Budget Preparation Management Control Systems Chapter 9 August 2014Iwan Pudjanegara SE., MM.1.
Transfer Pricing Management Control Systems Chapter 6 July 2014Iwan Pudjanegara SE., MM.1.
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Transcript of Transfer Pricing Management Control Systems Chapter 6 July 2014Iwan Pudjanegara SE., MM.1.
Transfer Pricing
Management Control Systems
Chapter 6
July 2014 Iwan Pudjanegara SE., MM. 1
Objectives of Transfer Prices
It should provide each business unit with the relevant information it needs to determine the optimum trade-off between company costs and revenues.
It should induce goal congruent decisions. The system should be designed so that decisions that improve business unit profits will also improve company profits.(induce = menyebabkan)
July 2014 Iwan Pudjanegara SE., MM. 2
Objectives of Transfer Prices
It should help measure the economic performance of the individual business units.
The system should be simple to understand and easy to administer.
July 2014 Iwan Pudjanegara SE., MM. 3
The Definition
The amount used in accounting for any transfer of goods and services between responsibility centers.
The value placed on a transfer of goods or services in transactions in which at least one of the two parties involved is a profit center.
July 2014 Iwan Pudjanegara SE., MM. 4
Fundamental Principle
The Fundamental Principle is that the transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendors.
July 2014 Iwan Pudjanegara SE., MM. 5
Fundamental Principle
When profit centers of a company buy products from, and sell to, one another, two decisions must be made periodically for each product:1) The Sourcing Decision should the company
produce the product inside the company or purchase it from an outside vendor?
2) The Transfer Price Decision if produced inside, at what price should the product be transferred between profit centers?
July 2014 Iwan Pudjanegara SE., MM. 6
The Ideal Situation
The Competent PeopleIdeally, managers should be interested in the long-run as well as the short-run performances of their RCs.
Good AtmosphereManagers must regard profitability as an important goal and a significant consideration of their performance.
July 2014 Iwan Pudjanegara SE., MM. 7
The Ideal Situation
A Market PriceThe ideal transfer price is based on a well-established, a normal market price for the identical product being transferred means a market price reflecting the same conditions (quantity, delivery time, quality) as the product to which the transfer price applies.
July 2014 Iwan Pudjanegara SE., MM. 8
The Ideal Situation
Freedom to Sourceo Alternatives for sourcing should exist,
and managers should be permitted to chose the best alternative.
o The buying manager should be free to buy from the outside, and the selling manager should be free to sell outside.
July 2014 Iwan Pudjanegara SE., MM. 9
The Ideal Situation
Full InformationManagers must know about the available alternatives and the relevant costs and revenues of each.
NegotiationThere must be a smoothly working merchanism for negotiating contracts between business units.
July 2014 Iwan Pudjanegara SE., MM. 10
Constraints on Sourcing
Limited MarketsWhy markets for the buying or selling profit centers may be limited???
1. The existence of internal capacity might limit the development of external sales.
2. If a company is the sole producer of a differentiated, no outside source.
July 2014 Iwan Pudjanegara SE., MM. 11
Constraints on Sourcing
3. If a company has invested significantly in facilities, it is unlikely to use outside sources unless the outside selling price approaches the company’s variable cost, which is not usual. (Ex. Integrated Oil Companies).
oThe Competitive Price: the transfer price that best satisfies the requirements of a profit center system.
July 2014 Iwan Pudjanegara SE., MM. 12
Constraints on Sourcing
How does a company find out what the competitive price is if it does not buy or sell the product in an outside market???
1. If published market prices are available, they can be used to establish transfer prices.
2. Market prices may be set by bids.
July 2014 Iwan Pudjanegara SE., MM. 13
Constraints on Sourcing
3. If the production profit center sells similar products in outside markets, it is often possible to replicate a competitive price on the basis of the outside price.
4. If the buying profit center purchases similar products from the outside market, it may be possible to replicate competitive prices for its proprietary products.
