MANAGEMENT ACCOUNTING

MANAGEMENT CONTROL SYSTEMS, RESPONSIBILITY ACCOUNTING & TRANSFER PRICING

(UNIT 7)

Management Control Systems – A management function aimed at achieving defined goals

within an established timetable, and usually understood to have three components: (1)
setting standards, (2) measuring actual performance, and (3) taking corrective action.
A typical process for management control includes the following steps:

• Actual performance is compared with planned performance

• The difference between the two is measured
• Causes contributing to the difference are identified
• Corrective action is taken to eliminate or minimise the difference
(Business Dictionary.com)
Management control is the process that helps organisations achieve their goals.
Management uses this process to influence other members to implement the strategies laid
down by the company and to direct the resources of its organisation so that the set
goals/targets are achieved.
Responsibility Accounting – This is a system of dividing an organisation into similar units,
each of which is to be assigned particular responsibilities. These units may be in the form of
divisions, segments, departments, product lines etc. Each department is comprised of
individuals who are responsible for particular tasks or management functions.
Responsibility Accounting refers to the various concepts and tools used by management
accountants to measure the performance of people and departments in order to ensure
that the achievement of the goals set by top management. Responsibility Accounting
therefore, represents a method of measuring the performances of various divisions of an
organisation. (Slideshare.net)
Types of Responsibility Centres
Cost Centre
According to the ICMA, a cost centre is “a location, person or item of equipment (or group
of these) in respect of which costs may be ascertained and related to cost units.” For
example, the machine shop, canteen or purchasing department.

Profit Centre
A profit centre is a responsibility centre which accumulates revenues a s well as costs. In
other words, it is a department or segment of an organisation which has been assigned
control over both revenues and cost. For example, the College’s canteen.

Investment Centre
These are responsibility centres in which managers and other employees control revenues,
costs and the level of investment. An investment is like an independent business.

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The Importance of Evaluating Performance
Performance evaluation is important to the management of all companies/organisations
who want to make sure that their operations are under control. To be able to go deeper
they need to view the company in segments – divided into several units of operations, in the
form of responsibility centres.
Using financial and non-financial control systems, each centre is assessed to get insight into
how each unit is performing, if goals are not being achieved then the appropriate actions
must be taken.
Financial control summarises the financial results of the operations (in each responsibility
centre) and compares them to planned results. Measures such as profit, revenue, cost and
return on investment are used to assess performance.
Non-Financial control examines the non-financial elements of performance such as quality
and service that create positive results in the long run.
Balanced Scorecard (BSC)
Is a general and flexible approach to performance measurement, it provides a framework
that selects financial and non-financial measures from the company’s strategy. The
measures include but are not restricted to, measures of operating, quality and process
improvements. The BSC measures organisational/centre performance across four different
but linked perspectives that are derived from the organisation’s vision, strategy and
objectives.
• Financial – how is success measured by our shareholders?
• Customer – how do we create value for our customers?
• Process – at which process do we excel to satisfy our customers and shareholders?
• Learning and growth – what employee capabilities, information systems and
organisational capabilities do we need to continually improve our processes and
customer relationships?

Perspective Question Explanation

Financial How do we create value for our
shareholders?
Customer What do existing and new
customers value from us?
Process What processes must we excel
at to achieve our financial and
customer objectives?
Learning and Can we continue to improve and Considers the business’s capacity to
growth create future value?
Covers traditional measures such as
growth, profitability and
shareholder value but set through
talking to the shareholders directly
Gives rise to targets that matter to
customers: cost, quality, delivery,
inspection, handling and so on.
Aims to improve internal processes
and decision making.
maintain its competitive position
through the acquisition of new skills
and the development of new
products

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 TRANSFER PRICING

As organisations grow, operations tend to increase in both scope and volume, and they are
divided among a number of larger number of subunits such as divisions and centres. As a
result, more of the freedom to make decisions is assigned to these subunits.
Decentralisation is most effective in organisations where cost and profit measurement is
necessary and is most successful in organisations where subunits are totally independent
and autonomous.

Goods and services are often exchanged between divisions of a decentralised organization.
The question then is: What monetary values should be assigned to these exchanges or
transfers?

The choice of transfer policy is normally decided by top management. The decision typically
includes consideration of the following:

• Goal congruence: Will the transfer price promote the goals of the company as a
whole? Will it harmonise the divisional goals with the organisational goals?
• Performance evaluation: Will the selling division receive enough credit for its
transfer of goods and services to the buying division? Will the transfer price hurt
the performance of the selling division?
• Autonomy: Will the transfer price preserve autonomy, the freedom of the selling
and buying division managers to operate their divisions as decedntralised entities?
• Other factors: Such as the minimization of tariffs and income taxes and observance
of legal restrictions.

The transfer price policy is generally aimed at:

i. Evaluating financial performance of different business units (profit centres) of a

conglomerate.
ii. To shift earnings from a high tax rate jurisdiction to a lower one. This is often
frowned upon by tax authorities.

Transfer prices can be based on:

i. Market price
ii. Cost-based price – variable or full
iii. Negotiated price

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MARKET PRICE
When there is a competitive and stable market for the transferred product, many firms use
the external market price as the transfer price. Market price is the best transfer price in the
sense that it will maximise the profits of the company as a whole, if it meets the following
two conditions:

i. There exists a competitive market price

ii. Divisions are independent of each other.

Advantage – Easy to use, no negotiation or calculations necessary

Disadvantage – Does not give the divisions involved any autonomy

COST BASED PRICE

The transfer price is based on the production cost of the division. A cost based transfer
price requires that the following criteria be specified:

i. Actual cost or standard cost

ii. Full cost or variable cost
iii. The amount of mark-up (if any) to allow the upstream division to earn a profit on the
transferred product.

Advantage – Easy to understand and convenient to use

Disadvantage – Inefficiences of the selling divisions are passed on to the buying divisions
with little incentive to control costs. The use of standard costs is
recommended in such a case.

The variable cost-based transfer price has an advantage over the full cost method
because in the short run it may tend to ensure the best utilisation of the overall
company’s resources.

NEGOTIATED PRICE
Senior management does not specify the transfer price. Rather divisional manager
negotiate a mutually agreeable price. This method is generally used when there is no clear
outside market.

Advantages – The division managers have control over the transfer prices and can be held
responsible for their resulting impact on profits.

Disadvantage – Individual managers, in their attempt to maximise profits in their own

divisions, may make decisions detrimental to the overall profit of the firm as
a whole.

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