510369745 8 Responsibility Accounting Transfer Price and Balance Scorecard PDF

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HOLY NAME UNIVERSITYCPA Review T a g b i l a r a nMANAGEMENT ADVISORY SERVICESRESPONSIBILITY ACCOUNTING, TRANSFER PRICING AND BALANCED SCORECARDRESPONSIBILITY ACCOUNTING – a system of accounting wherein costs and revenues are accumulated and reported by levels of responsibility or by responsibility ...

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HOLY NAME UNIVERSITY CPA Review Tagbilaran MANAGEMENT ADVISORY SERVICES RESPONSIBILITY ACCOUNTING, TRANSFER PRICING AND BALANCED SCORECARD

RESPONSIBILITY ACCOUNTING – a system of accounting wherein costs and revenues are accumulated and reported by levels of responsibility or by responsibility centers within the organization. Responsibility center (also called accountability center) - a clearly identified part or segment of an organization that is accountable for a specified function or set of activities. - any part of the organization that a particular manager is responsible for. TYPES OF RESPONSIBILITY CENTERS: a. Cost center (or expense center) – a segment of an organization in which managers are held responsible for the costs or expenses incurred in the segment. b. Revenue center – where management is responsible primarily for revenues. c. Profit center – a segment of the organization in which the manager is held responsible for both revenues and costs. d. Investment center – a segment of the organization where the manager controls revenues, costs and investments. The center’s performance is measured in terms of the use of the assets as well as the revenues earned and the costs incurred. CLASSIFICATIONS OF COSTS IN RESPONSIBILITY ACCOUNTING 1. By responsibility center. 2. By cost type, as to controllability. 3. By specific cost items or cost elements within which each classification in (1) and (2). RESPONSIBILITY AND ACCOUNTABILITY Responsibility has two facets, (1) the obligation to secure results, and (2) the obligation to report back the results achieved to higher authority. Accountability denotes the obligation to report results achieved to higher authority. THE CONCEPT OF DECENTRALIZATION Decentralization refers to the separation or division of the organization into more manageable units wherein each unit is managed by an individual who is given decision authority and held accountable for his decisions.  

Goal congruence – all members of an organization have incentives to perform for a common interest. Sub-optimization – occurs when one segment of a company takes action that is in its own best interests, but is detrimental to the firm as a whole.

BENEFITS OF DECENTRALIZATION 1. Better access to local information 2. Cognitive limitations 3. More timely response 4. Focusing of central management 5. Training and evaluation 6. Motivation 7. Enhanced competition COSTS OF DECENTRALIZATION 1. Some decisions made in one sub-unit may bring about negative effect to the other sub-units or the organization as a whole.

2. Decentralization necessitates a more elaborate reporting system hence, the costs of gathering and reporting of data increase. RM MONTALBAN MAS 1808

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3. Job duplication or overlapping of functions is usually encountered in a decentralized set-up. MEASURING THE PERFORMANCE OF INVESTMENT CENTERS Performance measures for investment centers usually attempt to assess how well managers are utilizing invested assets of the division to produce profits by relating operating to assets. Return on investment (ROI) – is the most common measure of performance for investment centers. ROI can be defined as follows:

Operating income refers to earnings before interest and taxes. Operating assets include all assets acquired to generate operating income, including cash, receivables, inventories, land, buildings and equipment. The ROI formula can also be broken down into the product of margin and turnover. Margin is the ratio of operating income to sales. Turnover is defined as sales divided by average operating assets. ROI = Margin x Turnover or

