Responsibility Centres and

Performance Management
Case: White Hills Children’s Museum

Eshan Tyagi – B19077

Gunjan Kumar Verma – B19078
Sajal Garg – B19102
Umang Tharad – B19115

SECTION - B
I) Executive Summary –

II) Problem –
The White Hills Children’s museum is facing multiple challenges, regarding intra-
departmental buying. Both the Urban life program department and the design and
engineering department are profit centres. Both managers have the possibility of earning
bonuses based on the profits of their profit centres. This has created certain challenges-
1. The price quoted by D&E department is higher than a local outsider firm. Ms.
Sweeney is interested to purchase its equipment from outside.
2. There is an absence of goal congruence. Both the department are seeking to
maximize its own profit leaving the whole firm in question.
3. There is underutilisation of D&E department.
4. Mike Sampson, the museum’s new director is in dilemma, whether to intervene in
this matter or not.

III) Analysis and Observation –

Urban Life D&E department Museum

Program overall
Option 1: Buy
from D&E
Revenue X 27,000 X
Variable cost 27,000 19,000 19,000
Contribution X-27,000 8,000 X-19,000

Option 2: Buy
from local firm
Revenue X 0 X
Variable cost 20,000 0 20,000
Contribution X-20,000 0 X-20,000

As can be seen from the above table, it is beneficial for the museum if the purchase could be
made from D&E department. It gives the higher contribution by $1,000. Although, Ms.
Sweeney could improve the profits of her department by buying the equipment from the
local firm, but the overall profit of the firm would decline. This happens because for Urban
life program purchased from the local firm, the museum pays a price that includes not just
variable costs but also a portion of local firm’s fixed costs plus a profit margin. Clearly, the
museum would prefer Ms. Sweeney to purchase the equipment from D&E department.
The problem is that when she purchases the equipment, Ms. Sweeney is charged $27,000
and not $19,000. As a result, for each equipment she purchases from D&E department, her
division’s surplus fall by $27,000, as compared to $20,000 if she purchases from the local
firm.
In summary, permitting Ms. Sweeney to purchase from outside the museum (which fairness
would allow) increases her department’s surplus but reduces the museum’s overall surplus
(thereby creating a goal congruence problem). Forcing her to buy from the D&E department
maximizes the museum’s overall surplus but reduces the surplus of her department
(thereby creating a fairness problem). Because she is paid a bonus, requiring her to buy
from the D&E division also reduces her bonus.

The Dilemma of Mike Sampson

Before delving into the dilemma of Mike Sampson, the new director of the White Hills
Children’s Museum, let us discuss a concept of transfer pricing.
Transfer prices play an important role in many organizations where there are
intraorganizational transactions. These sorts of transactions can exist between two profit
centres. Arriving at a set of satisfactory transfer prices is one of the most complicated
aspects of designing a responsibility accounting structure.
There are several issues when setting transfer prices. Namely,
1. Autonomy vs central control: Assuming an in-house facility (such as D&E
department) is not required for strategic reasons, senior management must decide
how much autonomy it wishes to give to its individual managers. Will it allow selling
units to set their own prices without intervention, or will it intervene to set prices?
Will it allow purchasing units to go outside if they can get a better arrangement (in
terms of price, quality, service, and so on) than internal selling divisions offer them?
2. Price consistency: Budgeted price vs inefficiency in a selling unit that cause the unit’s
actual costs to exceed its budgeted ones.

Coming back to the dilemma of Mike Sampson, the standard answer is to require that
transfer prices be at market price. Moreover, insisting that the transfer price for a
equipment be at market price removes control from the D&E division, and one might argue
that because it is a profit centre, it should be free to charge any price it wishes.
Therefore, the real question for Mr. Sampson is whether he wants to intervene in this
decision or leave them to their profit centre managers. Of course, leaving it to the
respective managers would end up in reduction of the museum’s surplus. So, there is a cost
attached to hands-off approach. The benefit of such approach is that the over time profit
centres would resolve their own differences leaving Mr. Sampson out of the discussion. If he
intervenes, he may find that a huge amount of time is spent in resolving these sorts of
disputes.
Mr. Sampson, can resolve this issue, by intervening now, and setting a clear mandate for the
profit centres to deal with their issues in future on their own.