Test two: Cost accounting

Transferring products or services at market prices generally leads to optimal decisions when three conditions are satisfied:

(1) The market for the intermediate product is perfectly competitive, (2) the interdependencies of subunits are minimal, and (3) there are no additional costs or benefits to the company as a whole from buying or selling in the external market instead of transacting internally.

That's because by transferring a unit internally, the subunit forgoes the contribution margin it could have obtained by selling the unit in the external market. We distinguish the incremental cost from the opportunity cost because financial accounting systems record incremental cost but do not record opportunity cost. The guideline measures a minimum transfer price because it represents the selling unit's cost of transferring the product.

1. A perfectly competitive market for the intermediate product exists, and the selling division has no unused capacity. 2. An intermediate market exists that is not perfectly competitive, and the selling division has unused capacity. 3. No market exists for the intermediate product.

steps for designing performance measures

1. Choose performance measures that align with the firm's financial goals. 2. Choose the details of each performance measure in step 1. 3. Choose a target level of performance and a feedback mechanism for each performance measure in step 1.

benefits of decentralized

1. Creates greater responsiveness to the needs of a subunit's customers, suppliers, and employees. Good decisions cannot be made without good information. Compared with top managers, subunit managers are better informed about their competitors, suppliers, and employees, as well as about local factors that affect performance, such as ways to decrease costs, improve quality, and better respond to customers. Flextronics, a global supply chain solutions company, uses decentralization to reduce bureaucracy and increase responsiveness. Managers can use the company's worldwide information technology to solve a local customer's problem or send a project to other managers without going through red tape. 2. Leads to gains from faster decision making by subunit managers. Decentralization speeds decision making, creating a competitive advantage over centralized organizations. Centralization slows down decision making because the decisions must be pushed upward through layer after layer of management before they are finalized. Interlake Mecalux, a leading provider of materials-handling solutions and storage products, cites this benefit of decentralization: "We have distributed decision-making powers more broadly to the cutting edge of product and market opportunity." Interlake's storage system solutions must often be customized to fit the needs of customers. Delegating decision making to the sales force allows Interlake to respond faster to changing customer requirements. 3. Assists management development and learning. Subunit managers are more motivated and committed when they can exercise initiative. Moreover, giving managers more responsibility helps a company develop an experienced pool of talent to fill higher-level management positions and weed out people unlikely to be successful top managers. According to Tektronix, an electronics company based in Oregon, "Decentralized units provide a training ground for general managers and a visible field of combat where product champions can fight for their ideas." 4. Sharpens the focus of subunit managers and broadens the reach of top management. In a decentralized setting, the manager of a subunit has a concentrated focus. The head of Facebook Indonesia, for example, can develop country-specific knowledge and expertise (about local advertising trends, cultural norms, payment forms, and so on) and focus on maximizing Facebook's profits in Indonesia. At the same time, this relieves Facebook's senior executives at its Menlo Park, California, headquarters from the burden of controlling day-to-day operating decisions in Indonesia. They can spend more time and effort on strategic planning for the entire organization.

cost of decentralized

1. Leads to suboptimal decision making. 2.Leads to unhealthy competition. 3.Results in duplication of output 4. Results in duplication of activities

what are the four elements of the budgeting cycle?

1. Planning the performance of the company as a whole and of its subunits-- expectations of managers 2. Providing subordinate managers with a frame of reference 3. Investigation into variations from the plan 4. Use of​ feedback, new conditions and experience to develop a plan for the next period

flexible budget variance can be divided into two more detailed variances

1. a price variance that reflects the difference between an actual int price and a budgeted input price 2. an efficiency variance that reflect the difference between an actual input quantity and a budgeted input quantity

unfavorable sales volume variance can arise from several different reasons

1. failure of Webb managers to execute the sales plan 2. weaker than anticipated overall demand for jackets 3. competitors taking away market shares from webb 4. unexpected changes in customer tastes and preferences away from Webb's design 5. quality problem leading to customer dissatisfaction

balanced scorecard

1. financial 2. customer 3. internal business process 4. learning and growth

Three main sources for budgeted input prices and budgeted input quantities

1. past data- 2. data from similar companies 3. standards

Managers should always consider bored range of possible causes for a price variance.

