Managerial Accounting

1
Responsibility Accounting, Segment Evaluation and Transfer Pricing

Module 007: Responsibility Accounting,

Segment Evaluation and Transfer Pricing

Course Learning Outcomes:

At the end of this module, the student will be able to:
1. Understand the importance of organizational structure to managerial
reporting.
2. Differentiate centralization from decentralization and empowerment.
3. Distinguish authority, responsibility and accountability.
4. Identify the different types of responsibility centers.
5. Explain the concept of controllability in relation to responsibility
accounting.
6. Apply various measurements in evaluating segment performance.
7. Prepare a segment performance report.
8. Explain the importance of transfer pricing to segment reporting.
9. Identify the various transfer prices and explain their importance to
segment evaluation.

Centralization, Decentralization and Empowerment

Decisions forge an organization. Making decisions could either be centralized or
decentralized. Centralized organization exists when decision rests only to the top
management. When the authority to make decisions is delegated to responsible officers in
different organizational levels, there is a decentralized organization. Either model,
centralization or decentralization, could fashion great results. However, managers have
realized that by doing things along with others, they can produce outstanding results and
more wealth. When they trust others and delegate authority, decisions are faster, actions
are quicker and services become more satisfying to customers. These organizational
attributes are needed to stay abreast and relevant in a competitive market. This premise
strengthens the practice of decentralization.
New organizations are bolder in their approach of trusting men up to the level of the
production supervisor and his teammates in the quality circle. The power to make
decisions may also be delegated up to the organization’s grassroots to the level of ordinary
workers. This is called empowerment. This powerful model in managing organizational
men is not covered in our discussions.
Authority, Responsibility and Accountability
As authority is shared, responsibility must be performed in line with the principle of
accountability. Authority is the power to give orders, to give command, to give instructions,

Course Module
 or to make decisions. Responsibility is the duty to do or not to do an activity, to perform
and produce results. Accountability is the answerability on the consequences of what has
been done or not done. Authority and responsibility must go together. One should not be
present without the other. Authority without responsibility is absolute power and absolute
power corrupts absolutely. Responsibility without authority is blind obedience, a plain
servitude. Using equation, we could express that:

Authority = Responsibility

The manner authority is exercised and the effects of the acts performed to fulfill a
responsibility should be evaluated. This is the moving concept of accountability. Without it,
there would be no logical value of assessing how things are done and what have been done.
Without accountability, there would be no compelling reasons to evaluate performance
fairly and objectively. In an expanded equation, we could say:

Authority = Responsibility = Accountability

Responsibility Centers
In a decentralized organizational structure, divisions, departments, segments, or units are
considered responsibility centers. Each center is managed by a responsible officer. A
responsibility center could be an investment center, profit center, revenue center or cost
center. An investment center manager decides on which strategic business opportunity
should the company take. A profit center manager controls the occurrence or non-
occurrence of both revenues and costs. A revenue center manager controls the generation
of revenue. A cost center manager has a control or influence over the incurrence of costs.

Controllability and Responsibility Centers

The span of authority given to a manager defines what he controls over with.
Controllability refers to the power of manager to decide or influence the incurrence or non-
incurrence of an item. This concept of controllability is extremely important in measuring a
manager’s performance. With the principle of decentralization is the truism that a manager
should be evaluated only on matters that he has control over.
Each responsibility center manager has his own breadth and depth of authority. The
authority given should commensurate with the responsibility given to him. Consequently,
he is accountable to his actions or inaction! This model stresses the need for performance
evaluation.

Performance Evaluation
A manager’s performance should be evaluated in line with the established objectives of his
center. Different responsibility center managers should be evaluated differently in as much
as their authority, responsibility and accountability vary from each other.
Performance evaluation (i.e., performance measurement, feedback) is a matter of control. It
could be done before, during or after a process. Performance is assessed based on reports
 Managerial Accounting
3
Responsibility Accounting, Segment Evaluation and Transfer Pricing

submitted to and gathered by the manager. Therefore, an effective, reliable, timely,

verifiable and relevant reporting system must be in place. Responsibility accounting
reports may either be information reports or performance reports.
Reports submitted by a responsibility manager should segregate the controllable from the
non-controllable items. Managers’ performance should be measured for items they have
control over. The techniques used in measuring managers’ performance are presented
below.
Responsibility Center Manager Evaluation Techniques
Cost center manager Cost variance analysis
Revenue center manager Revenue variance analysis
Profit center manager Segment margin analysis
Investment center manager Return on investment (ROI)
Residual income model
Economic value added (EVA), etc.

