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Q1. What are transfer pricing and its objectives? When market based transfer prices are most appropriate? Definition: Transfer Pricing  A transfer price is the internal price charged by a selling department, division, or subsidiary of a company for a raw material, component, or finished good or service which is supplied to a buying department, division, or subsidiary of the same company.  Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges made between related companies for goods, services, or use of property including intangible property.  The concept of transfer pricing is fundamentally aimed at stimulating external market conditions within the organization so that the managers of individual business units are motivated to perform well.

Objective of Transfer Pricing:  It should provide unit with the relevant information it needs to determine the optimum trade-off between company cost and revenues. from the objective. it is understandable that the Transfer price is mainly transferring of goods and services from one unit to another where much important is not given to accounting basis but also to all other effect.e.  It should help to measure the economic performance of the individual business units. Thus. the system should be designed so that decision that improve business unit profit will also improve company profits.  The system should be simple to understand and easy to administer.. .  It should bring goal correspondence decision i.

competitive.Methods of Transfer Pricing Market-based Transfer Pricing  When the outside market for the good is well-defined. Cost-based Transfer Pricing  In the absence of an established market price many companies base the transfer price on the production cost of the supplying division. Divisional managers are encouraged to negotiate a mutually agreeable transfer price. and stable. firms often use the market price as an upper bound for the transfer price. Negotiated Transfer Pricing  The firm does not specify rules for the determination of transfer prices.  When the outside market is neither competitive nor stable. . internal decision making may be distorted by dependence on market-based transfer prices.

it would be sell outside .  From company point of view .  The market price represent the opportunity cost to the seller of selling the product inside. the relevant cost of the product is the market price because that is the amount of cash that has been forgone by selling inside . if the selling profit center can sell all of its product to either insider or outsider and if the buying center can obtain all of its requirement from either outsider or insider.When market based transfer price are more appropriate?  Microeconomic theory shows that when divisional managers attempt to maximize divisional profits.  Market based transfer price appropriate. a market-based transfer price supports their incentives with owners’ incentives of maximizing overall corporate profits. This is because if the product were not sold inside . .

and manager should be permitted to choose the alternative that is in their own best interests. In this circumstance. The market thus establishes the transfer price. as measure in their income statement . Full information:- Manager must know about available alternatives and relevant cost and revenues of each.Other situation market based transfer price are more appropriate :- Competent people:Manager should be interested in long-run as well as the short-run performance of their responsibility center. Freedom to source:Alternative source should exist. The buying manger should be free to buy from outside. and selling manager should be free to sell outside. the transfer price policy simply gives the manager of each profit center the right to deal with either insider or outsider. . Negotiation:There should smoothly working mechanism for negotiating contract between business units. as an important goal and a significant consideration in the judgment of their performance. Good Atmosphere:Manager must regard profitability.

Also discuss their advantages and disadvantages . What do you understand by investment centre? Explain 2 different methods by which the performance of this canters are measured.Q2.

 Mantra to govern investment centre is “Profitable the case then invest else disinvest.Investment centre  It is a classification used for business units within an enterprise.  The essential element of an investment center is that it is treated as a unit which is measured against its use of capital.” .

Objective:  To make sound investment decision  Covers responsibilities of all the other responsibility centers  It is concerned with the profit earned against the assets employed  It is interested in earning profit and using the assets at its disposal in most effective manner .

Generate sales Cost centre Task.Earn Profit Revenue centre Task.Effective utilization of factor Investment centre Profit centre Task.Investment centre relation with other centre: Task .control costs .

EXAMPLE Formal relationship possibleProfits earned are related to Capital employed Inputs (Money invested in carrying out the task) Task/Work Outputs (Money Profits earned) .

supplies Product mix Selling price Capital investment Performance measure to be used – Actual ROI Actual Residual income i.To successful implement an investment centre controller must deliberate on following considerations/issues Decision rights need to be granted to centre manager about – Input mix – Labour. material.e. EVA Actual ROI and RI in comparison with budgeted ROI Typically used when – Responsibility centre manager has knowledge about correct price/quantity Responsibility centre manager has knowledge to select optimal product mix .

 It looks mare to long tern then short term decisions. value concept in performance evaluation over accounting standards.Performance measures for Investment Centre ROI  It is the profitability ratio EVA  It emphasizes the net present which relates the profits to the investment. .  Investment in turn represents the assets based utility by the unit to earn the profit.

3. What do you understand by non-profit organization? How do these organizations price their products? What criteria are used to measure their performance? .

In other words. expansion. It is not supposed to make profits. There is only one important difference.  While Non-profit organizations are permitted to generate surplus revenues they must be retained by the organization for its self-preservation. . Non profit organization (NPO) is refers to an organization that uses surplus revenues to achieve its goals rather than to distribute them as profit or dividends.  A non-profit company is like any other Company. it does not exist for commercial gain. or plans.