1. purchasing manager negotiated the DM price skillfully than planned 2. purchase manager switched to a lower-price supplier 3. purchasing manager ordered larger quantities than the quantities budgeted 4. Dm price decreased unexpectedly due to an oversupply of materials in the industry 5. budgeted purchase price of DM were set too high because managers did not carefully analyze market conditions 6. purchasing manager negotiated favorable prices because he was willing to accept unfavorable terms on factors other than price (lower quality)

standards can mean different things

1. standard input is a carefully determined quantity of input, such as square yard of cloth or direct manufacturing labor-hours, required for one unit of output 2. standard price- carefully determined price a company expects to pay for a unit of input. 3. standard cost- carefully determined cost of a unit of output such as the standard direct manufacturing labor cost of a jacket

budget definition

A budget is the quantitative expression of a proposed plan of action by management for a specified period. A budget is an aid to coordinating what needs to be done to implement that plan. A budget generally includes the plan's both financial and nonfinancial aspects and serves as a road map for the company to follow in an upcoming period.

responsibility center misconceptions

A common misconception is that profit center—and, in some cases, investment center—is a synonym for a decentralized subunit and cost center is a synonym for a centralized subunit. Profit centers can be coupled with a highly centralized organization, and cost centers can be coupled with a highly decentralized organization. For example, managers in a division organized as a profit center may have little freedom in making decisions. They may need to obtain approval from corporate headquarters for introducing new products and services or to make expenditures over some preset limit. When Michael Eisner ran Walt Disney Company, the giant media and entertainment conglomerate, from 1984 until 2005, the firm's strategic-planning division scrutinized business proposals so closely that managers were reluctant to pitch new ideas.3 In other companies, divisions such as information technology may be organized as cost centers, but their managers may have great latitude to make capital expenditures and purchase materials and services. In short, the labels profit center and cost center are independent of the degree of centralization or decentralization in a company.

controlable cost

A controllable cost is any cost primarily subject to the influence of a given responsibility center manager for a given period.

What is the definition of a master​ budget?

A master budget is a budget that expresses​ management's operating and financial plans for a specified period and includes a set of budgeted financial statements.

perfectly competitive market

A perfectly competitive market exists when there is a homogeneous product with buying prices equal to selling prices and no individual buyers or sellers can affect those prices by their own actions. By using market-based transfer prices in perfectly competitive markets, a company can (1) promote goal congruence, (2) motivate management effort, (3) evaluate the performance of subunits, and (4) preserve their autonomy.

transfer price

A transfer price is the price one subunit​ (department or​ division) charges for a product or service supplied to another subunit of the same organization. In this​ case, the transfer price will be the amount the raw lumber division charges the finished lumber division. Often, the subunits interact by supplying goods or services to one another. In these cases, top management uses transfer prices to coordinate the actions of the subunits and to evaluate the performance of their managers.

​"Budgeted performance is a better criterion than past performance for judging​ managers." Do you​ agree? Why?

Agree—because inefficiencies included in past results can be detected and eliminated in budgeting.​ Also, future conditions may be expected to differ from the​ past, and these can also be factored into budgets.

Prorating the Difference Between Maximum and Minimum Transfer Prices

An easy solution is to split the difference equally, resulting in a transfer price of $82.50. However, this solution ignores the relative costs incurred by the two divisions and might lead to disparate profit margins on the work contributed by each division to the final product. As an alternative approach, Horizon Petroleum could allocate the $5 difference on the basis of the variable costs of the two divisions. In effect, this approach results in a budgeted variable-cost-plus transfer price. The "plus" indicates the setting of a transfer price above variable cost.

An inherent trade-off exists between creating incentives and imposing risk.

An incentive should be some reward for performance. An incentive may create an environment in which suboptimal behavior may occur: the goals of the firm are sacrificed in order to meet a manager's personal goals. The motivation for having some salary and some performance-based compensation is to balance the benefit of incentives against the extra cost of imposing risk on a manager.

Different Transfer-Pricing Method

As the exhibit indicates, it is difficult for a transfer-pricing method to meet all the criteria. The transfer price a company will eventually choose depends on the economic circumstances and the decision being made. Surveys by Ernst & Young as well as those sponsored by the Institute of Management Accountants indicate that the full-cost-based transfer price is generally the most frequently used method around the world, followed by market-based transfer price and negotiated transfer price

automony

Autonomy is the degree of freedom to make decisions. The greater the freedom, the greater the autonomy.

benchmarks

BENCHMARKS ARE METRICS THAT CORRESPOND TO THE BEST PRACTICES OF ORGANIZATIONS AND MAY BE AVAILABLE INSIDE OR OUTSIDE OF THE ORGANIZATION. Benchmarking, which is also called relative performance evaluation, filters out the effects of the common uncontrollable factors.

​"The sales forecast is the cornerstone for​ budgeting." Why?

