Decentralization and Transfer

Pricing
 Decentralization
• Decentralization in an organization structure
gives managers at lower levels (subunits) the
freedom to make decisions.
• Why Decentralization required?
– Greater responsiveness to the needs of subunit’s
customers,, suppliers and employees
– Gain from faster decisions making by subunit
managers
– Sharpen focus of subunit manager
 Responsibility centers
• Responsibility center is segment or subunit of
the organization whose manager is accountable
for specified set of activities.
• Cost Center- the manager is accountable for costs
only
• Revenue center- the manager is accountable for
revenues only
• Profit center- the manager is accountable for
revenues and costs
• Investment centers- the manager is accountable
for investments, revenues and costs
 Transfer pricing
• A transfer price is the internal selling price
used when goods and services are transferred
between subunits in a decentralized
organization
– the revenue of the selling division and the cost of
the buying division
– Allows the selling division to record revenue and
earn profit to reflect their effort in producing the
product
 Transfer pricing
• Allows the buying division to record the cost
of that product to match against the revenue
when it is eventually sold to external
customers
• The transfer price should
– Result in divisional profits that are a reliable and
accurate measure of divisional performance
– Preserve and encourage divisional autonomy
 Transfer pricing
• Who sets the transfer prices?
– Managers of subunits usually have considerable autonomy
in deciding whether to accept or reject orders for goods or
services and where to source their materials
– They may also have autonomy on whether to set and
accept transfer prices
– Direct intervention by corporate managers to establish
transfer prices may be inconsistent with philosophy of
decentralization
– Corporate management may set a general policy for
transfer pricing
 Methods
• Market-based transfer price
• Cost-based transfer price
• Hybrid transfer price
 General Rules

• Minimum transfer price = Incremental cost per

unit incurred up to the point of transfer
+
opportunity cost per unit to the selling
subunit.
 General Rules
• Perfectly competitive market for the
intermediated product exists, and the selling
division has no excess capacity.
• Not Perfectly competitive market for the
intermediated product exists, and the selling
division has excess capacity.
• No market exist for the intermediate product