Profit and Investment Centres

1
Responsibility Accounting and Transfer Pricing
2
Transfer Pricing

• Is the set of rules organisations use to allocate
  jointly earned revenue among responsibility
  centres.
• Is a tool that organisations use to coordinate
  the activities of different units.
• It encounters the problem of goal in-congruency

3

• Responsibility Centres
• Cost Centre
• Revenue Centre
• Profit Centre
• Investment Centre

• Transfer Pricing
• Market price
• Marginal Cost
• Incremental Cost plus fixed fee
• Full cost
• Negotiated market-based price

4
Transfer Pricing

• The fundamental principle is that the transfer
  price should be similar to the price that would
  be charged if the product were sold to outside
  customers or purchased from outside vendors.

5
Transfer Pricing Important Decisions

• Should the company produce the product inside
  the company or purchase it from an outside
  vendor? This is the sourcing decision.
• If produced inside. At what price should the
  product be transferred between profit centres?
  This is the pricing decision.

6
Market Based Pricing

• Market Price Information
• Freedom to source
• Full Information
• Negotiation
• Constraints

7
Cost Based Pricing

• How to define cost?
• Actual cost
• Standard cost
• How to calculate profit mark-up?
• Percentage of cost
• Percentage of investment

8
Transfer Pricing and Upstream Fixed Cost and
Profits

• The profit center that finally sells to the
  outside customer may not be aware of the amount
  of upstream fixed costs and profit included in
  the price.
• Even if they are aware They may be reluctant to
  reduce the profits.
• How to mitigate this problem?

9
Transfer Pricing and Upstream Fixed Cost and
Profits

• Agreement among the business units
• Two-step pricing
• Profit sharing

10
Two-step pricing

• Establish a TP that include two charges
• Product Charge Standard variable cost of
  production
• Period chargeFixed costs associated with the
  facilities reserved for the buying unit.
• Profit may be included in the above.

11
(No Transcript)
12
(No Transcript)
13
(No Transcript)
14
Comment on the performance of the divisions