Because production and inventory levels generally depend on the forecasted level of sales.

budgeting cycle

Before the start of a fiscal year, managers at all levels take into account past performance, market feedback, and anticipated future changes to initiate plans for the next period. Senior managers give subordinate managers a frame of reference, a set of specific financial or nonfinancial expectations, against which they will compare actual results. Managers and management accountants investigate any deviations from the plan.

belief system

Belief systems articulate the mission, purpose, and core values of a company. They describe the accepted norms and patterns of behavior expected of all managers and other employees when interacting with one another, shareholders, customers, and communities.

benefits of multiple year analysis

Benefits of actions taken in the current period may not show up in short-run performance measures. If managers use NPV for investment decisions, then using a multiyear RI for performance achieves goal congruence. Motivates managers to take a long-run perspective by compensating them on changes in market price because stock prices incorporate the expected future effects of a firm's current decisions.

boundary system

Boundary systems describe standards of behavior and codes of conduct expected of all employees. Highlights actions that are "off-limits." Codes of business conduct signal appropriate and inappropriate individual behaviors.

Benefits of budgets

Budgets are an integral part of management control systems. As we have discussed at the start of this chapter, when administered thoughtfully by managers, budgets do the following: Promote coordination and communication among subunits within the company Provide a framework for judging performance and facilitating learning Motivate managers and other employees

controlability

Controllability is the degree of influence a specific manager has over costs, revenues, or related items for which he or she is responsible.

cost based pricing

Cost-based transfer prices are helpful when market prices are unavailable, inappropriate, or too costly to obtain. This can occur, for example, when markets are not perfectly competitive, when the product is specialized, or when the internal product is different from the products available externally in terms of its quality and the customer service provided for it. When using transfer prices based on costs rather than market prices, Horizon's top managers cannot easily determine the profitability of the investment made in the transportation division and hence whether Horizon should keep or sell the pipeline. Furthermore, if transfer prices are based on the actual costs of the transportation division, it would provide the division with no incentive to control costs. That's because all cost inefficiencies of the transportation division would get passed along as part of the actual full-cost transfer price. In fact, every additional dollar of cost arising from wastefulness in the transportation division would generate an additional 5 cents in profit for the division under the "105% of full cost" rule!

decentralized

Decentralization is an organizational structure that gives managers at lower levels the freedom to make decisions.

Efficiency Variance

Difference between the actual quantity of an input and the standard quantity of that input.

EVA

EVA is a variation of RI used by many companies. It is calculated as follows: EVA = After-tax Operating Income - {Weighted-Average Cost of Capital X (Total Assets - Current Liabilities)} Weighted average cost of capital equals the after-tax average cost of all long-term funds in use. EVA substitutes the following numbers in the RI calculation: Income: After-tax operating income Required rate of return: (After-tax) weighted-average cost of capital Investment: Total assets minus current liabilities

Compensation for Multiple Tasks & Team-Based

Employers want employees to allocate their time and effort intelligently among various tasks or aspects of their jobs. A team achieves better results than individual employees acting alone. Many companies reward employees on teams based on how well their team performs. Team-based incentives encourage individuals to help one another as they strive toward a common goal.

Choose the definition for kaizen budgeting.

Explicitly incorporates continuous improvement anticipated during the budget period into the budget numbers. how did past, detect deficiencies, improve future, lean management, continuous improvement, learning, growth, zero defects

Three different ways of hybrid pricing

For any internal transaction, there is generally a minimum transfer price the selling division will not go below, based on its cost structure. 1. Prorating the Difference Between Maximum and Minimum Transfer Prices 2. Negotiated Pricing 3.Dual Pricing

Four common Alternative definitions for investments

Four common alternative definitions of investment: Total assets available - all assets. Total assets employed - all assets less idle assets and assets purchased for future expansion. Total assets employed minus current liabilities - total assets employed less assets financed by short-term creditors. Stockholder's equity - assign liabilities to subunits and deduct from total assets.

How do you choose performance measures?

How should each measure be computed? Several questions should be answered to begin: What is the time horizon? Which definition of investment will be used? How shall we calculate various components of each performance measure such as the measurement of assets. Let's now discuss each of these measurement details.

hybrid transfer pricing

Hybrid transfer prices take into account both cost and market information. Top management may administer such​ prices, as LavenderLavender​'s management did in our​ problem, by specifying a transfer price that is an average of the minimum and maximum transfer prices. The most common form of hybrid prices arise via negotiationlong dash—the subunits of a company are asked to negotiate the transfer price between them and to decide whether to buy and sell internally or deal with external parties. The eventual transfer price is then the outcome of a bargaining process between selling and buying subunits.