Cost Center Manager’s Performance

A cost center manager has control or influence over the incurrence or non-incurrence of
costs. His report should separate the controllable from the non-controllable costs and
should highlight the variances between the actual and budgeted costs.
Variances are identified as either favorable (F) or unfavorable (U). Unfavorable variances
indicate excessive costs and should be avoided. Favorable variances mean savings,
however, should also be investigated.

Revenue Center Manager’s Performance

A revenue center manager has control or influence in generating revenue but not costs. His
performance should be focused on getting the variances between actual revenue and
budgeted revenue. When the actual revenue is greater than budgeted revenue, there is a
favorable variance, and vice-versa. A favorable variance should be encouraged and be given
a commensurate reward while an unfavorable variance should be avoided.
Responsibility centers that are responsible in developing and maintain sources of supply
such as sources of materials and labor may be classified as revenue centers.

Profit Center Manager’s Performance

A profit center manager has control over revenues and costs. His managerial performance
is evaluated based on controllable margin while the center’s performance is evaluated
based on segment (or direct) margin. Once more, the controllable margin and segment
margin computations are presented below:
Contribution margin Px
Less: Controllable direct fixed costs and expenses x
Controllable margin x
Course Module
 Less: Non-controllable direct fixed costs and expenses x
Segment margin Px

Deduct the allocated (or indirect or unavoidable) fixed costs and expenses from the
segment margin, you get the operating profit. The difference between controllable margin
and segment margin is fixed cost and expenses controllable not by the concerned manager
but by others.
The actual controllable margin and segment margin should be compared with the budgeted
amounts to get the variances and evaluate performances.

Illustration: Segment Performance

JKL Corporation has been experiencing negative operating results in the last 6 quarters. Its
most recent income statement is as follows:
Sales P6,300,000
Less: Variable costs 3,474,000
Contribution margin 2,826,000
Less: Fixed costs 2,906,000
Net loss P (80,000)
The company operates three product lines which has the following related data:
Product A Product B Product C Total
Sales P1,200,000 P2,100,000 P3,000,000 P6,300,000
Controllable direct
fixed costs 220,000 880,000 800,000 1900,000
Allocated fixed costs 102,000 102,000 102,000 306,000
Non-controllable
direct fixed costs 220,000 100,000 800,000 1,120,000
Variable cost ratio 56% 42% 64%
Required: Computed the segment margin for each of the product lines and the total for the
corporation. Evaluate the data.
Solutions/Discussions:
 The segment margins of the three product lines are determined as follows:
Product A Product B Product C Total
Sales P1,200,000 P2,100,000 P3,000,000 P6,300,000
Less: Variable costs 672,000 882,000 1,920,000 3,474,000
Contribution margin 528,000 1,218,000 1,080,000 2,826,000
Less: Controllable
direct fixed costs 220,000 880,000 800,000 1,900,000
Controllable margin 308,000 338,000 280,000 926,000
Less: Non-controllable 220,000
 Managerial Accounting
5
Responsibility Accounting, Segment Evaluation and Transfer Pricing

direct fixed costs 100,000 800,000 1,120,000

Segment margin 88,000 238,000 (520,000) (194,000)
Less: Allocated fixed
costs 102,000 102,000 102,000 306,000
Profit (loss) P(14,000) P136,000 P(622,000) P(500,000)

 Product line B registers the best performance in terms of peso amount amounting to a
segment margin of P238,000 and margin return on sales of 11% (i.e.,
P238,000/P2,100,000). Product line C produces a negative segment margin of
P520,000. This product line does not contribute to the overall profitability of the
company but rather reduces the overall amount of the company’s profit by the amount
of its negative segment margin. Product line C, based on the computations above,
should be disposed.
 In terms of individual segment manager’s performance, the manager of product line B
still registers the best performance posting a controllable margin of 16% (i.e.,
P338,000/P2,100,000) compared to that of product line C’s manager of 9% (i.e.,
P280,000/P3,000,000) and that of product line A’s manager of 3% (i.e.,
P308,000/P1,200,000).

