Management Control Systems,
Transfer Pricing, and
Multinational Considerations
Chapter 22
2009 Foster School of Business
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Overview
• What is a Management Control System?
• Centralized vs. decentralized control structure
• Transfer pricing:
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Function
Setting TPs
Dual TPs
Negotiated TPs (Calculating Min. & Max. range)
International tax issues
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Cost Accounting
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Management Control Systems
A management control system is a means
of gathering and using information.
It guides the behavior of managers and
employees.
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Management Control Systems
Financial data
Nonfinancial data
Formal control system
Informal control system
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Evaluating Management
Control Systems
Motivation
Goal congruence
Effort
Lead to rewards
Monetary
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Nonmonetary
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Organization (control) Structure
Total decentralization
Total centralization
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Benefits of Decentralization
Creates greater responsiveness to local needs
Leads to gains from quicker decision making
Increases motivation of subunit managers
Assists management development and learning
Sharpens the focus of subunit managers
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Limitations of Decentralization
Suboptimal decision making may occur
Focuses the manager’s attention on the subunit
rather than the organization as a whole
Increases the costs of gathering information
Results in duplication of activities
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Cost Accounting
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Decentralization in
Multinational Companies
Decentralization enables country managers to
make decisions that exploit their knowledge
of local business and political conditions.
Multinational corporations often rotate
managers between foreign locations
and corporate headquarters.
Control Problem: Barings Bank (200 yrs old)—1995 Nick Leeson caused
over ₤1 B loss.
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Cost Accounting
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Responsibility Centers
Cost
center
Revenue
center
Profit
center
Investment
center
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Transfer Pricing
A transfer price is the price one subunit charges
for a product or service supplied to another
subunit of the same organization.
Intermediate products are the products
transferred between subunits of an
organization.
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Transfer Pricing
Transfer pricing should: (1) help achieve
a company’s strategies and goals.
(2) fit the organization’s structure
(3) promote goal congruence
(4) promote a sustained high level
of management effort
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Transfer-Pricing Methods
Market-based transfer prices
Cost-based transfer prices
Negotiated transfer prices
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Market-Based Transfer Prices
By using market-based transfer prices
in a perfectly competitive market, a
company can achieve the following:
Goal congruence
Management effort
Subunit performance evaluation
Subunit autonomy
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Market-Based Transfer Prices
Market prices also serve to evaluate the
economic viability and profitability
of divisions individually.
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Market-Based Transfer Prices
When supply outstrips demand, market prices
may drop well below their historical average.
Distress prices are the drop in prices
expected to be temporary.
Basing transfer prices on depressed market prices will not
always lead to optimal decisions for an organization.
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Cost-based Transfer Prices
When transfer prices are
based on full cost plus a
markup, suboptimal
decisions can result.
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Dual Transfer Prices
An example of dual pricing is for Larry & Co.
to credit the Selling Division with
112% of the full cost transfer price of $24.64
per barrel of crude oil.
Debit the Buying Division with the market-based
transfer price of $23 per barrel of crude oil.
And debit a corporate account for the difference!
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Negotiated Transfer Prices
Negotiated transfer prices arise from the
outcome of a bargaining process between
selling and buying divisions.
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General Guideline: min. & max.
transfer price
Maximum transfer price = Market price
Minimum transfer price
= Incremental costs per unit incurred
up to the point of transfer
+ Opportunity costs per unit to the selling division
Incremental cost often times = variable cost
Opportunity costs often times = lost CM
Opportunity costs could = lost savings
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Min. & Max. transfer price--examples
Some examples:
(1) Slowcar
(2) S.F. Manufacturing
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Slowcar Company
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The Assembly Division of SLOWCAR Company has offered to purchase
90,000 batteries from the Electrical Division (ED) for $104 per unit. At a
normal volume of 250,000 batteries per year, production costs per battery are:
Direct materials
$40
Direct labor
20
Variable factory overhead 12
Fixed factory overhead
42
Total
$114
The Electrical Division has been selling 250,000 batteries per year to outside
buyers for $136 each. Capacity is 350,000 batteries/year. The Assembly
Division has been buying batteries from outside suppliers for $130 each.
Should the Electrical Division manager accept the offer? Will an internal
transfer be of any benefit to the company?
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SF Manufacturing
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The SF Manufacturing Co. has two divisions in Iowa, the Supply Division and
the BUY Division. Currently, the BUY Division buys a part (3,000 units) from
Supply for $12.00 per unit. Supply wants to increase the price to BUY to
$15.00. The controller of BUY claims that she cannot afford to go that high,
as it will decrease the division’s profit to near zero. BUY can purchase the
part from an outside supplier for $14.00. The cost figures for Supply are:
Direct Materials
$3.25
Direct Labor
4.75
Variable Overhead
0.60
Fixed Overhead
1.20
A. If Supply ceases to produce the parts for BUY, it will be able to avoid onethird of the fixed MOH. Supply has no alternative uses for its facilities.
Should BUY continue to get the units from Supply or start to purchase the
units from the outside supplier? (From the standpoint of SF as a whole).
(What is the min. & max. transfer price if BUY and SUPPLY negotiate?)
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SF Mfg.—continued
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Now, assume that Supply could use the facilities currently used to produce the
3,000 units for BUY to make 5,000 units of a different product. The new
product will sell for $16.00 and has the following costs:
Direct Materials
$3.00
Direct Labor
4.30
Variable Overhead
5.40
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B. What is the min. & max. transfer price if BUY and SUPPLY negotiate?
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C. What should be done from the company’s point of view? Why?
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Comparison of Methods
Achieves Goal Congruence
Market Price: Yes, if markets competitive
Cost-Based:
Often, but not always
Negotiated:
Yes
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Comparison of Methods
Useful for Evaluating Subunit Performance
Market Price: Yes, if markets competitive
Cost-Based:
Negotiated:
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Difficult, unless transfer
price exceeds full cost
Yes
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Comparison of Methods
Motivates Management Effort
Market Price: Yes
Cost-Based:
Negotiated:
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Yes, if based on budgeted
costs; less incentive if
based on actual cost
Yes
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Comparison of Methods
Preserves Subunit Autonomy
Market Price: Yes, if markets competitive
Cost-Based:
No, it is rule based
Negotiated:
Yes
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Comparison of Methods
Other Factors
Market Price: No market may exist
Cost-Based:
Negotiated:
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Useful for determining
full-cost; easy to implement
Bargaining takes time and
may need to be reviewed
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Multinational Transfer Pricing
IRC Section 482 requires that transfer prices
for both tangible and intangible property
between a company and its foreign division
be set to equal the price that would be
charged by an unrelated third party in a
comparable transaction (arm’s length).
This still leaves a little “room to wiggle.”
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