intensity incentives

Intensity of incentives—how large the incentive component of a manager's compensation should be relative to their salary component. Preferred performance measures are those that are sensitive to or that change significantly with the manager's performance. They do not change much with changes in factors that are beyond the manager's control. Sensitive performance measures motivate the manager and limit the manager's exposure to risk, reducing the cost of providing incentives. The tradeoff between considerations of sensitivity and risk, on the one hand, and the congruence of goals, on the other, determines the effective intensity of incentives placed on each measure of performance. The relative weight placed on the various measures in the scorecard is ideally aimed at achieving congruence between the extent to which the manager is motivated to maximize each performance metric and its importance in generating the long-run objective the firm wishes to achieve.

interactive control system

Interactive control systems are formal information systems managers use to focus the company's attention and learning on key strategic issues. Managers use interactive control systems to create an ongoing dialogue around these key issues and to personally involve themselves in the decision-making activities of subordinates. New strategies emerge from the dialogue and debate surrounding the interactive process.

formal management control system

Management control systems consist of formal and informal control systems. The formal management control system of a company includes explicit rules, procedures, performance measures, and incentive plans that guide the behavior of its managers and other employees. The formal control system is composed of several systems, such as: The management accounting systems, which provide information about the firm's costs, revenues, and income The human resources systems, which provide information about the recruiting and training of employees, absenteeism, and accidents The quality system, which provides information about yields, defective products, and late deliveries to customers

Performance Measures at the Individual Activity Level

Managers need to do two things when designing the measures used to evaluate performance of individual employees: Design performance measures for activities that require multiple tasks. Design performance measures for activities done in teams.

Three broad categories of methods top managers can use to determine transfer prices.

Market-based transfer prices. Top managers may choose to use the price of a similar product or service publicly listed on, say, a trade association's website. Or they may select the external price a subunit charges outside customers. Cost-based transfer prices. Top managers may choose a transfer price based on the cost of producing the product being transferred. Examples include the variable production cost, variable and fixed production costs, and full cost of the product. The full cost of the product includes all production costs plus costs from other business functions (R&D, design, marketing, distribution, and customer service). The cost used in cost-based transfer prices can be actual cost or budgeted cost. Sometimes, the cost-based transfer price includes a markup or profit margin that represents a return on subunit investment. Hybrid transfer prices. Hybrid transfer prices take into account both cost and market information. Top managers may set the prices by specifying a transfer price that is an average of the cost of producing and transporting the product internally and the market price for comparable products. At other times, a hybrid transfer price may allow for the revenue recognized by the selling unit to differ from the cost recognized by the buying unit. The most common form of hybrid prices arises via negotiation—the subunit managers are asked to negotiate the transfer price between them and to decide whether to buy and sell internally or deal with external parties. Negotiated transfer prices are often employed when market prices are volatile. Thus, managers need current information about the costs and prices of products to participate in the bargaining process.

multinational companies decentralized

Multinational companies—companies that operate in multiple countries—are often decentralized because centralizing the control of their subunits around the world can be physically and practically impossible. Also, language, customs, cultures, business practices, rules, laws, and regulations vary significantly across countries. Decentralization enables managers in different countries to make decisions that exploit their knowledge of local business and political conditions and enables them to deal with uncertainties in their individual environments. For example, Philips, a global electronics company headquartered in the Netherlands, delegates marketing and pricing decisions for its television businesses in India and Singapore to the managers in those countries. Multinational corporations often rotate managers between foreign locations and corporate headquarters. Job rotation combined with decentralization helps develop the ability of managers to operate in the global environment. There are drawbacks to decentralizing multinational companies. One of the most important is the lack of control and the resulting risks. In 1995, Barings PLC, a British investment banking firm, went bankrupt and had to be sold when one of its traders in Singapore caused the firm to lose more than £1 billion on unauthorized trades that went undetected. Similarly, in 2011, a London trader working for UBS, Switzerland's largest bank, circumvented the bank's risk controls and made unauthorized trades that resulted in a $2.3 billion loss for the company. UBS's CEO and other top managers resigned because of the scandal. Multinational corporations that implement decentralized decision making usually design their management control systems to measure and monitor the performance of divisions. Information and communications technology helps the flow of information for reporting and control.

Negotiated Pricing

Negotiated pricing is the most common hybrid method. Under this approach, top managers do not administer a specific split of the eventual profits across the transacting divisions. Rather, the eventual transfer price results from a bargaining process between the selling and buying subunits. In Horizon Petroleum's case, for example, the transportation division and the refining division would be free to negotiate a price that is mutually acceptable to both. Under a negotiated transfer price, the answer depends on several things: the bargaining strengths of the two divisions; information the transportation division has about the price minus the incremental marketing costs of supplying crude oil to outside refineries; and the information the refining division has about its other available sources of crude oil. The price negotiated by the two divisions will, in general, have no specific relationship to either costs or the market price. But the cost and price information is often the starting point in the negotiation process.

