit (SBU) often used to refer to investment centres and occasionally to profit centres which have their own distinct markets and strategies12-8Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithNew developments in organisational structuringShared servicesThe concentration of some support services that are typically spread across a decentralised organisation into a separate unit to service multiple internal customersMay focus on non-strategic areas, such as accounts payable, payroll, finance, information technologyCapture the best aspects of centralised and decentralised structuresBusiness units may choose to use a shared service unit or an outside provider, so there is an incentive for shared service units to deliver high quality service to internal customers12-9Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)New developments in organisational structuring (cont.)Team-based structuresFirms have moved away from hierarchical structures towards flatter structures that involve fewer levels of managementSelf-managed work teams may be used to manage all aspects of a processIn the production area, team responsibilities may includeProduction planning, ordering materials, liaising with suppliers and customers, all aspects of the production process, cost budgets and performance management12-10Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)New developments in organisational structuring (cont.)Team-based structuresTeams may manage some processes more effectivelyTeams may promote employee satisfaction, improved customer satisfaction and productivityGreater empowerment may result from the transfer of decision-making responsibility from middle managers to teamsTeams are often set up as cost centresNon-financial measures may be more important in managing a team than cost measures12-11Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithFinancial performance reportsA financial performance report shows key financial results appropriate for the types of responsibility centreSegmented profit statements may show profits for major responsibility centres and the entire organisationA contribution margin format may be used in these reports to provide more useful information for managers12-12Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Financial performance reports (cont.)Performance of units and unit managers may differA manager’s performance may be based on revenues and costs that the manager can control or significantly influenceReports that evaluate the economic performance of a unit should focus on revenues and costs that are attributable to that unitIn practice, not everyone agrees this distinction is warranted12-13Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Financial performance reports (cont.)Cost allocation in performance reportsSome costs attributable to a unit may be incurred outside of that unit and therefore need to be allocated to the unitCausal allocation bases may be used to charge the costs of services to the units that used the servicesCommon costs result from activities that are performed for the benefit of more than one responsibility centreArbitrary allocation of common cost to units may not provide useful information in reports12-14Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Financial performance reports (cont.) A hierarchy of financial performance reports may be preparedTo reflect the organisational structureBudgets and variance reports may be included in performance reportsAllocated costs should be included in performance reports when relevant12-15Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Financial performance reports (cont.)Real-time reportingInvolves managers having access to up-to-date information whenever they require itGaining a competitive advantage may rely on having latest information on company performance readily availableThe difficulties in achieving a virtual close may prevent real-time reportingA virtual close can be achieved by reducing the complexity of end-of-period closing of accountsFocus on critical performance dataImplement ERP systemsRe-engineer the reporting system12-16Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithTransfer pricingThe internal selling price used when goods and services are transferred between profit centres and investment centres in a decentralised organisationRevenue for the selling unit and cost for the buying unitAllows the selling unit to earn profit to reflect their effort in producing the productThe transfer price shouldResult in unit profits that are a reliable and accurate measure of unit performancePreserve and encourage unit autonomyEncourage goal-congruent behaviour12-17Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Transfer pricing (cont.)Who sets the transfer prices?Managers of profit centres and investment centres may have considerable autonomy in deciding whether to accept or reject orders for goods or servicesto source their materials inside or outside the organisationto set and accept transfer pricesDirect intervention by corporate (head office) managers to dictate transfer prices may be inconsistent with the philosophy of decentralisationCorporate management may develop general policies for transfer pricing12-18Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Transfer pricing (cont.)Transfer pricing methodsMarket-based pricesCost-plus pricesNegotiated pricesMarket-based pricesNeed competitive external markets for a productCost-plus pricesWhere there is no external market priceIntermediate products have no market outside the company, and are processed further to become final products12-19Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Transfer pricing (cont.)Cost-plus pricesStandard variable cost plus markup allows supplying unit to show a contribution margin on the transferred productStandard absorption cost may lead to overpricing of products and dysfunctional decisionsStandard costs should always be used in favour of actual costs, to prevent cost inefficiencies being passed onto buying unit12-20Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Transfer pricing (cont.)Negotiated pricesMarket price may form the starting point, and cost may be the lower boundaryWhether or not the supplying unit has spare (excess) capacity can influence the appropriate level of transfer price12-21Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Transfer pricing (cont.)General transfer pricing ruleProvides guidance on the appropriate transfer priceRepresents a minimum transfer priceMay guide unit managers to make goal-congruent decisions12-22unit supplying thetounitper cost opportunityunit supplyingby incurredunitper costsoutlay additionalpriceTransfer +=Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithTransfer pricing under different scenariosAn external market and spare capacity in the supplying unitWhere there is spare capacity, a transfer of product gives the supplying unit additional profits that it would not otherwise makeThe two units may negotiate a transfer price less than market to provide an incentive for the buying unit to purchase from the supplying unit12-23Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Transfer pricing under different scenarios (cont.)An external market and no spare capacity in the supplying unitWhen there is no spare capacity, the supplying unit will need to account for the opportunity cost of lost profits on sales due to the transferExternal market and limited capacity in the supplying unitWhere capacity is limited, an opportunity cost needs to be accounted for in the transfer price12-24Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Transfer pricing under different scenarios (cont.)No external market and spare capacity in the supplying unitThere is no opportunity cost associated with the transfer, so the transfer price may be based on cost-plusNo external market and no spare capacity in the supplying unitThe transfer price will need to account for opportunity cost on lost sales due to the transfer12-25Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith12-26Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithTransfer pricing: the influence of taxationTransfer pricing is used by many companies to transfer profits between business units in different countriesThis moves profits between different tax jurisdictions International tax considerations will influence the transfer prices that are used for domestic purposesService firms and not-for-profit organisations may use transfer pricing when services are transferred between business units12-27Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithTransfer pricing and service level agreementsA service level agreement (SLA) is a contract between two units whichestablishes the nature of the service that will be provided by one unit to the otheroutlines the responsibilities of each partyoutlines price, quality and timing of service delivery, performance targets, problem-solving arrangements, ways in which the agreement can be changed or terminatedThe price of the service is a transfer price, and can be determined using similar methods to those used for the transfer of goods12-28Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithSummaryDecentralisation is common in many organisations and coupled with responsibility accounting may improve access to better information and skills, more timely decisions, increase motivation of unit managers, and increase goal congruenceFinancial performance report can be structured along responsibility lines and should reflect the type of accountability assigned to units and their managers The performance of units should be distinguished from the performance of unit managers12-29Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Summary (cont.)Transfer pricing is used in decentralised organisations to recognise revenue and costs of goods and services transferred between unitsTransfer prices may be based on market prices, costs or may be negotiatedIn a decentralised organisation, it is inconsistent for corporate management to dictate transfer prices, but they may set broad policiesA general transfer pricing rule can provide a minimum transfer price that may reduce dysfunctional decisions12-30Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith