978-1337119207 Chapter 23 Part 2

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Chapter 23(9) Evaluating Decentralized Operations 426

INTERNET ACTIVITY—Balanced Scorecard

The balanced scorecard emphasizes that financial and nonfinancial measures are both important in

measuring the performance of an organization. In fact, the nonfinancial measures frequently focus

management on items leading to the long-term success of an organization. The four components of the

balanced scorecard are described in text Exhibit 10. These components are (1) Innovation and Learning,

(2) Customer Service, (3) Internal Processes, and (4) Financial Performance.

Choose an organization (such as your college or university) and ask students to develop at least one

measure in each of the four components of the balanced scorecard. For example, a measure in the

innovation and learning category might be the number of classrooms converted for multimedia

presentations.

Ask your students to perform an Internet search using “Balanced Scorecard” as the search criteria and ask

them to report what types of items their search uncovers. Your students will find numerous links to

consulting firms and companies that have developed software applications to assist with implementing a

businesses apply new management ideas.

OBJECTIVE 5

Describe and illustrate how the market price, negotiated price, and cost price approaches to

transfer pricing may be used by decentralized segments of a business.

SYNOPSIS

market price but higher than the supplying division’s variable costs per unit, computed as: variable costs

per unit < transfer price < market price. A negotiated price provides each division manager with an

incentive to negotiate the transfer of materials, and the overall company’s income from operations will

also increase. Cost is used to set the price in the cost price approach. In this approach, either total product

Key Terms and Definitions

 Cost Price Approach—An approach to transfer pricing that uses cost as the basis for setting the

transfer price.

 Market Price Approach—An approach to transfer pricing that uses the price at which the

product or service transferred could be sold to outside buyers as the transfer price.

Chapter 23(9) Evaluating Decentralized Operations 427

 Negotiated Price Approach—An approach to transfer pricing that allows managers of

decentralized units to agree (negotiate) among themselves as to the transfer price.

 Transfer Price—The price charged one decentralized unit by another for the goods or services

provided.

Relevant Check Up Corner and Exhibits

 Exhibit 11—Commonly Used Transfer Prices

 Exhibit 12—Income Statement—No Transfers Between Divisions

 Exhibit 13—Income Statements—Negotiated Transfer Price

 Check Up Corner 23(9)-4 – Transfer Pricing

SUGGESTED APPROACH

pricing.

LECTURE AID—Transfer Pricing

In some cases, one division of a company may make products that are used by another division of that

same company. For example, General Motors has separate divisions that make automobile components

(such as engines, transmissions, and stereos). These divisions “sell” their component parts to divisions

are transferred to another division.

TM 23(9)-10 lists the benefits that are gained when transfer pricing is used in intercompany transfers. The

information below will help you review that TM with your students.

Benefits of Transfer Pricing

1. Divisions can be evaluated as profit or investment centers.

preparing financial statements under financial accounting principles.)

Chapter 23(9) Evaluating Decentralized Operations 428

2. Divisions are forced to control costs and operate competitively.

3. If divisions are permitted to buy component parts wherever they can find the best price (either

internally or externally), transfer pricing will allow a company to maximize its profits.

If a component part can be produced cheaper by an outside company than an internal division, that

part will be purchased from the outside. This forces the internal division to cut costs to the point that

it competes with outside firms or is discontinued. In addition, the division manufacturing the

component parts is free to sell to outside organizations whenever (1) there is excess capacity or (2)

the outside organizations are willing to pay more than internal divisions.

Emphasize that transfer pricing can be used to turn any cost center into a profit center. For example, a

company may have a printing department that duplicates company documents. That department could use

a transfer price to charge other departments for its services. The same benefits of transfer pricing

discussed in TM 23(9)-10 apply to the printing department. It must keep its operating costs in line with

outside printing firms, or departments that need printing and duplication services will take their business

elsewhere.

ROLE PLAYING—Market and Negotiated Transfer Prices

To illustrate market and negotiated transfer prices, choose two students to participate in a role-playing

activity.

Explain to your students that they are managers of two divisions of a company that manufactures power

tools. One manages the division that produces the small engines that drive the tools. The other manages

the division that assembles the tools. Although the assembly division needs engines, it is free to purchase

them from the engine division or an outside company, wherever the best price can be obtained.

In private, tell the engine division manager that his or her engines require $35 of variable costs to

produce. They can be sold to outside companies for $50 per engine. Also tell the manager that his or her

division is operating at full capacity and can sell all the engines it makes to outside firms at $50 each if

the assembly division does not buy any of the engines.

Next, privately tell the assembly division manager that he or she needs to purchase 10,000 engines.

Engines can be purchased from outside firms for $50 each. These engines are the same quality as those

produced by the company’s engine division.

Begin the role playing by asking the assembly division manager to “telephone” the engine division

manager and negotiate a price for the engines. Because the engine division manager wants at least $50 per

engine, and the assembly division manager will not pay more than $50, the two should settle on the

market price of $50 for the transfer. After the trade is negotiated, share with the class the facts given to

each manager. This will allow you to emphasize that a company can set transfer prices at market prices if

divisions are operating at full capacity and can sell all their products.

Chapter 23(9) Evaluating Decentralized Operations 429

Next, privately tell the engine division manager to assume that his or her division is not producing at full

capacity. Therefore, he or she needs the assembly division’s business. Remind the student that his or her

division’s profits will be increased as long as the engines are sold for more than their variable cost of $35.

Next, in private, tell the assembly division manager to assume the same information as before: He or she

needs 10,000 engines, which can be purchased for $50 from an outside organization.

Allow the students to negotiate for a few minutes. The agreed-on transfer price will be based, in part, on

LECTURE AID—Transfer Pricing at Cost

Remind students that some companies transfer products at their cost. This cost may be the division’s

variable cost per unit or the total cost per unit. In addition, the products may be transferred at actual or

standard cost.

ADM OBJECTIVE

Describe and illustrate the use of profit margin, investment turnover, and ROI in evaluating

SYNOPSIS

Franchising is a popular method of expanding a brand, concept, product, or service offering. By using

profit margin, investment turnover, and ROI businesses can determine if franchising operations can

enhance overall performance.

Relevant Check Up Corner and Exhibits

 Make a Decision – Franchise Operations

Handout 23(9)-1

PERFORMANCE REPORT FOR PROFIT CENTERS

Watson Clothiers, a retailer specializing in men’s and ladies’ career clothing, has stores in two

Sales and direct costs for the stores in the current year were as follows:

Cincinnati Columbus

Net sales $220,000 $380,000

Cost of goods sold 80,000 152,000

Sales salaries 32,000 45,000

Property taxes, utilities, and depreciation 16,000 19,000

Miscellaneous operating expenses 1,000 2,000

current year:

General Administration $83,000

Personnel and Payroll 49,000

Advertising 67,000

was as follows:

Percent used by Cincinnati Percent used by Columbus

Personnel and Payroll 40% 60%

Advertising 25% 75%

revenues and controllable expenses.

Type Item Description Video Excel CLGL LO(s) Difficulty Time Est BUSPROG AICPA

ACBSP – Primary Bloom’s ADM Service Real World

Writing

Ethics

MC 1 1 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

MC 2 2 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

MC 3 4 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

MC 4 4 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

MC 5 5 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 1 Budgetary performance for cost center x 2 Easy 10 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 2 Service department charges x 3 Easy 10 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 3 Income from operations for profit center x 3 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 4 Profit margin, investment turnover, and ROI x 4 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

Focus

Assoc Assets

Tagging