​"Cash budgets must be prepared before the operating income​ budget." Do you​ agree? Why?

No. Cash budgets and operating income budgets must be prepared simultaneously. In preparing their operating income​ budgets, companies want to avoid unnecessary idle cash and unexpected cash deficiencies. The cash budget allows the accountant to plan cost effective ways to achieve the​ company's operating income goals.

operating vs. financial decision

Operating decisions deal with how to best use the limited resources of an organization (the operating budget). The operating budget begins with the Revenues budget, includes multiple schedules and concludes with the Budgeted Income Statement. Financial decisions deal with how to obtain the funds to acquire those resources (the financial budget). The financial budget is made up of the Capital Expenditure budget, the Cash budget, the Budgeted Balance Sheet, and the Budgeted Statement of Cash Flows.

possible alternative asset measurements include.

Possible alternative asset measurements include: Current cost - cost of purchasing an asset today identical to the one currently held. Gross value of fixed assets - historical cost. Net book value(NBV) of fixed assets - historical cost. (Historical cost is used to calculate ROI and there is always a question whether to use gross or net book value. NBV is the measure most commonly used by companies for internal performance evaluation.)

price variance

Reflects the difference between an actual input price and a budgeted input price

residual income (RI)

Residual income (RI) is an accounting measure of income minus a dollar amount for required return on an accounting measure of investment. RI = Income - (RRR X Investment) RRR = Required Rate of Return Required rate of return times the investment is the imputed cost of the investment. The imputed cost of the investment is a cost recognized in particular situations but not recorded in financial accounting systems because it is an opportunity cost.

responsibility accounting

Responsibility accounting helps managers to first focus on whom they should ask to obtain information and not on whom they should blame. Responsibility accounting focuses on gaining information and knowledge, not only on control. The fundamental purpose of responsibility accounting is to enable future improvement. Performance reports for responsibility centers are sometimes designed to change managers' behavior in the direction top managers desire even if the reports decrease controllability.

ROS

Return on sales is also known as the income-to-revenues ratio or the sales ratio It is frequently used, simple to compute, and widely understood. It does not take into account investment. It measures how effectively costs are managed It is calculated by taking Operating Income / Revenues and is expressed as a percentage.

​"Strategy, plans, and budgets are unrelated to one​ another." Do you​ agree? Why?

Strategy, plans, and budgets are interrelated and affect one another. Strategic analysis underlies both​ long-run and​ short-run planning. In​ turn, these plans lead to the formulation of budgets. Budgets provide feedback to managers about the likely effects of their strategic plans. Managers use this feedback to revise their strategic plans.

managers prefer full cost pricing

Surveys by accounting firms and researchers indicate that, despite its limitations, managers generally prefer to use full-cost-based transfer prices because (1) they represent relevant costs for long-run decisions, (2) they facilitate external pricing based on variable and fixed costs, and (3) they are the least costly to administer. However, full-cost transfer pricing does raise many issues. How are each subunit's indirect costs allocated to products? Have the correct activities, cost pools, and cost-allocation bases been identified? Should the chosen fixed-cost rates be actual or budgeted? The issues here are similar to the issues related to allocating fixed costs, discussed in Chapter 14. Many companies determine the transfer price based on budgeted rates and practical capacity because it overcomes the problem of inefficiencies in actual costs and costs of unused capacity getting passed along to the buying division.

budgetary slack

The amount by which a manager intentionally underestimates budgeted revenues or overestimates budgeted expenses in order to make it easier to achieve budgetary goals.

key challenges of budgets

The budgeting process is time-consuming. Estimates suggest that senior managers spend about 10-20% of their time on budgeting and financial planning departments spend as much as 50% of their time on it. For most organizations, the annual budget process is a months-long exercise that consumes a tremendous amount of resources.

flexible budget variance

The difference between actual and flexible budget amounts for revenues and expenses. The only difference is the price products are sold at and the costs of the products.

informal management control system

The informal management control system includes the shared values, loyalties, and mutual commitments among members of the organization, the company's culture, and the unwritten norms about acceptable behavior for managers and other employees.