Investment Center Manager’s Performance

The investment center manager has authority to decide over which investment opportunity
should be considered. As such, their performance is evaluated based on the results of
decisions on investments. The cost-benefit criterion plays a vital role in the investment
selection decision process. The benefit refers to the returns derived from investments
while the cost revers to the amount used in undertaking the opportunity.
There are several models in evaluating investment center performance. Some of these are
the return on equity, return on investment (DuPont Model), residual income, economic
value added, equity spread, total shareholders return, and the market value added. We will
take up only three – the ROI (return on investment) model, the residual income model, and
the economic value added (EVA).

The Return on Investment (ROI)

The ROI is sometimes referred to as return on assets (ROA) or accounting rate of return
(ARR). It is computed as follows:

ROI = Segment Profit / Segment Investment

ROI is a measure of benefit over cost analysis. Benefit is represented by the net income
while the cost is the amount of investment. The higher the ROI, the better it will be for the
business. The issue, therefore, is how to increase ROI. Quantitatively speaking, ROI is
increased by increasing net income and reducing investment.

Course Module
 Increase in ROI = Increase in profit / Decrease in Investment

The DuPont Model

E.I. du Pont de Nemours and Company, commonly referred to as DuPont, an American
chemical company that was founded in July 1802 and is the world’s third largest chemical
company based on market capitalization, evaluates the performance of its numerous
business investments using an extended ROI model as follows:

ROI = Profit / Net Sales x Net Sales /Investment

ROI = Return on Sales x Assets Turnover

This model encourages investment center managers to take investments only those which
are of relevance to their operations. This will result to efficiency in allocating investment
funds. Only those investments of which the investment center manager has control and use
in operations shall be included in the ROI determination.

Illustration: Return on Investment

JKL Corporation’s balance sheet indicates that the company has an investment of
P5,000,000 in operating assets. During 2018, JKL earned P1,100,000 of net income on
P11,000,000 of sales.
Required:
1. Compute JKL’s margin for 2018.
2. Compute JKL’s turnover for 2018.
3. Compute JKL’s return on investment for 2018.
4. Recompute JKL’s ROI under each of the following independent assumptions:
a. Sales increase from P5 million to P6 million and income increases from P1,100,000
to P1,300,000.
b. Sales remain constant, costs and expenses decrease, and income increases by
P400,000.
c. The amount of investment is decreased by P400,000 without affecting net income.
Solutions/Discussions:
1. Margin on sales or return on sales is computed as follows:
Return on sales = Profit/Net sales = P1,100,000/P11,000,000 = 10%
2. The turnover referred to here is the assets is the assets turnover and is determined as
follows:
Assets turnover = Net sales/Assets = P11 million/P5 million = 2.2
3. ROI = Return on sales x Assets turnover = 10% x 2.2 = 22%
Or, ROI may be computed directly as:
ROI = Profit/Average assets used = P1,100,000/P5,000,000 = 22%
 Managerial Accounting
7
Responsibility Accounting, Segment Evaluation and Transfer Pricing

4.
a. ROI = P1,300,000/P6,000,000 = 21.67%
b. ROI = (P1,100,000 + P400,000)/P5,000,000 = 30%
c. ROI = P1,100,000/P4,600,000 = 23.91%

The ROI and Its Limitations

The use of ROI has several limitations. Significant differences in the amount of investment
from one project to another and the differences in the life of the asset used in investment
opportunities may render the use of ROI difficult to apply. To highlight these limitations,
consider the following:
Company A Company B
Return on investment 20% 40%
Amount of investment P1 billion P1 million
Life of assets in years 15 years 2 years

Using the ROI model, Company B is better BUT…

The size matters…

Using the ROI company B manager with 40% ROI, would be better off than that of company
A manager with 20% ROI. However, considering the amount of investment supervised by
each manager respectively, we could easily say managing a million worth of business (e.g.,
Company B) is a lot much easier than managing a billion of resources (e.g., Company A).
The asset life also matters…
Also, considering the life span of the assets used, company B’s performance in an utter
dismay because only 80% of the investment would be recovered in 2 years, which is the life
of the investment, given a 40% ROI per annum. This performance falls short of recovering
the entire amount of investment over its operational life. Whereas company A has a total
return of 300% (e.g., 20% x 15 years) which means investment in company A is
recoverable three times and is better than the 80%recovery rate of company B.
The special assignment matters…
ROI model may not also be the most suitable method in evaluating the performance of an
excellent manager who is assigned to make a turnaround performance, say to deliver a
profitable performance of a previously unprofitable operations.

