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By Vinit Arondekar M1101 Nirvisha Bhuta M1105 Shariq Qureshi M1146 Poorva Saurkar M1150 Gauri Sawant M1152
Management Control Systems
• Management control systems are a means of gathering and using information for planning and control decisions. • Information is used to:
– Aid and coordinate planning and control decisions within an organization. – Guide the behavior of managers and other employees. – Basis for evaluation and reward – Consistent with “agency theory”
Management Control Systems
A management control system collects:
• Financial data such as cost, revenue, and net income Nonfinancial data
and costs. 4 . revenues. 3 Profit center –manager accountable for revenues and costs.Four Types of Financial Responsibility Centers 1 Cost center –manager accountable for costs only. 2 Revenue center –manager accountable for revenues only. 4 Investment center –manager accountable for investments.
Learning and growth . Financial 2. 1. Internal business process 4. Customer 3.Management Control Systems Many management control systems contain some or all of the balanced scorecard perspectives.
• Systems should be designed to fit the company structure and decision-making responsibility of individual managers. . management control systems should be closely aligned to the firm strategies and goals.Evaluating Management Control Systems • To be effective.
7 . • Effort – exertion toward a goal. • Goal congruence – subordinates’ individual goals are consistent with top management’s goals.Evaluating Management Control Systems • Motivation – desire to attain a selected goal combined with the resulting drive or pursuit toward that goal.
Evaluating Management Control Systems Motivation Goal congruence Effort Lead to rewards Monetary Nonmonetary .
• Autonomy is the degree of freedom to make decisions. .Organizational Structure and Decentralization • Decentralization is the freedom for managers at lower levels of the organization to make decisions. the greater the autonomy. The greater the freedom.
Decentralization Versus Centralization • Total decentralization means minimum constraints and maximum freedom for managers at the lowest levels of an organization to make decisions. . • Total centralization means maximum constraints and minimum freedom for managers at the lowest levels of an organization to make decisions.
Benefits of Decentralization Creates greater responsiveness to local needs Leads to gains from quicker decision making Increases motivation of subunit managers Assists management development and learning Sharpens the focus of subunit managers .
Costs of Decentralization Suboptimal decision making may occur Focuses the manager’s attention on the subunit rather than the organization as a whole Increases the costs of gathering information Results in duplication of activities .
Decentralization and Multinational Firms • Companies that operate in multiple countries are often decentralized – why? • What do you think is the biggest drawback to decentralization with multinational companies? .
Decentralization in Multinational Companies Decentralization enables country managers to make decisions that exploit their knowledge of local business and political conditions. Multinational corporations often rotate managers between foreign locations and corporate headquarters. .
Choices about Responsibility Centers • Regardless of the degree as decentralization. – Cost centers – Revenue centers – Profit centers – Investment centers . management control systems used one or a mix of the four types of responsibility centers.
• Management control systems use transfer prices to coordinate the actions of subunits and to evaluate their performance. .Transfer Pricing • A transfer price is the price one subunit of a corporation charges for a product or service supplied to another subunit of the same organization.
Transfer Pricing • The transfer price creates revenues for the selling subunits and purchasing cost for the buying subunits. . • The product or service transferred between subunits is called the intermediate product. affecting each subunits operating income.
Transfer-Pricing Methods Market-based transfer prices Cost-based transfer prices Negotiated transfer prices .
Transportation purchases crude oil in Alaska and sends it to Seattle. .Transfer-Pricing Methods Example Lomas & Co. has two divisions: Transportation and Refining. Refining processes crude oil into gasoline.
$13 $ 2 3 $ 5 .Transfer-Pricing Methods Example External market price for supplying crude oil per barrel: Transportation Division: Variable cost per barrel of crude oil Fixed cost per barrel of crude oil Total The pipeline can carry 35.000 barrels per day.
$23 $ 8 4 $12 .Transfer-Pricing Methods Example External purchase price for crude oil per barrel: Refining Division: Variable cost per barrel of gasoline Fixed cost per barrel of gasoline Total The division is buying 20.000 barrels per day.