NPV

The net present value method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows​ (in this​ scenario, future cash​ savings) and outflows back to the present point in time using the required rate of return.

cost and revenue of transfer price

The transfer price creates revenues for the selling subunit (the engine division in our example) and costs for the buying subunit (the assembly division in our example), affecting each subunit's operating income. These operating incomes can be used to evaluate the subunits' performances and to motivate their managers. The product or service transferred between subunits of an organization is called an intermediate product. The receiving unit (the assembly division in the engine example) may work on the product further or the product may be transferred from production to marketing and sold directly to an external customer. The rationale for transfer prices is that when subunit managers (such as the manager of the engine division) make decisions, they need only focus on how their decisions will affect their subunit's performance without evaluating how their decisions affect company-wide performance. In this sense, transfer prices ease the subunit managers' information-processing and decision-making tasks. In a well-designed transfer-pricing system, managers focus on maximizing the performance of their subunits and in doing so optimize the performance of the company as a whole.

Choose the explanation that tells how the choice of the type of responsibility center​ (cost, revenue,​ profit, or​ investment) affects behavior.

The type of responsibility center determines what the manager is accountable for and thereby affects the​ manager's behavior. The choice of a responsibility center type guides the variables to be included in the budgeting exercise.

Four types of responsibility centers

There are four types of responsibility centers. Cost—accountable for costs only Revenue—accountable for revenues only Profit—accountable for revenues and costs Investment—accountable for investments, revenues, and costs

Dual Pricing

There is seldom a single transfer price that simultaneously meets all the criteria we have discussed (achieving goal congruence, motivating managerial effort, evaluating the performance of subunits, and preserving their autonomy). As a result, some companies choose dual pricing, which uses two separate transfer-pricing methods to price each transfer from one subunit to another. An example of dual pricing arises when the selling division receives a full-cost-based price and the buying division pays the market price for the internally transferred products. Assume Horizon Petroleum purchases crude oil from Gulfmex in Matamoros at $79 per barrel. The dual-pricing system promotes goal congruence because it makes the refining division no worse off if it purchases the crude oil from the transportation division rather than from the external supplier at $85 per barrel. The transportation division receives a corporate subsidy. As a result, the operating income for Horizon Petroleum as a whole under dual pricing is less than the sum of the operating incomes of the divisions. Dual pricing is not widely used. One concern with dual pricing is that it leads to disputes about which price should be used when computing the taxable income of subunits located in different tax jurisdictions, such as in our example, where the transportation division is taxed in Mexico while the refining division is taxed in the United States. A second concern is that dual pricing insulates managers from the realities of the marketplace because costs, not market prices, affect the revenues of the supplying division.

criteria for evaluating transfer pricing

To help a company achieve its goals, transfer prices should meet four key criteria: Promote goal congruence, so that division managers acting in their own interest will take actions that are aligned with the objectives of top management. Induce managers to exert a high level of effort. Subunits selling a product or service should be motivated to hold down their costs; subunits buying the product or service should be motivated to acquire and use inputs efficiently. Help top managers evaluate the performance of individual subunits. Preserve autonomy of subunits if top managers favor a high degree of decentralization. A subunit manager seeking to maximize the operating income of the subunit should have the freedom to transact with other subunits of the company (on the basis of transfer prices) or to transact with external parties.

Three levers that help balance push of performance

To prevent unethical and outright fraudulent behavior, companies balance the push for performance (resulting from Diagnostic Control Systems) with three other levers of control: Boundary systems. Belief systems. Interactive control systems. Each lever is important and needs to be monitored. Levers should be interdependent and collectively represent a living system of business conduct.

multinational transfer price

Transfer prices affect not just income taxes, but also payroll taxes, customs duties, tariffs, sales taxes, value-added taxes, environment-related taxes, and other government levies. Our aim here is to highlight tax factors, and in particular income taxes, as important considerations for managers when determining transfer prices. Section 482 of the U.S. Internal Revenue Code governs how multinationals can set transfer prices for tax purposes. Section 482 requires that transfer prices between a company and its foreign division or subsidiary, for both tangible and intangible property, equal the price that would be charged by an unrelated third party in a comparable transaction. Regulations related to Section 482 recognize that transfer prices can be market-based or cost-plus-based, where the plus represents margins on comparable transactions. Under the U.S. Internal Revenue Code, Horizon could obtain advanced approval of the transfer-pricing arrangements from the tax authorities, called an advance pricing agreement (APA). The APA is a binding agreement for a specified number of years, usually at least five and sometimes as many as ten. The goal of the APA program is to avoid costly transfer-pricing disputes between taxpayers and tax authorities. Companies will have incentives to lower the transfer prices of products they are exporting into a country to reduce the tariffs and customs duties charged on those products. The restrictions some countries place on dividend- or income-related payments to parties outside their national borders also affect how firms set their transfer prices. By increasing the prices of goods or services transferred into divisions in these countries, companies can increase the cash paid out of these countries without violating dividend- or income-related restrictions.

what price will promote goal congruency?