The Residual Income Model

The limitations encountered in applying the ROI is improved by the residual income model
that uses amount as a basis of evaluating the acceptance of a prospective investment or in
evaluating the performance of an investment project. The residual income is computed as
follows:

Course Module
 Segment Income P x
Less: Minimum income (Investment x Implied interest rate) x
Residual income Px

The segment income is income expressed before tax. Segment income also refers to
earnings before interest and tax (e.g., EBIT) or is called now as profit before income tax
(PBIT). Minimum income is sometimes labeled as imputed income, implied income, implicit
income or desired income. The investment base used in computing the minimum income is
to the amount agreed upon by the corporate headquarter and the investment center
manager. The imputed interest rate is to be determined by the corporate headquarter
management. Normally, the imputed interest rate is based on the prevailing market rate
from which the business generates profit without accepting a high business risk. The
imputed rate is ordinarily the pre-tax cost of capital, and in principle, should reflect the
degree of risk of the reporting responsibility center. If the residual income is positive, the
performance is above standard and is, therefore, favorable. Residual income is considered
superior than the ROI because it considers two levels of assessments, the compliance to
minimum return and the size of the excess return over the designated minimum return.

Illustration: Residual Income

JKL Corporation gathered the following data relative to Northern Division’s performance:
Net Sales P12,000,000
Costs and expenses 11,000,000
Average operating assets 5,000,000
Desired minimum (or imputed) rate of return
established by management 15%
Average industry rate of return 28%
Income tax rate 40%
Compute the Northern Division’s residual income.
Solutions/Discussions:
Segment profit (P12 million – P11 million) P1,000,000
Less: Minimum income (P5 million x 15%) 750,000
Residual income P 250,000
 The average industry rate of return may be considered in setting the minimum desired
rate of return but is not considered in determining the residual income. The desired
minimum income is normally expressed in amount before tax, hence, it is compared
with operating income.
 Since the residual income of a division is positive, the division has met the expectations
or standards set by top management in terms of profitability and is therefore
considered acceptable.
 Managerial Accounting
9
Responsibility Accounting, Segment Evaluation and Transfer Pricing

Economic Value Added

The economic value added (EVA) is a more specific after-tax version of residual income.
It represents the business unit’s true economic profit because a change in the cost of equity
capital is implicit in the cost of capital. The cost of equity is an opportunity cost, that is, the
return that could have been obtained with the best alternative investment having similar
risk. The EVA is computed as follows:
Operating profit after tax (PBIT x after-tax rate) P x
Less: Minimum income (Investment x weighted average cost
of capital) x
Economic value added Px

The operating profit after tax (OPAT) is computed by multiplying the profit before interest
and tax (PBIT) by the after-tax rate. The weighted average cost of capital is computed after
tax. EVA measures the marginal benefit obtained by using resources in relation to the
business of increasing shareholders’ value. Some adjustments in PBIT are needed such as
research and development costs which are capitalized and amortized over 5 years. The true
economic depreciation rather than the accounting depreciation used for tax purposes is to
be used in computing the EVA.

Illustration: Economic Value Added

JKL Holdings operates Star Corporation, a division in electronics industry and provided you
the following data with regard to the Division’s 2018 performance:
Divisional income before interest and tax P200 million
Interest expense P60 million
Tax rate 40%
Weighted average cost of capital 12%
Average total assets
Carrying amount P90 million
Current value P120 million
Average current liabilities P40 million

Required: Economic value added assuming the investment base is:

1. Market value of long-term financing
2. Carrying amount of long-term financing
3. Market value of total assets
4. Carrying amount of total assets

Solutions/Discussions:
1. Investment base is the market value of long-term financing.
Course Module
 OPAT (P200 million x 60%) P 120 million
Less: Minimum return on market value of long-term
financing [(P120 million – P40 million) x 12%] 9.60 million
Economic value added P 110.40 million

2. Investment base is the carring amount of long-term financing.

OPAT (P200 million x 60%) P 120 million
Less: Minimum return on carrying amount of long-
term financing [(P90 million – P40 million) x 12%] 6 million
Economic value added P 114 million

3. Investment base is the market value of the total asset.

OPAT (P200 million x 60%) P 120 million
Less: Minimum return on market value of long-term
assets [P120 million x 12%] 14.40 million
Economic value added P 105.60 million

4. Investment is base is the carrying amount of the total asset.

OPAT (P200 million x 60%) P 120 million
Less: Minimum return on carrying amount of long-
term assets [P90 million x 12%] 10.80 million
Economic value added P 109.20 million

The economic value added is a measure of the management effectiveness in increasing

investors’ value. The best investment base to use is the market value of the long-term
financing. You may also use the market value to reflect the true amount of investment and
exercise prudence in the process. Also, use long-term financing to isolate the interest of the
true investors from the short-term ones. Maximizing interest of the long-term investors,
both creditors and owners, are the real intentions of enterprise management.

