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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
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