What transfer price will promote goal congruence for both the transportation and refining divisions? The minimum transfer price is $80 per barrel. A transfer price below $80 does not provide the transportation division with an incentive to purchase crude oil from Gulfmex in Matamoros because it is below the transportation division's incremental costs. The maximum transfer price is $85 per barrel. A transfer price above $85 will cause the refining division to purchase crude oil from the external market in Houston rather than from the transportation division. A transfer price between the minimum and maximum transfer prices of $80 and $85 will promote goal congruence: Each division will increase its own reported operating income while increasing Horizon Petroleum's operating income if the refining division purchases crude oil from Gulfmex in Matamoros.

Standards Calculations

When dealing with direct​ inputs, a company uses carefully determined standards to compute the flexible budget. A standard input is a carefully determined quantity of​ input, such as units of materials or direct​ manufacturing-labor hours, required for one unit of output.

distress prices

When supply outstrips demand, market prices may drop well below their historical averages. If the drop in prices is expected to be temporary, these low market prices are called "distress prices." Which transfer price should be used for judging performance if distress prices prevail? Some companies use the distress prices themselves, but others use long-run average prices, or "normal" market prices. In the short run, the manager of the selling subunit should supply the product or service at the distress price as long as it exceeds the incremental costs of supplying the product or service. If the distress price is used as the transfer price, the selling division will show a loss because the distress price will not exceed the full cost of the division. If the long-run average market price is used, forcing the buying division's manager to purchase internally at a price above the current market price will hurt his short-run operating income. But the long-run average market price will provide a better measure of the long-run profitability and viability of the supplier division. Of course, if the price remains low in the long run, the company should use the low market price as the transfer price. If this price is lower than the variable and fixed costs that can be saved if manufacturing facilities are shut down, the production facilities of the selling subunit should be sold and the buying subunit should purchase the product from an external supplier.

when are budgets most useful?

`Budgeting is most useful when it is integrated with a company's strategy. Strategy specifies how an organization matches its capabilities with the opportunities in the marketplace to accomplish its objectives.

unfavorable variance journal entry

always debits (they decrease operating income), and favorable variances are always credits (they increase operating income)

operating budget

budget for day-to-day expenses

expected performance

budgeted performance, point reference for making comparisons

how are the words budgeted and standard related?

budgeted- broader term- budgeted price quantities and costs need not be based on standards-- they could be based on past costs or competitive benchmarks standards are used to obtain budgeted input quantities and prices, the term standard and budget are used interchangeably. - allow for normal disruptions - a normal disruption could include a short delay in the receipt of materials needed to produce the jackets or a production hold up because a piece of equipment needed a minor repair

financial budgets

budgets that focus on the firm's financial goals and identify the resources needed to achieve these goals capital expenditure budget, the cash budget, the budget balance sheet, and the budgeted statement of cash flow. how operations and planned capital outlays affect cash. cash budget and budgeted income statement to prepare two other financial statement (BS and STM CF)

flexible budget

calculates budgeted revenue and budgeted costs based on the actual output in the budget period. it is prepared at the end of the period after managers know that actual output of 10,000 jackets. flexible budget is hypothetical budget that would be prepared at the start of the budget period if it had correctly forecasted retrospective based on actual output of 10,000 jackets. flexible budget variance are better measures of sales price and cost performance than static budget variance because they compare actual revenue to budgeted revenue and actual costs to budgeted costs for the same amount of units output

variance suggest

changing strategy motivate managers correct problems decision making

actual results vs. budgeted results

companies should tailor and negotiate budgets for a particular subunit, a particular accounting system, and a particular performance measure while keeping in mind the pitfalls of using historical cost accounting. q

responsibility centers

cost- only concerned cost revenue- only concerned revenue profit- concerned cost and revenue investment- the manager is accountable for investments, revenues, and costs.

unfavorable

decreasing operating income relative to budgeted amount

variance

difference between actually results and expected performance

static budget varaince

difference between the actual results and the corresponding budgeted amount in the static budget

sales volume varaince

difference between the flexible budget and the static budget.

goal congruence

exists when individuals and groups work toward achieving the organization's goals—that is, managers working in their own best interest take actions that align with the overall goals of top management.

favorable DM price variance

favorable because the actual price of cloth is less than the budget price, resulting in an increase in operating income. direct manufacturing labor price variance is unfavorable because the actual wage rate paid to labor is more than the budget rate, resulting in a decrease in operating income

selling price var

flexible budget variance for revenue. actual selling price and the budgeted selling price.

reasons for unfavorable flexible budget variance

higher input quanties and/or higher input prices relative to the budgeted amount could be the result of webb deciding to produce a better product than what was planned. or there could have been inefficiencies.