Other Evaluation Models

Other divisional evaluation models are equity spread, total shareholders’ return and
market value added. The equity spread, like the EVA, is also a straightforward method for
measuring managerial performance regarding creation of shareholder value. It is computed
as follows:

Shareholders’ equity - beginning P x

x (Return on equity – Cost of equity rate) x%
Equity spread Px
 Managerial Accounting
11
Responsibility Accounting, Segment Evaluation and Transfer Pricing

The return on equity is equal to net income divided by average shareholders’ equity.
Total shareholders’ return equals the change in the stock price plus dividends per share
divided by initial stock price. The market value added is the difference between the
market value of the equity (i.e., market price x shares outstanding) and the equity supplied
by the shareholders.

Transfer Pricing
The issue of transfer pricing occurs when an independent unit sells to or buys from another
independent unit within the same business conglomerate. This is an issue of
interdependence.
Since independent business unit managers have the authority to decide on how they run
their business operations, they deal with external suppliers and customers and also with
affiliated divisions (e.g., internally independent business units) as well. Issues on transfer
pricing arise when the individual goal of the investment center managers runs in conflict
with the overall goal of the organization. When the overall goal of the organization prevails
over that of the divisional goals, it is called goal congruence or optimization. When the
individual goal of investment managers prevails over that or the overall organization’s
goals, it is called sub-optimization.
Managerial effort is the extent to which a manager attempts to accomplish a goal. Goal
congruence and managerial effort are managerial motivation. Motivation is the desire to
attain a specific goal (goal congruence) and the commitment to accomplish the goal
(managerial effort).

Transfer Prices
Transfer price is our artificial price used to record inter-divisional transactions of goods
or services and properly evaluate divisional performance in line with the objective of goal
congruence.
Transfer price may be a market-based pricing, cost-based pricing, negotiated
pricing, arbitrary pricing, or dual pricing.
The best transfer price is market price. Because business units or segments have to
compete with the rest of the world, they have to beat the prevailing market price to stay
competitive. They have to follow the market streams of capitalistic model or free enterprise
system.
A cost-based transfer price equals cost plus a lump sum or a mark-up percentage. Cost
may either be standard or actual cost. Standard cost has the advantage of isolating
variances. Actual costs give the selling division a little incentive to control costs. Actual
cost-based transfer pricing does not promote long-term manufacturing efficiencies.
Another, the cost-based transfer pricing does not give motivation on the part of the buying
division since the costs incurred by the selling division may not reflect the best possible
performance in the market which is adversely transferred to the buying division.
Course Module
Negotiated transfer price may occur when segments are free to determine the prices at
which they buy and sell internally. It is especially appropriate when market prices are
subject to rapid fluctuations. It reflects the best bargain price acceptable to the selling and
buying divisions without adversely sacrificing their respective interests.
Arbitrary transfer pricing is set by the management in the corporate headquarters. Its
strength is anchored on the premise that the entire corporate organization has to promote
its overall goals (optimization) over and above that of the division’s goals (sub-
optimization).
On the contrary, it does not jibe well with the very principle of decentralization where
authority is given to division managers to make decisions with regard to their operations.
Dual pricing is used when the selling and buying division records the transfer at market
prices as if the sale is made to outside customers, while the buying division records the
purchases at variable cost of production. Each division’s performance would improve using
the dual pricing scheme. In a sense, the variable costs would be the relevant price for
decision-making purposes but the segment’s performance is evaluated based on market
prices. In this pricing model, the su of the profits of the individual divisions would be
greater than the overall profit of the organization. This model reduces managerial efforts to
control costs. The seller is assured of a high price, and the buyer is assured of an artificially
low price. This model is rarely used in practice because division managers are assured of a
good segment performance and may not exert much to report higher segment margin.
Transfer pricing policy is normally set by top management. The segment’s goal is also
relevant but the overall goal of the organization is paramount. Other factors that are
considered are excess capacity, opportunity cost of the transfer, international tax issues
(e.g., income taxes, sales taxes, value-added taxes, inventory and payroll taxes, and other
governmental changes), and other international issues such as foreign exchange rate
fluctuations and limitations on transfers of profits outside the host country.
When capacities are considered, transfer price may be computed as the sum of the
incremental cost plus the opportunity costs from the best alternative use of capacity, as
follows:

