Management Accounting Business Responsebility Centers

Question: Describe about the Management Accounting for Business Responsebility Centers. Answer: Introduction A significant aspect of decentralised companies is responsibility centres. These centres are analysed on the grounds of different accounting figures like ROI, standard cost or divisional profit. One purpose of the management accounting mechanism is hence to tie a dollar value to transactions amidst various responsibility centres. Transfer price fits here as it is the price charged by companys one division from the other for the goods transferred to the latter (Holtzman and Nagel, 2014). The present report discusses transfer pricing, its different types and its use at length. Part A Transfer Pricing Defined In its essence, transfer pricing is a model of selling a product from one business unit or division of an organisation to other. Transfer price is basically the value charged for intra-company goods that the organisationalgroups purchase from one another. Coordinating the management of both the buying and selling decision is one of the primary purposes of transfer pricing. It is not essential that any money changes hands between the concerned segments (Schuster, 2015). The transfer price may just be utilised for the purpose of internal record keeping. It is revenue for the centre selling the products and expense for the one buying the products. The product which is transferred can be categorised on two measures. The first on is whether or not the product has a readily available outer market price. The second is whether or not the buying segment will sell it in the same form or will it turn into an input for the marketing divisions own manufacturing process (Ceteris, 2010). Purpose of Using Transfer pricing The below-mentioned reasons are the primaryobjectives of establishing transfer pricing scheme Yield separate revenue figures for every business unit and hence analyse the performance of every unit separately (Fernandes, Pinho and Gouveia, 2015). Assist in the synchronisation of manufacturing, pricing and sales decisions of the distinct business units. Through transfer prices, managers become aware of the value that their services and products carry for other divisions of the entity (OECD, 2009). It enables the firm to produce profit or cost data for every segment separately. Transfer price not only impacts the recognised profit for every division but also influences resource allocation. When transnational corporations move goods across international boundaries, transfer rates are appropriate in the computation of income taxes and are at times pertinent to legislative issues and global trade (Wittendorff, 2010). Different Types of Transfer Price Transfer at cost Entities employing transfer at cost method acknowledge that sales by global associates add to business profitability by yielding economies of scale in local manufacturing systems. This pricing method enables minimum duties. The firms making use of this approach do not expect a profit on transfer sale; instead, their expectation is related to their partner generating revenues by eventual sale (Drury, 2008). This transfer pricing method is used because companies presume that low costs will result in better performance of the partner, which eventually profits the whole company. Cost-plus pricing Organizations adopting the cost-plus pricing system believe in showing the profit accruing from any service or product at each stage of its movement through the company and its subsidiaries, business units or affiliates. This approach may lead to a price which may not be competitive or related to the demand in global markets. This is a widely used method because the management needs a projection of the long run marginal cost to make decisions (Chand, 2015). Market-based price This is obtained from the priceneeded to stay competitive in the global marketplace. This limitation in this method is cost. Nonetheless, there exists a significant amount of difference in the way cost is characterised. As with volume, cost usually reduces, a choice needs to be made between existing or planned levels of volume as the basis of pricing (Bakker, 2009). For employing this approach to penetrate a market which is very small with the intention of supporting local production, third nation sourcing might be needed. This allows the organisation to set up its franchise or name without having to invest in a physical set up. This is also suitable for a perfect market, where the products are homogeneous with the same price for both buyers and seller and no selling or purchasing costs. Adopting market-based transfer pricing in such a market matches the standards of a sound transfer price i.e. it will preserve divisional independence, will endorse consistent goal decisions and offer a consistent basis to evaluate performance (Muhammadi, Ahmed and Habib, 2016). Negotiated Transfer PricingIn this case, the company