imperfect competition

if markets are not perfectly competitive, selling prices affect the quantity of product sold. Faced with an imperfectly competitive market, the manager of the selling division will choose a price and quantity combination for the intermediate product that maximizes the division's operating income. If the transfer price is set at this price, the buying division may find that acquiring the product is too costly and results in a loss and decide not to purchase the product. Yet, from the point of view of the company as a whole, it may well be that profits are maximized if the selling division transfers the product to the buying division for further processing and sale. For this reason, when the market for the intermediate good is imperfectly competitive, the transfer price must generally be set below the external market price (but above the selling division's variable cost) in order to induce efficient transfers.4

generally managers have more control of price or efficiency variance?

in general managers have more control over efficiency variance than price because the quantity of input used is primarily affected by factors inside the company, where else changes in price of materials or in wage rates may be largely dictated by market forces outside the company

ROI

income/ investment Most popular metric for two reasons: Blends all the ingredients of profitability (revenues, costs, and investment) into a single percentage Can be compared with the rate of return on opportunities elsewhere, inside or outside the company Also called the accounting rate of return (ARR) or the accrual accounting rate of return (AARR)

DuPont Method of Profitability

income/ revenue x revenue/ investment Analysis. It recognizes the two basic ingredients in profit making: increasing income per dollar of revenue and using assets to generate more revenues. An improvement to either with no change in the other will increase ROI. income/ revenue = return on sales revenue/ investment = investment turnover increasing income per dollar of revenue and using assets to generate more revenues. An improvement to either with no change in the other will increase ROI.

favorable

increasing operating income relative to budgeted amount

minium transfer price

incremental per unit incurred up to pt of transfer + opportunity cost per unit to selling subunit The incremental cost in the formula is the additional cost of producing and transferring the product or service. The opportunity cost is the maximum contribution margin forgone by the selling subunit if the product or service is transferred internally.

Unfavorable Efficiency Variance

inefficient use of the activity base(larger quantity of input than budgeted). efficient if it used smaller input quantities than was budgeted for that output level. actual - budgeted = positive (unfavorable) actual - budgeted = negative (favorable)

management control system

is a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and other employees. Well-designed management control systems use information both from within the company, such as its net income and levels of employee satisfaction, and from outside the company, such as its stock price and customer-satisfaction data. To be effective, management control systems should be closely aligned with the organization's strategies and goals. Management control systems should also be designed to support the organizational responsibilities of individual managers. Effective management control systems should also motivate managers and other employees.

static budget

least detail and level 1. master budget based on the level of output planned at the start of the budget period and is developed around a single planned output level.

Goal:

managers want to know how much of the static-budget variance is due to inaccurately forecasting what it expected to produce and sell and how much is due to how it actually performed manufacturing and selling 10,000 jackets

management by exception

practice whereby managers focus more closely on ares that are not operating as expected and less closely on areas that are.

transfer price plus a mark up

rate (transfer price + variable cost + fixed) The full cost plus a markup transfer-pricing method causes the refining division to regard the fixed cost (and the 5% markup) of the transportation division as a variable cost and leads to goal incongruence.

Cash budget

schedule of expected cash receipts and cash disbursements can help avoid unnecessary idle cash and unexpected cash deficiencies a. cash available for needs: cash balance + receipts (before any financing) - information on the expected collectibility of AR is needed for accurate predictions key factors include bad debt and average lag between sales and collection. b. cash disbursements - DM(suppliers paid in full after the goods have been deliver) -DML and other wage and salary outlays- all payroll related costs are paid in the month in which the labor efforts occurs - other costs- depends on timing and credit terms (Depr does not require a cash outlay) - other cash dispurments property plant equipment and long-term investments income tax payment c. financial efforts short-term financing requirements depends on how the total cash available for needs compares with the total cash disbursements plus the minimum ending cash available for needs and total cash needed. d. ending cash balance- self-liquidating cash loans

suboptimal decision making

suboptimal decision making—also called incongruent decision making or dysfunctional decision making—occurs when a decision's benefit to one subunit is more than offset by the costs to the organization as a whole.

effectiveness

the degree to which a predetermined objective or target is met such as the sales, market share, and customer satisfaction rating

capital budgeting

the process of planning and managing a firm's long-term investments Capital budgeting is the process of making​ long-run planning decisions for investments in projects. In much of​ accounting, income is calculated on a​ period-by-period basis. In choosing​ investments, however, managers make a selection from among a group of multiple​ projects, each of which may span several periods. To make capital budgeting​ decisions, managers analyze each project by considering all the​ life-span cash flows from its initial investment through its termination.

efficency

the relative amount of input used to achieve a given output level.