1、1Transfer pricing LESSON72Introduction of lesson 7Lesson 7 focuses on decentralization and the impact of transfer pricing on decision making and costs within organizations.The review material for the lesson asks you to apply your understanding to determine transfer prices using a range of pricing me
2、asures.3Lesson 6 Topics outline Organizational structure and decentralization Transfer pricing policies Transfer pricing measures Determining minimum transfer price Multinational companies and transfer pricing4Topic 1:Organizational structureand decentralizationLEARNING OBJECTIVE Describe the benefi
3、ts and drawbacks of decentralization.Required readingChapter 22,pages 625-627,from“Organization Structure and Decentralization”up to“Transfer Pricing”5 Decentralization vs.CentralizationTopic 1:Organizational structure and decentralizationIn centralized decision making,decisions are made at the very
4、 top level,and lower-level managers are charged with implementing these decisions.Decentralization is the practice of delegating decision-making authority to the lower-levels.Autonomy is the degree of freedom to make decisions.The greater the freedom,the greater the autonomy6Illustrate Centralizatio
5、n Vs.DecentralizationTopic 1:Organizational structure and decentralization7Illustration of PepsiCos Decentralized DivisionsTopic 1:Organizational structure and decentralization8 Decentralization vs.CentralizationTotal decentralization means minimum constraints and maximum freedom for managers at the
6、 lowest levels of an organization to make decisionsTotal centralization means maximum constraints and minimum freedom for managers at the lowest levels of an organization to make decisionsCompanies structures generally fall somewhere in between these two extremes,as each has benefits and costs.Struc
7、ture chosen cost vs.benefit analysisTopic 1:Organizational structure and decentralization9 Benefits of DecentralizationCreates greater responsiveness to local needsLeads to gains from faster decision makingIncreases motivation of subunit managersAssists management development and learningSharpens th
8、e focus of subunit managersTopic 1:Organizational structure and decentralization10 Costs of DecentralizationLeads to Suboptimal Decision Making arises when a decisions benefit to one subunit is more than offset by the costs or loss of benefits to the organization as a whole.Also called Incongruent D
9、ecision Making Focuses mangers attention on the subunit rather than the company as a wholeIncreases costs of gathering informationResults in duplication of activitiesTopic 1:Organizational structure and decentralization11Multinational FirmsMultinational firms companies that operate in multiple count
10、ries are often decentralized because centralized control of a company with subunits around the world is often physically and practically impossibleTopic 1:Organizational structure and decentralization12 Decentralization and Multinational FirmsDecentralization enables managers in different countries
11、to make decisions that exploit their knowledge of local business and political conditions and to deal with uncertainties in their individual environmentsBiggest Drawback to International Decentralization:Loss or lack of controlTopic 1:Organizational structure and decentralization13 Choices About Res
12、ponsibility CentersRegardless of the degree of decentralization,management control systems uses one or a mix of the four types of responsibility centers:Cost Center Revenue Center Profit Center Investment Center The objective in identifying these centers is to measure their performance more effectiv
13、ely and more fairly.Topic 1:Organizational structure and decentralization14Topic 2:Transfer pricing policiesLEARNING OBJECTIVES Determine the impact of transfer pricing policies on profits.Required reading Chapter 22,pages 627-630,from“Transfer Pricing”up to“Market-Based Transfer Prices”15Transfer P
14、ricing Transfer Price needed when segments within the same company sell products or services to one another.the price one subunit(department or division)charges for a product or service supplied to another subunit of the same organization Management control systems use transfer prices to coordinate
15、the actions of subunits and to evaluate their performanceTopic 2:Transfer pricing policies16Transfer Pricing The transfer price creates revenues for the selling subunit and purchase costs for the buying subunit affecting each subunits operating income Intermediate Product the product or service tran
16、sferred between subunits of an organizationTopic 2:Transfer pricing policies17Three Transfer Pricing Methods1.Market-based Transfer Prices sets the price at which the product transferred could be sold to outside buyers.2.Cost-based Transfer Prices uses a variety of cost concepts for setting the tran
17、sfer price.3.Negotiated Transfer Prices allows decentralized managers to agree(negotiate)among themselves.Topic 2:Transfer pricing policies_181.Market-based Transfer Prices Top management chooses to use the price of similar product or service that is publicly available.Sources of prices include trad