The Refining Division is operating at 30.000 barrels capacity per day. .Transfer-Pricing Methods Example The external market price to outside parties is $60 per barrel.
Transfer-Pricing Methods Example What is the market-based transfer price from Transportation to Refining? $23 per barrel What is the cost-based transfer price at 112% of full costs? .
00 per barrel.16 and $23. $13 2 3 $18 .Transfer-Pricing Methods Example Purchase price of crude oil Variable costs per barrel of crude oil Fixed costs per barrel of crude oil Total 1.12 × $18 = $20.16 What is the negotiated price? Between $20.
What is the Transportation Division operating income using the market-based price? .000 barrels of crude oil into 500 gallons of gasoline and sells them.000 barrels of crude oil from the Transportation Division. The Refining Division converts these 1.Transfer-Pricing Methods Example Assume that the Refining Division buys 1.
Transfer-Pricing Methods Example Transportation Division: Revenues: ($23 × 1.000 What is the Refining Division’s operating income using the market-based price? .000) $23.000 Operating income $ 5.000) 18.000 Deduct costs: ($18 × 1.
000) 23.000 Division variable ($8 × 500) 4.000 .000 Deduct costs: Transferred-in ($23 × 1.000 Division fixed ($4 × 500) 2.Transfer-Pricing Methods Example Refining Division: Revenues: ($60 × 500) $30.000 Operating income $ 1.
Transfer-Pricing Methods Example What is the operating income of both divisions together? Transportation Division $5.000 Refining Division 1.000 Total $6.000 .
00 × 1.000 Operating income $ 2.Transfer-Pricing Methods Example What is the Transportation Division’s operating income using the 112% of full cost price? Transportation Division: Revenues: ($20.000) $20.160 Deduct costs: ($18.16 × 1.000) 18.160 What is the Refining Division operating income using the full cost price? .
000 2.Transfer-Pricing Methods Example Refining Division: Revenues ($60 × 500) Deduct costs: Transferred-in ($20.160 4.000 $ 3.00 × 500) Operating income $30.00 × 500) Division fixed ($4.16 × 1.000) Division variable ($8.000 20.840 .
840 $6.Transfer-Pricing Methods Example What is the operating income of both divisions together? Transportation Division Refining Division Total $2.000 .160 3.
Comparison of Methods Achievement of Goal Congruence • Market Price: Yes. but not always • Negotiated: Yes 32 . if markets competitive • Cost-Based: Often.
Comparison of Methods Usefulness for Evaluating Subunit Performance • Market Price: Yes. unless transfer price exceeds full cost • Negotiated: Yes 33 . if markets competitive • Cost-Based: Difficult.
Comparison of Methods
Motivating Management Effort
• Market Price: Yes • Cost-Based: Yes, if based on budgeted costs; less incentive if based on actual cost • Negotiated: Yes
Comparison of Methods
Preserving Subunit Autonomy
• Market Price: Yes, if markets competitive • Cost-Based: No, it is rule based • Negotiated: Yes
Comparison of Methods
Other Factors to Consider
• Market Price: • Cost-Based: • Negotiated: No market may exist Useful for determining fullcost; easy to implement Bargaining takes time and may need to be reviewed
sales taxes. customs duties. payroll taxes. environmental related taxes. • Tax factors include: – – – – – – – – income taxes. . tariffs. value added taxes. and other government levies.Multinational Transfer Pricing and Tax Considerations • Transfer prices often have tax implications.
.Problem 1 • User Friendly Computer with headquarters in San Francisco. • The company has three divisions each of which is located in a different country. manufactures and sells a desktop computer.
. • US Division – packages and distributes desktop computers.Three Divisions • China Division – manufactures memory devices and keyboards. • South Korean Division – assembles desktop computers using internally manufactured parts and memory devices and keyboards from the China division.
• The cost for work done in each division for a single desktop computer is as follows. China Division South Korea Division United States Division Variable costs = Fixed cost = Variable cost = 1000 yuan 1800 yuan 360.000 won $100 $200 .000 won Fix cost = Variable cost = Fixed costs = 480.Additional Information • Each division is run as a profit center.