 They also prepare their accounts following the same accounting principles and systems that are followed by business for profit organizations that are run with an objective to earn profits. . etc.  The main source of income is admissions fees. grant-in-aid. subscriptions.Characteristics of Not-for-profit organizations (NPOs)  The objective of such organizations is not to make profit but to provide service to its members . donations.

indirect cost and perhaps a small allowance for increasing the organization equity. .PRODUCT PRICING  A full cost price is sum of direct cost. Pricing for peripheral activity should be market based. Thus a NP hospital should price its health care services at full cost. This principle is applies to services that are directly related to the organization objective.

follows that it is more difficult to measure performance in a Not-For-Profit Organization than in a for-profit organization. though rupee is the language of financial reporting. thus. but all are struggling with developing quantitative measures to track their work’s impact on their mission. It.Measurement of NPO Performance  The best indicators of the performance of a NPO are generally not measurable in rupee (currency) terms. .  Indeed the research shows that most NPOs are attempting results measurement of some type.

.4. Explain the element of control and how each element is helping the management control. with diagram.

devices must be in the place to ensure that is strategic intentions are achieved. that is. . But controlling the organization is much more complicated than controlling a car. An organization must also be controlled.

comparison with standard 1. Effectors.Element of control system:  Every control system has at least four elements: Control device 2. if needed Entity being controlled . Detector.behavior alteration.information about what is happening 3. Assessor.

 An effector – a device (often called feedback) that alter the behavior if the assessor indicates the need to do so. A detector or sensor.  An assessor.device that transmit information between the detector and assessor and between the assessor and the effector.the device that determine the significance of what is actually happening by comparing it with standard or expectation of what should happen. .a device that measures what is actually happening in the process being controlled.  A communication network.

Steps in control system .

Short Note: • Balance scorecard • Interactive control • Internal control .

2.Balance scorecard  Balanced Scorecard (BSC) is a performance management tool  Comprehensive view Implementing a Balanced Scorecard We can summarize the implantation of a balanced scorecard in four general steps. Define measure of strategy. 1. requiring the participation of senior executive and employees throughout the organization . Each of these steps is iterative. Review measures and result frequently. 4. Integrate measures into the management system. Define strategy. 3.

.  Measures overload. could limit the usefulness of the balanced scorecard approach:  Poor correlation between nonfinancial measures and result.Difficulties in implementing Balanced Scorecard The following problems unless suitably dealt with.  Fixation on financial result.  No mechanism for improvement.

Interactive control .

Internal Control  Internal control is the process designed to ensure reliable financial reporting.  internal control objectives relate to the reliability of financial reporting.  Roles and responsibilities in Internal Control Management Board of Directors Auditors  Limitations . and compliance with applicable laws and regulations. and compliance with laws and regulations. timely feedback on the achievement of operational or strategic goals. effective and efficient operations.

Case Study North Country Auto .

service. . body shop and oil change ― operated as part of one business.e.  He developed a system for so that each department will be treated as decentralized profit centers to track the departmental performance effectively. the new cars sales and used cars sales. parts.Background  Five Departments i.  New leader assumed that the existing compensation system not enough for motivating the employees.

Background  This new system requires that cost be broken down per department. .  Earlier the Department Managers were paid salaries and a year-end bonus from Company profits. and the proper allocation of company profits. Also. the bonuses per each department head will be based on departmental gross profits.  Issues of setting of transfer prices and allocation of costs and profits between departments. as well as intercompany transactions. the divisional structure (use of profit or cost center).

full retail better than others.Issues Problem  The different departments of North Country Auto. . must choose between three pricing systems: base on market price. and based on book value.  Also. the company must decide whether they should continue treating each department independently in order to gain huge profits considering that the manager’s incentives are determined upon the department’s earnings.

Executive Summary  North Country Auto Inc. and the proper allocation of company profits among departments. the divisional structure (use of profit or cost center). .  However. a recent new car purchase sparked friction and disagreements among division heads on setting of transfer prices and allocation of costs and profits. was restructured by George Liddy so that each department will operate as an independent profit center. formalizing intercompany transactions.  Issues that needed to be resolved include setting of transfer prices between departments.

Solution Return On Sales:  A ratio widely used to evaluate a company's operational efficiency. It is calculated using this formula: = Net income before interest and tax / sales . ROS is also known as a firm's "operating profit margin".

while a decreasing ROS could signal looming financial troubles. .  An increasing ROS indicates the company is growing more efficient. and compare it to other companies in the industry.  As with many ratios. it is best to compare a company's ROS over time to look for trends. providing insight into how much profit is being produced per dollar of sales.  In some instances. a low return on sales can be offset by increased sales.Return On Sales  This measure is helpful to management.

 Since the departments rely on each other to maximize efficiency. . then some of the other departments (sales).Hybrid Transfer Pricing  A hybrid transfer-pricing system would be the best system to implement.  Furthermore. it seems unfair to charge full retail price within your own organization. some of the departments (service) have a higher standard profit margin. on average.

 Here we can use return on sales ratio to determine the effectiveness of respective departments. . Liddys’ expectations and it will solve any inter-departmental conflict too.  A better system should be established such that managers of the two departments are given incentives based not on the gross profits of their respective departments but on the profits of the company as a whole.  This would help ensure that conflicts of the two departments will be lessened and that the two departments will no longer compete but will work together to enrich the value of the firm. This will be enough for Mr.Recommendation  Incentives should be based on company profits.

Thank you .

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