vi. Incentive compensation for employees probably
should be linked to balanced scorecard
performance measures.
1. However, this should only be done after the
organization has been successfully managed
those being evaluated with them.
B. The balanced scorecard – an example
i. Assume that Jaguar pursues a strategy as shown
on this slide. Examples of measures that Jaguar
might select with their corresponding cause-and-
effect linkages include:
1. If “employee skills in installing options”
increases, then the “number of options
available” should increase and the “time to
with options available” increases, then the
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“contribution margin per car” should
increase.
5. If the “number of cars sold” and the
“contribution margin per car” increase,
then the “profit” should increase.
VII. Appendix 11A: transfer pricing (Slide #57 is a title slide)
A. Key concepts/definitions
ii. The fundamental objective in setting transfer
prices is to motivate managers to act in the best
interests of the overall company.
Suboptimization occurs when managers do
not act in the best interests of the overall
company or even their own divisions.
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iii. There are three primary approaches to
setting transfer prices, namely negotiated
transfer prices, transfers at the cost to the
selling division, and transfers at market price.
B. Negotiated transfer prices
1. Negotiated transfer prices have two
advantages:
a. They preserve the autonomy of the
2. The range of acceptable transfer prices is
the range of transfer prices within which the
profits of both divisions participating in the
transfer would increase.
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ii. Grocery Storehouse– an example
1. Assume the information as shown with
respect to West Coast Plantations (WCP)
(1). If Grocery Mart had no outside
supplier for oranges, then its
highest acceptable transfer price
2. If WCP has sufficient idle capacity (3,000
crates) to satisfy Grocery Mart’s demands
(1,000 crates) without sacrificing sales to
other customers, then the lowest and highest
possible transfer prices are computed as
follows:
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3. If WCP has no idle capacity and must
sacrifice other customer orders (1,000
crates) to meet the demands of Grocery
Mart (1,000 crates), then the lowest and
highest possible transfer prices are
computed as follows:
save costs of $20.
4. If WCP has some idle capacity (500
crates) and must sacrifice other customer
orders (500 crates) to meet the demands of
Grocery Mart (1,000 crates), then the lowest
and highest possible transfer prices are
computed as follows:
a. The lowest acceptable transfer price,
as determined by the seller, is $17.50.
iii. Evaluation of negotiated transfer prices
1. If a transfer within the company would
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buying divisions would have higher profits
if they agree to the transfer.
2. Nonetheless, if managers are pitted against
each other rather than against their past
prices.
C. Transfers at the cost to the selling division
i. Many companies set transfer prices at either
the variable cost or full (absorption) cost
incurred by the selling division. The drawbacks
of this approach include:
2. If cost is used as the transfer price, the
selling division will never show a profit on
any internal transfer. The only division
costs of one division are passed on to the
next, there is little incentive for anyone to
work on reducing costs.
D. Transfers at market price
1. Works best when the product or service is
sold in its present form to outside customers
and the selling division has no idle capacity.
a. With no idle capacity the real cost of
the transfer from the company’s
perspective is the opportunity cost of
the lost revenue on the outside sale.
2. Does not work well when the selling
division has idle capacity. In this case,
E. Divisional autonomy and suboptimization
i. The principles of decentralization suggest that
companies should grant managers autonomy
to set transfer prices and to decide whether to
sell internally or externally.
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VIII. Appendix 11B: Service Department Charges (Slide #71
is a title slide)
Learning Objective 6: Charge operating departments
for services provided by service departments.
departments.
i. Four reasons for allocating service
department costs
1. To encourage operating departments to
wisely use service department resources.
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B. Charging costs by behavior
i. Whenever possible, variable and fixed
service department costs should be charged
separately to provide more useful data for
planning and control of departmental
operations.
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2. A fixed cost should be allocated to
consuming departments in predetermined
lump-sum amounts that are based on either
the department’s peak-period or long-run
average servicing needs. Importantly, fixed
cost allocations:
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as a whole. This discussion can be used to reinforce
ideas developed when covering transfer pricing.
ii. Budgeted variable and fixed service
department costs (rather than actual costs)
should be allocated to operating
departments.
A. Sipco – an example
i. Assuming the facts as shown with respect to
Sipco, the allocation of maintenance costs
to the two operating departments would be
as follows:
1. The variable costs would be allocated by
multiplying the budgeted variable rate
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B. Pitfalls in allocating fixed costs
1. This is a pitfall because it creates a situation
where the fixed costs allocated to one
department are heavily influenced by what
happens in other departments.
1. This creates a situation where the sales in
one department will influence the service
department costs allocated to another
department.
iii. Autos R Us – an example
1. Assume the facts as shown with respect to
Autos R Us.
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3. The allocations of service department costs
for year two are as shown. Notice:
a. The New Cars Department increased
sales by $500,000 while the other
departments’ sales remained
unchanged.
Helpful Hint: Ask students to suppose they are a
division manager in a company that allocates fixed
costs on the basis of actual sales. Ask if the fixed costs