00 US dollar . United States income tax rate is 30%. A South Korean income tax rate is 20%.00 US dollar – 1.Additional Information • • • • Chinese income tax rate is 40%. Exchange rates: – 8 yuan = $1.200 won = $1.
Additional Information • Each desktop computer is sold through retail outlets in the United States for $3200. .
• The Chinese division sells a comparable memory/keyboard package to a Chinese manufacturer for 3600 yuan.Additional Information • Both China and South Korea sell part of their production under a private label.560. • The South Korea division sells a comparable desktop computer to a South Korean distributor for 1.000 won .
and (c) 300% of variable costs. ( b) 200% of full costs. .Question • Calculate the after tax operating income per unit earned by each division under the following transfer pricing methods: (a) market price. • Income taxes are not included in the computation of cost based transfer prices.
. three-division transfer pricing problem with three alternative transfer pricing methods.Analysis • This is a three-country.
summing to see the total corporate net income under each alternative. . • Then prepare income statements for each division using each transfer price method. • Then organize this data into transfer price alternatives.Analysis • Let’s take this approach in solving the problem: • First begin by summarizing the costs in US dollars.
Summary of Costs in US Dollars • China Plant: – Variable costs: 1000 yuan = $125 per subunit – Fixed costs: 1800 yuan = $225 per subunit. • United States Plant: – Variable costs: $100 per unit – Fixed costs: $200 per unit . • South Korea Plant: – Variable costs: 360.000 won = $400 per unit.000 won = $300 per unit – Fixed cost: 480.
Market Prices for Private Label Sale Alternatives: China Plant: 3600 yuan = $450 per subunit South Korea Plant: 1.000 won = $1300 per unit. .560.
S.300 per unit . Plant = $1.Transfer Prices Market Price as a transfer price: China to South Korea = $450 per subunit South Korea to U.
Plant: 2.Transfer Prices 200% of Full Cost as a transfer price China to South Korea: 2.S.0 ($125 + $225) = $700 per subunit South Korea to U.800 per unit Where does this come from? It is the transfer price of the memory devices and keyboards from China .0 ($700 + $300 + $400) = $2.
0 ($375 + $300) = $2.Transfer Prices 300% of Variable Costs: China to South Korea: 3.S.0 $125 = $375 per subunit South Korea to U. Plant: 3.025 per unit .
China Division Division revenue per unit Cost per unit: Division variable cost per unit Division fixed cost per unit Total division cost per unit Div income per unit Income tax at 40% Division net income per unit Method B Internal Transfers at 200% of Full Costs Method C Internal Transfers at 300% of Variable Costs $ 450 125 225 350 100 40 $ 60 $ 700 125 225 350 350 140 $ 210 $ 375 125 225 350 25 10 $ 15 These figures were calculated on the earlier slides. Method A Internal Transfers at Market Price 1. .Let’s Start in China which makes the memory devices and keyboards.
China Division Division revenue per unit Cost per unit: Division variable cost per unit Division fixed cost per unit Total division cost per unit Division income per unit Income tax at 40% Division net income per unit Method B Internal Transfers at 200% of Full Costs Method C Internal Transfers at 300% of Variable Costs $ 450 125 225 350 100 40 $ 60 $ 700 125 225 350 350 140 $ 210 $ 375 125 225 350 25 10 $ 15 The rest of this data is given in the problem .Method A Internal Transfers at Market Price 1.
300 450 300 400 1.800 700 300 400 1.Now Let’s Move to South Korea that does assembly. .025 375 300 400 1.400 1. Korea Division Division revenue per unit Cost per unit: Transferred-in cost per unit Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 20% Division net income per unit Method B Internal Transfers at 200% of Full Costs Method C Internal Transfers at 300% of Variable Costs $1.400 280 $1.075 950 190 $ 760 These are the costs transferred from China under each transfer pricing assumption. So. Method A Internal Transfers at Market Price 2.120 $2.150 150 30 $ 120 $2.
