Module+12000+III+Explanation+and+Examples

III. Module 12000 Explanation and Examples amb

 A. **Transfer Pricing** Explanations and Examples JKS


 * __Responsibility Accounting__**
 * 1) __Types of Responsibility Centers__

i. __Cost Center__: Are centers where cost is the only area of concern for the manager.

__Examples__: Human resources, accounting, legal, and other administrative items don’t directly generate revenues; however they do create expenses for an organization. Other items such as maintenance and engineering also fall into this category.

ii. __Revenue Center__: Are centers where revenue is the only are of concern for the manager.

__Examples:__ Hotels’ revenue centers lie in their room and food departments. This is because they are the areas that produce revenue through the sales of their services.

iii. __Profit Center__: Are centers where both cost and revenue are concerns for the manager

__Examples:__ Restaurant chains may view each individual store as profit center, where the manager must take into account both revenues and expenses. Stores that generated more revenue would inevitably encounter more food costs that the manager would have to deal with at each location.

iv. __Investment Center__: Are centers where revenues, costs, and investments are a concern for the manager.

__Examples:__ The corporate headquarters which is measured on terms such as ROI and RI is an example of such a center. They have to make decisions such as opening or closing stores, continuation of products, and etc.


 * 1) __The Role of Information and Accountability__

i. The essence of the role of information is that each department is handled by a manager that only focuses on that area. For instance, sales are the responsibility of sales managers and departmental costs are the responsibility of the production managers.

ii. Management accountants are effected in the sense that they are required to stay up to date on various areas of the business from politics to marketing; anything that may affect the firm.

iii. Accountability is an evaluation of the different department managers and the management accountants against expected outcomes.

iv. Responsibility accounting is the mixture of responsibility, accountability, and performance evaluation.


 * __Decentralization__**


 * 1) __Concept__

i. __Decentralization:__ When lower divisions/sub-units are in control of the decision making processes.

__Example:__ Lower level managers may be in charge of setting their own price or implementing their own marketing campaigns.


 * 1) __How to Decentralize__

i. Creating division or sub-units through segmentation is how decentralization is normally achieved. The divisions or sub-units are usually created on the bases of the goods or services they produced or types of customers served.

__Examples:__ The table below depicts some of PepsiCo’s divisions and sub-divisions


 * ** PepsiCo ** ||
 * **PepsiCo Americas Beverage** ||  **PepsiCo Americas Food**  ||
 * SoBe ||  Frito-Lay  ||
 * Tropicana ||  Quaker Foods & Snacks  ||
 * Gatorade ||  Sabritas  ||
 * Aquafina Water ||  Gamesa and Latin America Foods  ||
 * Pepsi Cola ||   ||

ii. These divisions or sub-units are organized based on their respected responsibility center (list mentioned above) allowing for them to be controlled through responsibility management.


 * 1) __Why Decentralize__

There are 7 reasons as to why a firm would want to decentralize; they are as follows:

i. __Better Access to Local Information__: Due to their ability to understand and access local information, lower level managers present the company with vital information concerning local competition, the local labor force, and etc. that would be difficult to obtain if upper level management controlled the decisions.

ii. __Cognitive Limitations__: Allows companies to reduce costs by letting the lower level managers deal with specialized issues on their own. Companies’ would need individuals to dissect the lower level managers’ information if it was transmitted to the headquarters, therefore, why not cut this cost by having the managers handle the information themselves. In doing so, lower level managers develop specific fields of expertise in addition to their managerial talent.

iii. __More Timely Response__: By allowing lower level managers to implement and make decisions, the chance of potential miscommunication and delays in transmitting information is greatly reduced.

iv. __Focusing of Central Management__: Central management within the organization can now focus on future long term strategic matters and not have to worry about day to day items.

v. __Training and Evaluation of Segment Managers__: This prepares lower level managers for possible promotions into upper management roles, by allowing them to make and implement decisions on their own concerning day to day operations.

vi. __Motivation of Segment Managers__: Greater responsibility can produce more job satisfaction and motivate local managers; which may in turn benefit the company as a whole.

vii. __Enhanced Competition__: Competition is enhanced through central management’s ability to view its organization as independent components; forcing each division to produce its own financial figures that can measure its performance.


 * __Return on Investment (ROI)__**


 * 1) ROI is a formula that calculates the efficiency of an investment in terms of profit earned per dollar of investment; most commonly measures performance for an investment center


 * 1) ROI has three advantages:

i. The relationship between sales, expenses, and investment becomes closely observed by managers.

ii. It promotes cost efficiency.

iii. Enormous investments in operating assets are discouraged.