Transfer price = Incremental cost + Opportunity costs - Savings

Illustration: Basic Transfer Prices

JKL, Inc. has two independent divisions, Asian Enterprises and Malayan Corporation, that
conduct business in the same country. Asian Enterprises produces product “Cute” of which
Malayan Corporation buys from an external supplier at P80 per piece. The relevant
production data of Asian Enterprises is as follows:
Variable production costs P66
Allocated factory overhead 15
Required: Determine the profit for Asian Enterprises, Malayan Corporation, and JKL, Inc., if
an inter-divisional transfer of goods occurred under each of the following transfer prices:
1. Market price of P80
 Managerial Accounting
13
Responsibility Accounting, Segment Evaluation and Transfer Pricing

2. Variable production costs of P66

3. Negotiated price of P73
4. Dual pricing

Solutions/Discussions:
The computation of the profit of the companies shall be as follows:
1. Transfer price is market price of P80.
Asian Enterprise (Seller)
Transfer price P 80
Less: Variable production cost 66
Profit P 14
Malayan Corporation (Buyer)
Market price P 80
Less: Transfer price 80
Profit -
JKL, Inc. (HQ Company
Market price P 80
Less: Variable production costs 66
Profit P 14
2. Transfer price is variable production costs of P66.
Asian Enterprise (Seller)
Transfer price P 66
Less: Variable production cost 66
Profit -
Malayan Corporation (Buyer)
Market price P 80
Less: Transfer price 66
Profit P 14
JKL, Inc. (HQ Company
Market price P 80
Less: Variable production costs 66
Profit P 14

3. Transfer price is negotiated price of P73.

Asian Enterprise (Seller)
Transfer price P 73
Less: Variable production cost 66
Profit P7

Course Module
 Malayan Corporation (Buyer)
Market price P 80
Less: Transfer price 73
Profit P7
JKL, Inc. (HQ Company
Market price P 80
Less: Variable production costs 66
Profit P 14

4. Transfer price is dual prices.

Asian Enterprise (Seller)
Transfer price P 80
Less: Variable production cost 66
Profit P 14
Malayan Corporation (Buyer)
Market price P 80
Less: Transfer price 66
Profit P 14
JKL, Inc. (HQ Company
Market price P 80
Less: Variable production costs 66
Profit P 14

 If the transfer price is the market price, the selling division reports all the profit of P14
and reports higher return on investment or residual income or EVA. The selling division
manager has a higher chance of getting promoted the next time promotions come
around, assuming all things are the same on all divisions.
 If the transfer price is based on costs, the buying division registers all the profit of P14,
reports higher return on investment or residual income or EVA. The selling division
manager would have a higher chance of getting promoted, assuming all things are the
same on all divisions.
 If the transfer price is based on negotiated pricing, both the selling and the buying
divisions have share on the transaction profit, report higher return on investment or
residual income or EVA, and have an equal chance of being considered in the next round
or promotions, assuming all things are the same on divisions.
 If the transfer price is based on dual pricing, both the selling and the buying divisions
record profit at P14, report much higher return on investment or residual income or
EVA, and have an equal chance of being considered in the next round or promotions,
assuming all things are the same on all divisions.
 The allocated factory overhead is not considered in the computation of divisional profit
for performance purposes because it is not reflective of the controllable performance
and it does not change regardless of the option to buy the product from an outside
supplier or from a relative division.
 Managerial Accounting
15
Responsibility Accounting, Segment Evaluation and Transfer Pricing

 Overall, the profit of JKL, Inc. remains the same at P14, despite the differences in the
transfer price used by the transacting divisions. Following the doctrine of goal
congruence, a holding company should continue advising its buying division to buy the
goods from its selling division as long as the incremental costs of producing the goods is
lower than the cost of buying the same from an outside supplier. This decision would
produce overall savings, regardless of the transfer price used in recording the
interdivisional transaction, and would be beneficial for the overall operations of the
holdings company.