.150 150 30 $ 120 $2.800 700 300 400 1. So.300 450 300 400 1.400 1.400 280 $1.120 $2.075 950 190 $ 760 These costs will be transferred to the United States under each pricing assumption.Method A Internal Transfers at Market Price 2. Korea Division Division revenue per unit Cost per unit: Transferred-in cost per unit Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 20% Division net income per unit Method B Internal Transfers at 200% of Full Costs Method C Internal Transfers at 300% of Variable Costs $1.025 375 300 400 1.
325 875 262.600 480 $1.Finally we package and distribute in the United States Method A Internal Transfers at Market Price 3.200 2.120 Method B Internal Transfers at 200% of Full Costs $3.200 1.025 100 200 2.600 1.200 2. US Division Division revenue per unit Cost per unit: Transferred-in cost per unit Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 30% Division net income per unit $3.100 100 30 $ 70 Method C Internal Transfers at 300% of Variable Costs $3.300 100 200 1.800 100 200 3.5 .5 $ 612.
50 $1.50 $ The company will maximize its net income by using 200% of full costs as the transfer price. the country with the lowest income rate. This is because method B sources the largest proportion of income in S.400 300% of Variable Cost 15.120 $1.00 760.So what transfer pricing scheme gives the company the greatest profit? Division Net Income China Division So. .300 $ 200% of Full Costs $ 210 1. Market Price 60 120 1.120 70 $1. Korea Division US Division User Friendly Computer.387. Korea. Inc.00 612.
. • Currently all output is converted into cranberry juice by Processing and sold to large companies. • The Processing Division has a yield of 500 gallons of juice per 1.Problem 2 • Crango Products is a cranberry cooperative with two divisions: Harvesting and Processing.000 pounds of cranberries.
20 $0.40 $2.10 Variable processing cost per gallon of juice produced $0.Problem 2 • Cost information is given below: Harvesting Division Variable cost per pound of cranberries Fixed cost per pound of cranberries Selling price per pound of cranberries in outside market Processing Division $0.25 Fixed cost per gallon of juice produced $0.60 Selling price per gallon of juice $0.10 .
10 per gal.000 $ 50.000 $ 50.000 lbs.000 $200. $0.000 .) Fixed costs (250.) Total Processing Division costs Total costs Operating income 500.000 gals.000 $525.000 gals.000 150.000 125. $0.000 175.000 250.25 per lb. $2.) Fixed costs (500. $0.000 100.20 per gal.000 lbs.000 325.) Costs Harvesting Division Variable costs (500.000 lbs.40 per gal.Question • Compute Crango’s operating income from harvesting 500. Pounds of cranberries harvested Gallons of juice processed (500 gals per 1. $0.000 gals.10 per lb.000 pounds of cranberries during June 2006 and processing them into juice.) Revenues (250.) Total Harvesting Division costs Processing Division Variable costs (250.
Question • Crango rewards its division managers with a bonus equal to 5% of operating income. • Compute the bonus earned by each manager for each of the following transfer pricing methods: – 200% of full cost – Market price .
000 $8.000 100.60) 1.000 300.000 $ 25. Processing Division Revenues (250.10 per lb.000 175.000 100.250 $525.) Costs Transferred-in costs Division variable costs (250.10 per gal.000 $175.25) 2.000 $3. $0. $0.60) Costs Division variable costs (500.000 gals.000 50.70 $0.000 $1.25 per lb.000 50.000 gals.) Total division costs Division operating income Harvesting Division manager's bonus (5% of operating income) 2.10 + $0.000 $ 75.) Division fixed costs (500.000 450.70.000 500.000 lbs.000 $125.250 $525.000 50.000 350. $0.60 $350. Harvesting Division Revenues (500.20 per gal.40 per gal. Answer Transfer price per pound (($0. $0.000 125. $0.000 $6.000 175.000 gals.000 lbs.) Division fixed costs (250.750 $300. $0. $0.) Total division costs Division operating income Processing Division manager’s bonus (5% of operating income) 200% of Full Costs Market Price $0.000 50.000 lbs. $2.000 125.750 .
