CHAPTER 10
Decentralization: Responsibility Accounting, Performance Evaluation,
and Transfer Pricing
COLLABORATIVE LEARNING EXERCISE SOLUTION
1. a. The positive and negative behavioral implications arising from employing a negoti-
ated transfer price system for goods exchanged between divisions include the fol-
lowing:
Positive:
Both the buying and selling divisions have participated in the negotiations
and are likely to believe they have agreed on the best deal possible. Negotiat-
ing and determining transfer prices will enhance the autonomy/ independence
of the divisions.
Negative:
The result of a negotiated transfer price between divisions may not be opti-
mal for the firm as a whole and therefore will not be goal congruent. The ne-
gotiating process may cause harsh feelings and conflicts between divisions.
b. The behavioral problems which can arise from using actual full (absorption) manu-
facturing costs as a transfer price include the following:
• Full-cost transfer pricing is not suitable for a decentralized structure where
the autonomous divisions are measured on profitability, as the selling unit is
unable to realize a profit.
• This method can lead to decisions that are not goal congruent if the buying
unit decides to buy outside at a price less than the full-cost of the selling unit.
2. The behavioral problems that could arise if Lynsar Corporation decides to change its trans-
fer pricing policy to one that would apply uniformly to all divisions include the following:
• A change in policy may be interpreted by the divisional managers as an at-
tempt to decrease their freedom to make decisions and reduce their autono-
my. This perception could lead to reduced motivation.
• If managers lose control of transfer prices and, thus, some control over prof-
itability, they will be unwilling to accept the change to uniform prices.
Selling divisions will be motivated to sell outside if the transfer price is lower than market
as this behavior is likely to increase profitability and bonuses.
3. The likely behavior of both “buying” and “selling” divisional managers, for each of the fol-
lowing transfer pricing methods being considered by Lynsar Corporation include the follow-
ing:
a. Standard full manufacturing costs plus markup
• The selling divisions will be motivated to control costs because any costs
over standard cannot be passed on to the buying division and will reduce the
b. Market selling price of the product being transferred
• Creates a fair and equal chance for the buying and selling divisions to make
the most profit they can and should promote cost control, motivate divisional
c. Outlay (out-of-pocket) costs incurred to the point of transfer plus opportunity
cost per unit
• This method is the same as market price when there is an established market
price and the seller is at full capacity. At any level below full capacity, the
transfer price is the outlay cost only (as there is no opportunity cost), which