Multinational Transfer Pricing

Multinational transfer pricing applies when the transacting divisions are not located in the
same country of operations.
In multinational transfer pricing, the objective of the holdings company is still to minimize
costs and maximize profit. Costs are minimized if the internal costs of producing the goods
are lower than the costs of acquiring the goods externally.
A special focus of multinational transfer pricing is the analysis of the effects of the taxes
paid by the holding company to the host countries. The holding company would endeavor
to reduce the overall tax payments by striking the best transfer price that would result to
the lowest total tax payments to be made.

Quality Improvements
Feedback and performance evaluation are important in effective management. Feedback
regarding managerial performance may take the form of financial and nonfinancial
measures that may be internally and externally generated. Some examples of financial and
external measures are stock price, industry average on return on equity, return on assets,
return on sales, debt-to-equity ratio, and price-earnings ratio. Examples of internal and
financial measures are cost variances, return on investment, residual income, break-even
point, break-even time, return on sales, and other financial ratios.
Break-even time is the point where the cumulative discounted net cash inflows from
investment equals the cost of investment.
Non-financial measures are important in a modern, quality-oriented organizations.
Emphasis is made on kaizen or continuous improvement, value-chain analysis, process
innovation or reengineering), process mapping where standards are geared towards
process analyses and not on absolute costs benchmarks. Examples of external nonfinancial
measures are customer satisfaction, market share, number of sales returns, delivery
performances, and competitive rank. Examples of internal nonfinancial measures are set up

Course Module
 time, retooling, rework, outgoing product quality, new product development time,
manufacturing cycle time, and productivity rate.
Product development time pertains to the period where the product is conceptualized,
designed, approved, prototype is made and is readied for commercial production. As
customer tastes, preferences, needs, and wants change now more frequently, product life
cycle shortens and the quickness of addressing customer wants, etc. becomes a critical
factor in a business growth and relevance. Manufacturing cycle time refers to a period
where the materials from suppliers are received, stocked, checked, processed, and
prepared for delivery to customers. To improve manufacturing cycle time, non-value-added
activities should be eliminated, therefore, production gets faster, costs diminish, and
customers will be served on tie. Partial productivity rate is a measure of output (finished
goods) over process input (e.g., materials, labor hours).
Balanced scorecard uses multiple measures in determining as to whether a manager is
achieving objectives at the expense of others. The scorecard approach is a goal congruence
tool that informs managers about the factors that top management believes to be
important. For example, the value of improving operating results at the expense of new
product development could be evaluated using the scorecard approach. A typical scorecard
includes measures in four categories:
 Learning and growth perspectives;
 Internal business processes perspectives;
 Customer satisfaction perspectives; and
 Financial perspectives.

References and Supplementary Materials

Books and Journals
1. Rodelio S. Roque (2016). Management Advisory Services. CM Recto, Manila. GIC
Enterprises and Co., Inc.
2. Leonardo E. Aliling, Ma. Flordeliza L. Anastacio (2015). Management Accounting 1.
856 Nicanor Reyes, Sr. St., CM Recto Avenue, Manila. Rex Book Store, Inc.
3. Franklin T. Agamata (2019). Management Services. Certs Publications. Agdao, Davao
City, Philippines
4. Ray H. Garrison, Eric W. Noreen, Peter C. Brewer, 16 th ed. Managerial Accounting. The
McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York

Online Supplementary Reading Materials

1. https://www.opencostaccounting.org/toc/chapter10/
2. http://www.accountingnotes.net/responsibility-accounting/notes-on-responsibility-
accounting/6241
3. https://www.academia.edu/6261712/
RESPONSIBILITY_ACCOUNTING_Significance_of_Responsibility_Accounting
4. https://people.ucsc.edu/~shep/migrated/110/110OVR/malory/chap012.ppt
 Managerial Accounting
17
Responsibility Accounting, Segment Evaluation and Transfer Pricing

5. https://www.google.com/search?
q=responsibility+accounting&rlz=1C1CHBD_enPH807PH807&ei=pWqNXc37BdTbhw
Ps26rQDQ&start=60&sa=N&ved=0ahUKEwiN4pbE8e_kAhXU7WEKHeytCto4MhDy0
wMIiQE&biw=1266&bih=601#
6. http://faculty.cbpp.uaa.alaska.edu/afrfb/acct202/Chpt_12_HO.ppt

Course Module