Three advantages of using ROI to evaluate the performance of investment centers: 1. It encourages managers to pay careful attention to the relationships among sales, expenses and investment, as should be the case for a manager of an investment center. 2. It encourages cost efficiency. 3. It discourages excessive investment in operating assets. Two disadvantages of using ROI are: 1. It encourages managers from investing in projects that would decrease the divisional ROI but would increase the profitability of the company as a whole. (Generally, projects with an ROI less than a division’s current ROI would be rejected.) 2. It can encourage myopic behavior, in that managers may focus on the short run at the expense of the long run. Residual Income (RI) – the difference between operating income and the minimum peso return required on a company’s operating assets. The equation of RI can be expressed as follows: RI = Operating Income – (Minimum Rate of Return x Operating Assets) ECONOMIC VALUE ADDED (EVA) – a more specific version of residual income. It represents the segment’s true economic profit because it measures the benefit obtained by using resources in a particular way. After-tax operating income (EBIT x (1 – T)) Less: Desired Income (WACC x (Total Assets – Non-interest Bearing Current Liabilities) Economic Value Added

xx xx xx

TRANSFER PRICING TRANSFER PRICE – the monetary value or the price charged by one segment of a firm for the goods and services it supplies to another segment of the same firm. Objectives of Transfer Pricing:

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1. To facilitate optimal decision-making. 2. To provide a basis in measuring divisional performance. 3. To motivate the different department heads in improvement their performance and that of their departments. APPROACHES FOR DETERMINING TRANSFER PRICE: 1. Negotiated transfer price A negotiated transfer price is appropriate when market prices are subject to rapid fluctuation. In negotiating a transfer price, the range is:  MINIMUM PRICE – seller’s point of view; seller’s incremental cost plus opportunity cost  MAXIMUM PRICE – buyer’s point of view; the prevailing market price 2. Cost-based transfer price (Cost plus markup) The markup may be lumpsum (pesos) or a markup percentage. Cost may be the standard cost or actual cost. 3. Market-based transfer price A transfer price equal to the prevailing market price encourages both the selling and the buying segments to sell/buy internally, if a market price for the goods/services exist. 4. Incremental cost plus opportunity cost to the seller The opportunity cost is usually the contribution margin to be lost from outside customers if the goods are transferred to a buying segment within the firm. This transfer price is the minimum amount that the selling segment would be willing to transfer the goods/services to another segment. 5. Full absorption cost This transfer price includes materials, labor, and allocated fixed factory overhead. 6. Dual transfer price The seller records the transfer price at the usual market price that would be paid by an outsider, while the buyer (another segment within the firm) records the purchase cost at cost, usually the variable production cost. General Rules in Choosing a Transfer Price  The maximum price should be no greater than the lowest market price at which the buying segment can acquire the goods or services externally.  The minimum price should no less than the sum of the selling segment’s incremental costs associated with the goods or services plus the opportunity cost of the facilities used.  A good should be transferred internally whenever the minimum transfer price (set by the selling division) is less than the maximum transfer price (set by the buying division). By using this rule, total profits of the firm are not decreased by an internal transfer.

THE BALANCED SCORECARD: STRATEGIC-BASED CONTROL The Balanced Scorecard is a strategic management system that defines a strategic-based responsibility accounting system. Strategy is defined as choosing the market and customer segments the business unit intends to serve, identifying the critical internal and business processes that the unit must excel at to deliver the value propositions to customers in the targeted market segments, and selecting the individual and organization capabilities required for the internal, customer, and financial objectives. The Balanced Scorecard translates an organization’s mission and strategy into operational objectives and performance measures for four different perspectives: the financial perspective, the customer perspective, the internal business process perspective, and the learning and growth (infrastructure) perspective. Common characteristics of balanced scorecards a. It should be possible, by examining a company’s balanced scorecard, to infer its strategy and the assumptions underlying that strategy.

