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Chapter 22
Management Control
Systems,
Transfer Pricing,
and Multinational
Considerations
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Learning Objectives (1 of 2)
22.1 Describe a management control system and its three
key properties
22.2 Describe the benefits and costs of decentralization
22.3 Explain transfer prices and the four criteria managers
use to evaluate them
22.4 Calculate transfer prices using three methods
22.5 Illustrate how market-based transfer prices promote
goal congruence in perfectly competitive markets
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Learning Objectives (2 of 2)
22.6 Understand how to avoid making suboptimal decisions
when transfer prices are based on full cost plus a
markup
22.7 Describe the range of feasible transfer prices when
there is unused capacity and alternative methods for
arriving at the eventual hybrid price
22.8 Apply a general guideline for determining a minimum
transfer price
22.9 Incorporate income tax considerations in multinational
transfer pricing
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Management Control Systems
(1 of 3)
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Management Control Systems
(2 of 3)
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Effective Management Control
(1 of 2)
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Effective Management Control
(2 of 2)
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Two Aspects of Motivation
• 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.
• Effort is the extent to which managers strive or endeavor in
order to achieve a goal. Effort goes beyond physical
exertion to include mental actions as well.
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Decentralization
• Decentralization is an organizational structure that gives
managers at lower levels the freedom to make decisions.
• Autonomy is the degree of freedom to make decisions.
The greater the freedom, the greater the autonomy.
• Subunit refers to any part of an organization. It may be a
large division or a small group.
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Benefits of Decentralization
• Creates greater responsiveness to the needs of a subunit’s
customers, suppliers, and employees.
• Leads to gains from faster decision making by subunit
managers.
• Assists management development and learning.
• Sharpens the focus of subunit managers and broadens the
reach of top management.
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Costs of Decentralization
• Leads to suboptimal decision making, which arises when a
decision’s benefit to one subunit is more than offset by the
costs or loss of benefits to the organization as a whole.
– Also called incongruent decision making or
dysfunctional decision making
• Leads to unhealthy competition
• Results in duplication of output
• Results in duplication of activities
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Comparing Benefits and Costs
• Top managers must compare the benefits and costs of
decentralization, often on a function-by-function basis, when
choosing an organizational structure.
• Companies report that the decisions made most frequently at
the decentralized level are related to product mix and
advertising.
• Decisions related to the type and source of long-term
financing are made least frequently at the decentralized level.
• Centralizing its income tax strategies allows an organization
to optimize across subunits by offsetting the income in one
subunit with losses in others.
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Decentralization in Multinational
Companies
• Multinational firms, 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.
• 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.
• Biggest drawback to international decentralization: loss or lack
of control and the resulting risks.
• Multinational corporations that implement decentralized
decision making usually design their management control
systems to measure and monitor the performance of divisions.
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Choices about Responsibility Centers
Recall from Chapter 6 that a responsibility center is a
segment or subunit of the organization whose manager is
accountable for a specified set of activities.
• To measure the performance of subunits in centralized or
decentralized companies, the management control system
uses one or a mix of the four types of responsibility
centers:
Cost center
Revenue center
Profit center
Investment center
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Transfer Pricing (1 of 2)
Transfer price—the price one subunit (department or
division) charges for a product or service supplied to another
subunit of the same organization.
In a decentralized organization, much of the decision-making
power resides in its individual subunits. Those subunits
often supply goods or services to one another.
• In that case, top management uses transfer prices to
coordinate the actions of the subunits and to evaluate the
performance of their managers.
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Transfer Pricing (2 of 2)
• The transfer price creates revenues for the selling subunit
and purchase costs for the buying subunit affecting each
subunit’s operating income.
• The operating incomes can be used to evaluate the
subunits’ performances and to motivate their managers.
• Intermediate product—the product or service transferred
between subunits of an organization.
• 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.
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Criteria for Evaluating Transfer Prices
To help a company achieve its goals, transfer prices should
meet four key criteria:
1. Promote goal congruence so that division managers
acting in their own interest will take actions that are
aligned with the objectives of top management.
2. Induce managers to exert a high level of effort.
3. Help top managers evaluate the performance of
individual subunits.
4. Preserve autonomy of subunits if top managers favor a
high degree of decentralization.
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Calculating Transfer Prices
There are three broad categories of methods top managers
can use to determine transfer prices. They are as follows:
1. Market-based transfer prices.
2. Cost-based transfer prices.
3. Hybrid transfer prices.
Under what circumstances should each of these options be
used? Let’s look in more detail at each category.
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Market-Based Transfer Prices
(1 of 2)
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Market-Based Transfer Prices
(2 of 2)
Imperfect Competition
• If markets are not perfectly competitive, selling prices
affect the quantity of product sold.
• 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.
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Cost-Based Transfer Prices
(1 of 3)
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Cost-Based Transfer Prices
(2 of 3)
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Cost-Based Transfer Prices
(3 of 3)
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Hybrid Transfer Prices
(1 of 3)
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Hybrid Transfer Prices (3 of 3)
Additional Approaches
• Prorating the difference between the maximum and
minimum cost-based transfer prices.
• Dual-pricing—using two separate transfer-pricing
methods to price each transfer from one subunit to
another. Example: selling division receives full cost
pricing, and the buying division pays market pricing.
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Comparison of Transfer-pricing
Methods
Exhibit 22.3 Comparison of Different Transfer-Pricing Methods
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General Guideline for Transfer-pricing
Situations
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 prices.
The transfer price a company will eventually choose
depends on the economic circumstances and the decision
being made.
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Minimum Transfer Price
The minimum transfer price in many situations should be:
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How Multinationals Use Transfer
Pricing to Minimize their Taxes (1 of 2)
• Transfer pricing is an important accounting priority for
managers around the world.
• The reason is that parent companies can save large sums
of money in taxes depending on the transfer pricing
methods they use.
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How Multinationals Use Transfer
Pricing to Minimize Their Taxes (2 of 2)
• 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.
• Tax factors, particularly income taxes, are an important
consideration for managers when determining transfer
prices.
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Terms to Learn—(1 of 2)
TERMS TO LEARN PAGE NUMBER
REFERENCE
Autonomy 878
Decentralization 878
Dual pricing 891
Dysfunctional decision making 880
Effort 878
Goal congruence 878
Incongruent decision making 880
Intermediate product 882
Management control system 877
Motivation 878
Perfectly competitive market 886
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Terms to Learn—(2 of 2)
TERMS TO LEARN PAGE NUMBER
REFERENCE
Suboptimal decision making 880
Transfer price 882
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Copyright
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