 * 1) ROI has disadvantages when it is used as the sole bases for decision making, for instance:

i. It doesn’t say anything about the expected returns and costs that were predicted, and if the predictions were accurate.

ii. Doesn’t say anything about the risk involved with the investment.

iii. Can be modified to suit to the desired situation.


 * 1) ROI can be calculated in the following 3 ways:

i. ROI = Operating Income / Average Operating Assets

ii. ROI = (Operating Income / Sales) * (Sales / Average Operating Assets)

iii. ROI = Operating income margin * Operating asset turnover


 * 1) The Average Operating Assets, the Operating Income Margin, and the Operating Asset Turnover figures are broken down as such:

i. Average Operating Assets = (Beginning Assets + Ending Assets) / 2

ii. Operating Income Margin = Operating Income / Sales

iii. Operating Asset Turnover = Sales / Average Operating Assets

**__Residual Income (RI) __**
 * 1) Residual Income (RI) is another performance measure. Ultimately, it’s the difference between operating income and the minimum dollar return required on a company’s operating assets


 * 1) RI is advantageous because all a manager has to do is see if the figure is greater than the minimum rate of return, and if so it will increase profitability for the entire organization.


 * 1) RI has two disadvantages:

i. Difficult to compare divisions that are different sizes

__Solution__: Compute a residual return on investment, as follows. Residual return on investment = RI / Average Operating Assets

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">ii. Can cause managers to overemphasis short-run results at the expense of long-term profitability.


 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Residual Income is calculated as follows:

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">i. Residual Income = Operating Income – (Minimum Rate of Return * Operating Assets)

**__<span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Economic Value Added (EVA) __**


 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">EVA is a performance measure that tries to illustrate the true economic profit of a company through a calculation that takes into account residual wealth. Simply put, positive EVAs indicate a creation of wealth and negative EVAs indicate a destruction of wealth.


 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Difficulty arises with this calculation, because the cost of capital figure that needs to be computed. Steps in finding this figure are as follows:

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">i. Calculate the Weighted Average Cost of Capital as a percentage

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 16px; line-height: 24px; text-align: left;">Done by multiplying the sources of invested funds by their after-tax cost <span style="display: block; font-family: 'Times New Roman',serif; font-size: 16px; line-height: 24px; text-align: left;">After- Tax Cost of Debt = Cost * (1 – Tax Rate) <span style="display: block; font-family: 'Times New Roman',serif; font-size: 16px; line-height: 24px; text-align: left;">No adjustments are made for equity

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 16px; line-height: 24px; text-align: left;">ii. Find the dollar amount of capital used
 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">The formula for EVA is as follows:

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">i. EVA = After-Tax Operating Income – (Weighted Average Cost of Capital * Total Capital Employed)

**__<span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Transfer Pricing __**
 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Transfer Prices are prices that are transferred through the divisions within an organization that must simultaneously meet three objectives:

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">i. Provide Accurate Performance Evaluation

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">ii. Encourage Goal Congruence

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">iii. Maintain Autonomy


 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">The problem with transfer pricing is trying to find a system that will actually simultaneously meet all three of the aforementioned objectives.

**__<span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Balanced Scorecard __**
 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">The Balanced Scorecard is a strategy that is used by businesses to help align the vision and strategies of the company, improve communication, and measure performance against organizational goals.


 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Measures four different items:

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">i. Financial Items <span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">ii. Customer Items <span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">iii. Process Items <span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">iv. Learning/Growth Items


 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">This strategy uses past information, found in the financials, and combines it with customer, process, and learning/growth items to develop a strategy that will help an organization better create future value for itself.

**__<span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Cycle Time, Velocity, and Manufacturing Cycle Efficiency __**


 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Cycle Time is the time it takes for the materials of a product to be delivered as finished goods.

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 16px; line-height: 24px; text-align: left;">It is calculated as follows: <span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">i. Cycle Time = Time / Units Produced


 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Velocity is the number of units that can be produced during a give time

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 16px; line-height: 24px; text-align: left;">It is calculated as follows: <span style="display: block; font-family: 'Times New Roman',serif; font-size: 12pt; text-align: left;">i. Velocity = Units Produced / Time


 * 1) <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">Manufacturing Cycle Efficiency is measure of how efficiently an organization’s manufacturing capabilities uses time

<span style="display: block; font-family: 'Times New Roman',serif; font-size: 16px; line-height: 24px; text-align: left;">It is calculated as follows: <span style="font-family: 'Times New Roman',serif; font-size: 12pt;">i. Manufacturing Cycle Efficiency = Processing Time / (Processing Time + Move <span style="font-family: 'Times New Roman',serif; font-size: 16px; line-height: 24px;">Time + Inspection Time + Waiting Time + Other Non Value Added Time)

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