July 2014 Iwan Pudjanegara SE., MM. 14
Excess or Shortage of Industry Capacity
Excess Capacity : if the selling profit center cannot sell to the outside markets all it can produce.
Shortage Capacity : if the buying profit center cannot obtain the product it requires from the outside while the selling profit center is selling to the outside.
July 2014 Iwan Pudjanegara SE., MM. 15
Cost-Based Transfer Prices
When to use it??? If competitive prices are not available.
Two decisions must be made :1. How to define cost
2. How to calculate the profit markup.
July 2014 Iwan Pudjanegara SE., MM. 16
Cost-Based Transfer Prices
The Cost Basis• The usual basis is standard costs.• Actual costs should not be used because
production inefficiencies will be passed on to the buying profit center.• If the standard costs are used, an incentive
is needed to set tight standards and improve standards.
July 2014 Iwan Pudjanegara SE., MM. 17
Cost-Based Transfer Prices
The Profit Markup• Two decisions made in calculating the profit
markup:What the profit markup is based onThe level of profit allowed
• The simplest and most widely used base is a percentage of costs.• A conceptually better base is a percentage of
investment.July 2014 Iwan Pudjanegara SE., MM. 18
Upstream Fixed Costs and Profits
Transfer pricing can create a significant problem in integrated companies.
The profit center that finally sells to the outside customer may not even be aware of the amount upstream fixed costs and profits included in its internal purchase price.
July 2014 Iwan Pudjanegara SE., MM. 19
Upstream Fixed Costs and Profits
Methods that companies use to mitigate the problem are :
1) Agreement among Business Units
2) Two-Step Pricing
3) Profit Sharing
4) Two Sets of Price
July 2014 Iwan Pudjanegara SE., MM. 20
Pricing Corporate Services
Control over Amount of ServiceBUs may be required to use company staffs
for services such as IT and R&D, but the BU Manager:cannot control the efficiency with which
these activities are performed,can control the amount of the service
received
July 2014 Iwan Pudjanegara SE., MM. 21
Pricing Corporate Services
3 Opinions about such services:• That a BU should pay the standard
variable cost of the discretianory services• That a price equal to the standard variable
cost plus a fair share of the standard fixed costs = the full cost.• That a price is equivalent to the market
price, or to standard full cost plus a profit margin.
July 2014 Iwan Pudjanegara SE., MM. 22
Pricing Corporate Services
Optional Use of ServicesWhether to use central service units, orProcure the service from outside, by develop
their own capability, orChoose not to use the service at all. These service centers are independent and
most often found for such activities as IT, Internal Consulting Group, and maintenance work.
July 2014 Iwan Pudjanegara SE., MM. 23
Pricing Corporate Services
• Simplicity of the Price MechanismThe price charged for corporate services will not accomplish their intended results unless the methods of calculating them are straightforward enough for BU Managers to understand.
July 2014 Iwan Pudjanegara SE., MM. 24
Administration of Transfer Prices
NegotiationCompromises made by buyer and seller.Because BUs have the best information on markets
and costs, so they want to get reasonable prices. Arbitration and Conflict Resolution
3 Responsibilities of Abritration Committe:
(1) Settling transfer price disputer, (2) reviewing sourcing changes, (3) changing the transfer price rules when appropriate.
July 2014 Iwan Pudjanegara SE., MM. 25
Administration of Transfer Prices (Product Classification)
Class I• All products for which
Sr. management wishes to control sourcing.
• Large-volume products.• Products for which no
outside source exists• Products over whose
manufacturing.
Class II• All other products that
can be produced outside the company without significant disruption to present operations.
• Relatively small volume.
• Produced with general-purpose equipment.
July 2014 Iwan Pudjanegara SE., MM. 26
Administration of Transfer Prices (Product Classification)
Class I• For quality/secrecy
reasons.• Senior management
wishes to maintain control.
• The sourcing of products can be changed only by permission of central management.
Class II• Products are transfered
at market prices.• The sourcing of
products is determined by the Business Units involved.
July 2014 Iwan Pudjanegara SE., MM. 27