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b. The balanced scorecard should emphasize improvement rather than just meeting present standards or targets. c. Some of the performance measures of the balanced scorecards should be non-financial. d. The scorecards for individuals should contain only those performance measures they can actually influence. e. The ultimate objectives of the organization are usually financial, but better financial results cannot be attained without improving customers’ perception of the company’s products and services. In order to improve customers’ perspective of products and services, it is usually necessary to improve internal business processes so that the products and services are actually better. And in order to improve the business processes, it is necessary that employees learn. The balanced scorecards as a motivation and feedback mechanism. The performance measures on the balanced scorecard provide motivation and feedback for improving. The Financial Perspective The financial perspective establishes the long- and short-term financial performance objectives. The financial perspective is concerned with the global financial consequences of the other three perspectives. Thus, the objectives and measures of the other perspectives must be linked to the financial objectives. The financial perspective has three strategic themes: revenue growth, cost reduction, and asset utilization. The Customer Perspective The customer perspective is the source of the revenue component for the financial objectives. This perspective defines and selects the customer and market segments in which the company chooses to compete. The Process Perspective To provide the framework needed for this perspective, a process value chain is defined. The process value chain is made up of three processes: the innovation process, the operations process, and the post sales processes. Cycle time is the time required to produce one unit of product. Velocity is the number of units that can be produced in a given period of time (e.g., units per hour) Learning/Innovation and Growth Perspective The learning and growth perspective is the source of the capabilities that enable the accomplishment of the other three perspectives’ objectives.

SOME INTERNAL BUSINESS PROCESS PERFORMANCE MEASURES a. Delivery Cycle Time. This is the total elapsed time between when an order is placed by a customer and when it is shipped to the customer. Part of this time is wait time that occurs before the order is placed into production. b. Throughput (manufacturing cycle) Time. This is the total elapsed time between when an order is initiated into production and when it is shipped to the customer. It consists of process time, inspection time, move time, and queue time. The only element that adds value is processing time. Inspection time, move time, queue time, and their associated activities do not add value and should be minimized. c. Manufacturing Cycle Efficiency (MCE). MCE is the ratio of value-added time (i.e., process time) to total throughput time. It represents the percentage of time an order is in production in which useful work is being done. The rest of the time represents non-value-added time (i.e., inspection time, move time, and queue time).

PRODUCTIVITY MEASUREMENT Productivity – measures the relationship between actual inputs used (both quantities and costs) and actual outputs produced.

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Partial productivity – compares the quantity of output produced with the quantity of an individual input used.

Total factor productivity – the ratio of quantity of output produced to the costs of all inputs used based on current period prices.

STRATEGIC ANALYSIS OF OPERATING INCOME STRATEGY – specifies how an organization matches its own capabilities with the opportunities in the market place to accomplish its objectives. Two basic strategies: 1. Product differentiation – ability to offer products and services offered by customers to be superior and unique relative to the products or services of competitors. 2. Cost leadership – ability to achieve lower costs relative to competitors through productivity and efficiency improvements, elimination of waste, and tight cost control. To evaluate the success of its strategy, a company can analyze the change in operating income by breaking down into growth, price recovery, and productivity components. Growth component – measures the change in revenue and costs from selling more or less units, assuming nothing else has changed. Price recovery component – measures changes in revenue and costs solely as a result of changes in the prices of outputs and inputs. Productivity component – measures the decrease in costs from using fewer units, a better mix of inputs and reducing capacity

GROWTH COMPONENT OF OPERATING INCOME CHANGE (Year 1 and Year 2) Revenue effect of growth = (Year 2 units sold – Year 1 units sold) x Year 1 selling price Cost effect of growth for variable costs

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(units of input required to produce Year 2 output in Year 1

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Actual units of input used to produce Year 1 output)

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Year 1 input price

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Actual units of outputs sold in Year 2

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Units of input required to produce Year 2 output in Year 1

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Actual units of capacity in YEAR 1, because adequate capacity exist to produce Year 2 output in Year 1

Price-Recovery Component of Operating-Income Change Revenue effect of price recovery

Cost effect of price recovery for variable costs

Cost effect of price recovery for fixed costs

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=

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(Selling price in year 2

(input price in Year 2

(price per unit of capacity in Year 2

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Selling price in Year 1)

Input price in Year 1

Price per unit of capacity in Year 1)...