does not outline the rules for determining the transfer price. Business unit managers are motivated to negotiate a reciprocally satisfying transfer price. This approach is basically merged with free sourcing. However, in certain organisations, the head office holds the right to arbitrate the process of negotiation and enforce an adjudicated solution (Drury, 2008). In a market which is imperfect, transfer prices established at the planned or current market price do not tend to be the most favourable. In such situations, it is suitable to follow the negotiated approach. In cases of unused capacity, the range of transfer price negotiation usually falls between the maximum rate the buying segment is ready to pay and the minimum price at which the selling division is ready to sell (Rossing and Rohde, 2014). Part 2. (a) Transfer prices are based on total actual cost and not appropriated as the basis for divisional performance measurement because: As it do not leads to an optimal decision for the company. It provides small amount of incentive for sales department to control manufacturing costs as all the cost incurred will be recovered. (b) Calculation of contribution margin Data available: Particular Cleaning and Scrapping Division Processing Division Transfer price from cleaning and scrapping 0 77 Direct Material 18 5 Direct Labour 12 10 Manufacturing Overhead 40 25 Total direct cost 70 117 Calculation of variable manufacturing overhead Particular Cleaning and Scrapping Division Processing Division Total Manufacturing Overhead 40 25 75% variable in cleaning scrapping dept. 30 40% variable in processing division 10 Calculation of total variable cost Particular Cleaning and Scrapping Division Processing Division Transfer price 77 Direct Material 18 5 Direct Labor 12 10 Variable Manufacturing Overhead 30 10 Variable Selling cost 5 0 Total variable cost 65 102 Calculation of selling price Particular Cleaning and Scrapping Division Processing Division Price at which it can be sold in open market 95 160 Total selling price 95 160 Formula for contribution margin = Selling Price Product variable cost Selling Price Contribution Ratio Particular Cleaning and Scrapping Division Processing Division Selling Price 100 160 Variable Cost 65 102 Contribution Margin 35 36.25 (c) Calculation of price range Normal markup per unit Particular Cleaning and Scrapping Division Processing Division Variable cost per unit 60 102 Fixed Overhead per unit 10 15 Variable selling cost 5 0 Total cost 75 117 Normal markup per unit 20 43 Market price per unit 95 160 Production capacity 400000 400000 Price range for cleaning and scrapping division As per the economic transfer pricing rule the minimum price is the marginal cost and the maximum price is fixed by the receiving department. $65 - $ 95 Price range for processing division As explained above regarding the rule of economic transfer pricing the minimum price will be calculated and the maximum price will include margin also. $75 - $160 (d) As the division is having an opportunity to sell goods externally instead of selling it to other department. The minimum transfer price would be cost plus their profit margin. In present case the normal profit markup is 10% of the cost. Calculation of lowest transfer price acceptable to cleansing scrapping division according to general transfer pricing rule Particular Cleaning and Scrapping Division Variable cost per unit 60 Fixed Overhead per unit 10 Variable selling cost 5 Total cost 75 Normal markup per unit 7.5 Market price per unit 95 Production capacity 400000 The selling variable cost will be included in case the goods are to be sold externally and not while selling goods to another division; as no selling variable cost is paid in that case. Conclusion In vertically integrated firms, there are mainly two segments, a manufacturing and a buying division. In such companies, there is a regular exchange of goods and services among their departments to facilitate business operations. Transfer pricing is hence, the internal prices of goods developed with two main purposes: coordination (to arrive at decisions most appropriate for the business), and profit allocation (for assessing segment profits and to measure performance. The paper also discussed the different types of transfer prices (Lin and Chang, 2010.). From the different types of transfer pricing techniques, the cost based approach is the most widely used and is followed by the market-based approach. Transfer pricing also becomes suitable in respect of legislative issues such as global trade disputes etc. References Bakker, A., 2009. Transfer Pricing and Business Restructurings: Streamlining All the Way. IBFD. Ceteris., 2010. Guide to International Transfer Pricing: Law, Tax Planning and Compliance Strategies. Kluwer Law International. Chand, S., 2015. 5 Types of Transfer Pricing Methods used in International Marketing. [Online]. 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