Chapter 13

Responsibility Accounting, Support Department

Allocations, and Transfer Pricing

Note: For Homework

EX 26: allocation order Administration first, then HR, then
Accounting
EX 27: do both step and direct methods of allocation
Problem 48: do both direct and step methods of allocation

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 Decentralization
 Transfer of authority, responsibility, and
decision-making rights from the top to the
bottom of the structure of an organization
Moves location of certain decisions to the
organizational ͞location͛ where those decisions
have direct impact
Top management selectively determines types of
authority to delegate and to withhold from lower
level managers

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Centralization Decentralization
Top management Top management
retains the major delegates
portion of decision-making
authority authority to
subunit
managers

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 Personnel
train and screen aspiring managers
develop leadership qualities, problem-solving
abilities, and decision-making skills
compare managers͛ results
increase job satisfaction and job enrichment
 Effective means of achieving organizational
goals
 Reduces decision-making time
 Allows management by exception
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 £ack of goal congruence
Goals at top and goals at local level not consistent
 Suboptimization
pursuing the subunit manager͛s goals instead of the
company͛s goals
manager͛s decisions may be beneficial for a given
profit center, but NOT for the entire company
 Requires more effective communication skills
 Higher level managers must relinquish
control
 Expensive
train managers in decision-making skills
absorb cost of poor decisions
requires a sophisticated planning and reporting
system

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Managers
delegate decision-making authority
but retain responsibility for outcomes.
Therefore, they must have some means to
ensure lower level operations are
not ͞out of control.͟

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 Responsibility   
A sophisticated accounting and
reporting system that provides top
management
Information about overall subunit
accountability
Measures to evaluate subunit
performance


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 Responsibility   
 Reporting system
provides information about subunits
allows management to measure
subunit performance
 Consistent with standard costing


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 Responsibility   
 -pward flow of information
from operations to top
management
 -nit level reports are detailed
 -pper-level reports are summarized
 Encourages management by
exception
Major deviations are highlighted
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 Responsibility   
 Disadvantages of responsibility accounting
include
Important details may not be visible at
upper management levels
Managers might ͞promote͟ their unit
while ͞blaming͟ their competitor units
Departmental interdependencies might
not be visible
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  Centers
 Responsibility accounting systems
identify, measure, and report on
activities in responsibility centers
Cost center
Revenue center
Profit center
Investment center
 Each of these centers is under the
control of a manager
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 Cost  
 Manger has authority to incur costs
 Evaluated on how well costs are controlled
 Revenues may
not exist ʹ equipment maintenance center
exist but are not under manager͛s control ʹ
community libraries
exist but cannot be measured - R&D center
 Focus on variances outside acceptable range

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 Revenue  
 Responsible for generating revenue
 No control of selling price or costs
Individual sales departments in retail stores
 Sales prices set by higher level authority but
revenue center manager responsible for the
amount of profit generated by the center
 Costs are ͞budgeted͟ by higher authority
 Somewhat rare because in most revenue
centers, manager does have control over
some costs
Revenue and limited cost center might be
more appropriate description
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 Profit  
 Responsible for generating revenues ʹ allowed
to set selling prices
 Responsible for controlling expenses - allowed to
purchase components at most economical price
 Responsible for net income
 Not responsible for long-term asset investment
 Goal is to maximize the center͛s profit
Independent units - bank branches, national chain
stores (£owes, Home Depot, Walmart), scattered
manufacturing plants, etc.
 Evaluate on profit variance
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 Investment  
 Responsible for revenues, costs, and capital
investments
 Responsible for
Revenues
Costs
Investment in long term assets
 Goal is maximize rate of return on assets
Divisions or subsidiaries
 Evaluate on rate of return on assets and other
performance measures
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 Interdependencies  
 From an overall company perspective, all
costs of the company must eventually
be ͞covered͟ by revenues
Only revenue, profit, and investment centers
generate revenue
Cost centers generate costs that are incurred to
͞support͟ the functions of revenue generating
centers
These support costs must be somehow related
to the revenues generated by the revenue
generating centers
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 To control cost center performance and ensure
all costs are considered in decisions,
management may either
Assign costs incurred in cost centers to revenue-
producing areas through service department
cost allocation
͞Create͟ revenue through a system of internal
charges (charge-backs) for the center͛s tangible or
intangible output used by other company units
known as transfer prices

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 Service Department Cost Allocation

 Service departments  Administrative

provide functional departments provide
tasks for other management activities
organizational units for the organization
Purchasing
Personnel
Maintenance
Engineering £egal
Security Payroll
Warehousing Insurance
Distributing Accounting
products Data Processing