.Question • Which transfer pricing method will each division manager prefer? • The Harvesting Division manager will prefer to transfer at 200% of full costs because this method gives a higher bonus. The Processing Division manager will prefer transfer at market price for its higher resulting bonus.
. However.Question • How might Crango resolve any conflicts that may arise on the issue of transfer pricing? – Basing division managers’ bonuses on overall Crango profits in addition to division operating income. – Letting the two divisions negotiate the transfer price between themselves. this may result in constant re-negotiation between the two managers each accounting period. This will motivate each manager to consider what is best for Crango overall and not be concerned with the transfer price alone.
. – US Processing Division which polishes raw diamonds for use in industrial cutting tools.Problem 3 • Industrial Diamonds has two divisions: – South African Mining Division which polishes raw diamonds for use in industrial polishing tools.
000 pounds of raw diamonds is sent for processing to the United States. there is also an active market for raw diamonds in South Africa. • Although all of the Mining Division’s annual output of 2.Problem 3 • The Processing Division’s yield is 50%. . • It takes two pounds of raw diamonds to produce 1 pound of top-quality polished industrial diamonds.
Problem 3 • The foreign exchange rate is 7 ZAR (South African Rands) = $1. Largest hand dug diamond mine in South Africa . • The information shown on the following slide is for the two divisions.00 US Dollar.
Information on Diamond Divisions South African Mining Division Variable cost per pound of raw diamonds 560 ZAR Fixed cost per pound of raw diamonds Market price per pound of raw diamonds Tax rate US Polishing Division Variable cost per pound of raw diamonds Fixed cost per pound of raw diamonds Market price per pound of raw diamonds Tax rate 1.000 30% US Dollar US Dollar US Dollar .150 18% ZAR ZAR 150 700 5.540 3.
of each division using 200% of full cost and market price transfer pricing methods. in US dollars. • Then calculate after-tax income using same methods. .Question • Compute the annual pre-tax operating income.
000 $5.000 Costs Division variable costs.000 1.000 Division variable cost.000 160.000 150.000 900. Answer—Pre-tax Operating Income 200% of Full Cost Mining Division Division revenues. $600.200.000 700.000 600.000 Costs Transferred-in costs.000 160.000 2. $450 x 2. $220 x 2. $600.000 Division fixed costs.000 $3.000 $ 600.000 440.000 150.000 $ 900. $700 x 1.000 .000 x 1.000.000.000 Total division costs Division operating income Processing Division Division revenues. $150 x 1. $450 x 2.000 600.000 700.000 440.000 Division fixed costs.000 $2.050.000 $ 300.750.000 Total division costs Division operating income Market Price $1.000 $5.200. $80 x 2.000 1. $5.250.950.
950.065.000 The Mining Division manager would prefer 200% of full cost for the purpose of calculating a bonus.000 108.000 $2.000 975. .000 $2.000 $2.250. would prefer market price.275.Answer—After-Tax Income 200% of Full Cost Market Price Mining Division Division operating income Income tax at 18% Division after-tax operating income Processing Division Division operating income Income tax at 30% Division after-tax operating income $600.000 $300.000 $246.000 885.000 $492. The Processing Division manager.000 54.000 $3. however.
Question • In addition to tax minimization. what other factors might Industrial Diamonds consider in choosing a transfer-pricing method? – Performance evaluation – Management motivation – Pricing and product emphasis – External market recognition – Overall income of the company – Income or dividend repatriation restrictions – Competitive position of subsidiaries in their respective markets .
Answer—After-Tax Income 200% of Full Cost Market Price Mining Division Division operating income Income tax at 18% Division after-tax operating income Processing Division Division operating income Income tax at 30% Division after-tax operating income $600.000 $246.000 975.000 Due to differing tax rates.065.250. the company will pay less tax and keep more profit if they use 200% of full cost as the transfer price.000 108.000 $2.000 $300.000 $492.000 $3.275.000 $2.000 885.950.000 $2. .000 54.
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