18、e associations,competitors,etc.Topic 2:Transfer pricing policies_Market-based19Market-based Transfer Prices Lead to optimal decision-making when three conditions are satisfied:1.The market for the intermediate product is perfectly competitive2.Interdependencies of subunits are minimal3.There are no
19、additional costs or benefits to the company as a whole from buying or selling in the external market instead of transacting internallyTopic 2:Transfer pricing policies_Market-based20Market-based Transfer Prices A perfectly competitive market exists when there is a homogeneous product with buying pri
20、ces equal to selling prices and no individual buyer or seller can affect those prices by their own actions Allows a firm to achieve goal congruence,motivating management effort,subunit performance evaluations,and subunit autonomy Perhaps should not be used if the market is currently in a state of“di
21、stress pricing”Topic 2:Transfer pricing policies_Market-based21Market-based transfer prices A market price approach works best when the product or service is sold in its present form to outside customers and the selling division has no idle capacity.Market-based transfer pricing policies are recomme
22、nded by text books,but are not preferred when agency theory and transactions costs are considered.Topic 2:Transfer pricing policies_Market-based22Market-based transfer prices A market price approach does not work well when the selling division has idle capacity.If a firm has been producing an interm
23、ediate good internally for some time,then its market price is not to be a good proxy for the firms opportunity cost of producing it.A firm may be producing internally to control quality,timely deliveries and trade secrets.Topic 2:Transfer pricing policies_Market-based23Transfer Price at MarketIf the
24、re is an outside market for the product being transferred between divisions,the transfer price should be based on the market price of the product.However,the buyer and seller must be allowed to go outside if doing so would create a better profit.Topic 2:Transfer pricing policies_Market-based242.Cost
25、-based Transfer Prices Useful when market prices are unavailable,inappropriate,or too costly to obtain.Top management chooses a transfer price based on the costs of producing the intermediate product.Examples include:Variable Production Costs Variable and Fixed Production Costs Full Costs(including
26、life-cycle costs)One of the above,plus some markupTopic 2:Transfer pricing policies_Cost-based25Cost-based Transfer Prices Alternatives Prorating the difference between the maximum and minimum cost-based transfer prices Dual-Pricing using two separate transfer-pricing methods to price each transfer
27、from one subunit to another.Example:selling division receives full cost pricing,and the buying division pays market pricingTopic 2:Transfer pricing policies_Cost-based263.Negotiated Transfer Prices Occasionally,subunits of a firm are free to negotiate the transfer price between themselves and then t
28、o decide whether to buy and sell internally or deal with external parties May or may not bear any resemblance to cost or market data Often used when market prices are volatile Represent the outcome of a bargaining process between the selling and buying subunitsTopic 2:Transfer pricing policies_Negot
29、iated27Reasons for negotiating transfer prices1.They preserve the autonomy of the divisions,which is consistent with the spirit of decentralization.2.The managers negotiating the transfer price are likely to have much better information about the potential costs and benefits of the transfer than oth
30、ers in the company.3.If a transfer within a company would result in higher overall profits for the company,there is always a range of transfer prices within which both the selling and buying divisions would have higher profits if they agree to the transfer.Topic 2:Transfer pricing policies_Negotiate
31、d28When imperfections exist in competitive markets for the intermediate product,market price may no longer be suitable.Negotiated Transfer PricesTopic 2:Transfer pricing policies_Negotiated29In this case,negotiated transfer prices may be a practical alternative.Opportunity costs can be used to defin
32、e the boundaries of the negotiation set.Negotiated Transfer PricesTopic 2:Transfer pricing policies_Negotiated301.A division manager who has private information may take advantage of another divisional manager.2.Performance measures may be distorted by the negotiated skills of managers.3.Negotiation
33、 can consume considerable time and resources.Disadvantages of Negotiated Transfer PricesTopic 2:Transfer pricing policies_Negotiated31Disadvantage of Negotiated Transfer Prices4.If managers are pitted against each other rather than against their past performance or reasonable benchmarks,a noncoopera