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 Allocation Bases 

 
 Rational and systematic base
Benefit received by revenue-producing
department
Causal relationship
Fairness or equity of the allocations
Ability of revenue-producing
department to bear the allocated cost

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 Direct method
Cost of each service center directly allocated to
revenue producing centers
No allocations from one service center to other
service centers
 Ignores any inter service department charges, takes the
total costs of each service department directly to revenue
producing centers and ignore the other service centers
Allocates the cost of a service department without
consideration of services rendered to other service
departments
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 Direct Method
›
    

  
 

Ô
   

 
Ô 

Ô 

 
 




 
 
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 Step method
Benefits-provided ranking
Service center providing most benefits to A££ other
centers (service and revenue) allocated first
Then ͞new͟ cost of next most ͞benefiting͟ service
center allocated to A££ other centers
Repeated until all service center costs are charged
to revenue centers

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 Step Method


 


  
 

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Ô 

Ô 

 

 


  
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 Algebraic method
Simultaneous equations used to allocate all service
centers to other service centers and to revenue
centers simultaneously
 The most accruate, but also the most difficult

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 Allocated service department costs are
included in the overhead application
rate for the revenue-producing areas
 Revenue centers would include the
service center costs allocated to them in
the calculation of their overhead
application rates
 Service department costs are allocated
to products or jobs through normal
overhead assignment procedures
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 Transfer Pricing
Internal charges for the exchange of goods
or services within a decentralized
organization
 Alternative to allocation
 Creates a ͞pseudo-profit center͟ by creating an
artificial ͞sales price͟ (transfer price) for transfer
of services from internal cost center to other
responsibility centers within the same company
Create a ͞play like͟ price that revenue centers must
͞pay͟ to the center providing the service

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 Transfer Pricing
 Promote goal congruence
 Make performance evaluation among segments
more comparable
 For internal use only
Eliminated on external financial reports
 Encourages managers to be entrepreneurial
Example: radio division of car company charging
assembly divisions for radios provided
 Transfer of a radio internally may reduce radios available for
sale to customers outside of the car company
 ͞Selling͟ a radio to a department in the same company may
eliminate a ͞real͟ sale to an external customer

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 Transfer Prices for Services
Advantages
 Encourage development of beneficial
services
 Promote cost consciousness of services
provided
 Promotes making a service department
a profit center
Creates ͞artificial͟ revenue

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!
 Maximum - no higher than the current market
price (price being paid to outside vendor)
Setting internal price higher than outside would
cause internal buying division to refuse the internal
transfer and continue to buy outside even if that was
not best for the overall company
 Minimum - no less than the variable cost
related to making the item
At any transfer price below this, the division
making the item for the internal transfer would
lose money
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!
 Cost-based prices
 Market-based prices
 Negotiated prices

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 Cost-Based 
!
 Definition of cost
variable cost vs. absorption cost
actual vs. standard
 Standard cost is superior to actual cost
actual costs vary according to season and
production volume
standard costs are stable measures of
production costs
variances are attributed to selling division
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 Market-Based 
!
 Objective, simulate arm͛s-length measure
 Best to evaluate performance of individual departments
 Potential problems when the market
determines the transfer price
No exact counterpart in the external market
Ignores internal cost savings
Market price varies
 current depressed price vs. long-run market price
Different prices, discounts, and credit terms for
different buyers
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 Negotiated 
!
 Outside market price is the maximum transfer price
 Buying unit could buy outside for less if internal transfer
price was above outside market price
 Company would lose money by not buying the
͞cheapest͟ material
 Variable cost (production and SG&A) of producing
would be the minimum transfer price
 Would cost more to produce (variable cost) than selling
unit would receive if transfer price set below variable cost
of producing
 Fixed cost would not be relevant if there is idle capacity in
the ͞selling͟ divisionʹ they would not change in total if
internal transfer was accomplished
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 Transfer Pricing Systems
 Permit evaluation of segment
performance
 Allow for rational acquisition of goods
and services between corporate
divisions
 Provide flexibility to respond to changes
 Encourage and reward goal congruence

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 Transfer Pricing Systems
 May cause disagreement among managers
 Adds costs and takes time
 May not work for all departments
 May cause underutilization or overutilization of
services
 May cause dysfunctional organizational
behavior
 Complicates tax planning for multinationals

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 After the Break
 We will go over the Homework Assignment for
Ch 13
 Before next week͛s class, you must do the Ch 13
Quiz on Blackboard
 Next Week: Test 3, Chapters 9, 11, 13
 Probably 50 questions
 You will need a Scantron, pencils, and
calculator
 Grades will be posted by midnight Thursday
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