34、tive atmosphere is almost guaranteed.Given the disputes that often accompany the negotiation process,most companies rely on some other means of setting transfer prices.Topic 2:Transfer pricing policies_Negotiated32Despite the disadvantages,negotiated price transfer prices offer some hope of complyin
35、g with the three criteria of goal congruence,autonomy,and accurate performance evaluation.Topic 2:Transfer pricing policies_Negotiated33Maintain goal congruenceThe fundamental objective in setting transfer prices is to motivate managers to act in the best interests of the overall company.Topic 2:Tra
36、nsfer pricing policies34Comparison of MethodsAchieves Goal CongruenceMarket Price:Yes,if markets competitiveCost-Based:Often,but not alwaysNegotiated:YesTopic 2:Transfer pricing policies35Comparison of MethodsUseful for Evaluating Subunit PerformanceMarket Price:Yes,if markets competitiveCost-Based:
37、Difficult,unless transferprice exceeds full costNegotiated:YesTopic 2:Transfer pricing policies36Comparison of MethodsMotivates Management EffortMarket Price:YesCost-Based:Yes,if based on budgetedcosts;less incentive ifbased on actual costNegotiated:YesTopic 2:Transfer pricing policies37Comparison o
38、f MethodsPreserves Subunit AutonomyMarket Price:Yes,if markets competitiveCost-Based:No,it is rule basedNegotiated:YesTopic 2:Transfer pricing policies38Comparison of MethodsOther FactorsMarket Price:No market may existCost-Based:Useful for determiningfull-cost;easy to implementNegotiated:Bargaining
39、 takes time andmay need to be reviewed Topic 2:Transfer pricing policies39Topic 3:Transfer pricing measuresLEARNING OBJECTIVEDetermine transfer prices using market-based,cost-based,and negotiated transfer pricing measures.Required readingChapter 22,pages 630-630 from“Market-Based Transfer Prices”up
40、to“Negotiated Transfer Prices”40Transfer Pricing Illustration(P801)Topic 3:Transfer pricing measuresObtained crude oil supplied in MalamorosTransportation DivisionCapacity:40,000 barrels of crude oil per dayRefining DivisionCapacity:30,000 barrels of crude oil per dayCrude oil transferred10,000 barr
41、els of crude oil per dayAnother producer supplied to Houston refinery 20,000 barrels of crude oil per dayGasoline sold to externalAssume 3 barrels of crude oil to yield on barrel of gasoline41Transfer Pricing IllustrationTopic 3:Transfer pricing measuresContract price per barrel of crude oil supplie
42、d in Malamoros$72Transportation DivisionVariable cost$1Fixed cost 3Full cost per barrel$4 of crude oilRefining DivisionVariable cost$1Fixed cost 3Full cost per barrel$4 of gasolineCrude oil transferredMarket price price per barrel of crude oil supplied to Houston refinery$85$19042Transfer Pricing Il
43、lustrationTopic 3:Transfer pricing measuresBarrels of crude oil transferred=100Barrels of gasoline sold=50 79.8=(72+1+3)1.0543Transfer Pricing IllustrationTopic 3:Transfer pricing measuresBarrels of crude oil transferred=100Barrels of gasoline sold=5044Topic 4:Determining minimumtransfer priceLEARNI
44、NG OBJECTIVEDetermine the minimum transfer price under varying levels of production capacity.Required readingChapter 22,pages 636-638,“A General Guideline for Transfer-Pricing Situations”45Minimum Transfer PriceIf a transfer within a company would result in higher overall profits for the company,the
45、re is always a range of transfer prices within which both the selling and buying divisions would have higher profits if they agree to the transfer.Topic 4:Determining minimum transfer priceUpper limit is determined by the buying division.Lower limit is determined by the selling division.Range of Acc
46、eptable Transfer Prices46Minimum Transfer PriceThe minimum transfer price in many situations should be:Incremental cost is the additional cost of producing and transferring the product or serviceOpportunity cost is the maximum contribution margin forgone by the selling subunit if the product or serv
47、ice is transferred internallyTopic 4:Determining minimum transfer price47Variable Costper Unit$73Market Priceper Unit$85Full Costper Unit$76Range of Negotiated PriceTransfer PricesOpportunity cost Costper Unit$1Topic 4:Determining minimum transfer priceMinimum Transfer Prices48Transfer pricing with
48、perfect informationIn the perfect information case,each manager in the firm knows the following about any particular exchange between two divisions:Each divisions marginal costs of production,which are usually defined as variable costs.Each divisions opportunity costs,which depend on whether excess
49、capacity exists.Topic 4:Determining minimum transfer price49Transfer pricing with asymmetric informationWith asymmetry of information,lower level managers have incentives to set the transfer price above the variable cost to increase the selling divisions profits.This could lead to lower than optimal
50、 production levels,and lower profit for the firm.The selling division has the monopoly rights in information,and could behave like a monopolist by raising prices and restricting output.Topic 4:Determining minimum transfer price50Computer illustration 6-1:Transfer pricing and information asymmetryTop
