Professional Documents
Culture Documents
Accounting, Performance
Evaluation, and Transfer Pricing
Chapter 10 Objectives
Objective 1
10-3
Decentralization
Objective 210-4
Decentralization
Reasons for Decentralization:
• Better access to local information
• Cognitive limitations
• More timely response
• Focusing of central management
• Training and evaluation of segment managers
• Motivation of segment managers
• Enhanced competition
Objective 210-5
Decentralization
Objective 210-6
Measuring the Performance of
Investment Centers
Return on Investment (ROI) is the most common measure of
performance for an investment center.
Where:
Margin = portion of sales available for interest, taxes and profit
Turnover = how productively assets are being used to generate sales
Operating income = refers to earnings before interest and income
taxes
Operating assets = includes all assets used to generate operating
income
Objective 310-7
Measuring the Performance of
Investment Centers
Advantages of the ROI Measure:
1. Helps managers focus on the relationship between sales,
expenses and investment.
2. Encourages cost efficiency.
3. Discourages excessive investment in operating assets
Objective 310-8
Measuring the Performance of
Investment Centers
Residual Income is the difference between operating income and the
minimum dollar return required on a company’s operating
assets:
Objective 310-9
Measuring the Performance of
Investment Centers
Economic Value Added (EVA) is after-tax operating profit minus the
total annual cost of capital
if positive, the company is creating wealth
if negative, then the company is destroying wealth
key feature: focuses on after-tax operating income and the actual
cost of capital
Objective 310-10
Measuring and Rewarding the
Performance of Managers
Incentive Pay for Managers
Why would managers not provide good service?
There are three reasons:
1. They may have low ability.
2. They may prefer not to work hard.
3. They may prefer to spend company resources on perquisites.
Objective 410-11
Measuring and Rewarding the
Performance of Managers
Managerial Rewards
• Frequently managerial rewards include incentives tied to
performance.
• The objective of managerial awards is to encourage goal
congruence, so that managers will act in the best interests of the
firm.
• Managerial rewards include salary increases, bonuses based on
reported income, stock options, and noncash compensations.
Objective 410-12
Measuring and Rewarding the
Performance of Managers
Cash Compensation
• Good management performance may be rewarded by granting
periodic raises.
• Unlike periodic raises, bonuses are more flexible.
• Many companies use a combination of salary and bonuses to
reward performance by keeping salaries fairly level and allowing
bonuses to fluctuate with reported income.
Objective 410-13
Measuring and Rewarding the
Performance of Managers
Stock-Based Compensation
• Stock options frequently are offered to managers to encourage
them to focus on the longer term.
• A stock option is the right to buy a certain number of shares of the
company’s stock, at a particular price, after a set length of time.
• The price of the stock is usually set approximately at market price
at the time of issue. Then, if the stock price rises in the future, the
manager may exercise the option.
Objective 410-14
Transfer Pricing
Transfer prices are the prices charged for goods produced by one division
and transferred to another.
The price charged affects the revenues of the transferring division and the
costs of the receiving division.
Objective 510-15
Transfer Pricing
Objective 510-16
Setting Transfer Prices
A transfer pricing system should satisfy three objectives:
• Accurate performance evaluation
• Goal congruence
• Preservation
Objective 610-17
Setting Transfer Prices
• Market price
• Negotiated transfer prices
• Cost based transfer prices
• Variable cost transfer pricing
• Full (absorption cost) cost transfer pricing
Objective 610-18
Setting Transfer Prices
Objective 610-19
Setting Transfer Prices
Objective 610-20
Setting Transfer Prices
Objective 610-21
Setting Transfer Prices
• Disadvantages of Negotiated Transfer Prices
• One divisional manager with private information may take
advantage of another divisional manager
• Performance measures may be distorted by the negotiating skills of
managers
• Negotiation can consume considerable time and resources
• Despite the disadvantages, negotiated price transfer prices offer some
hope of complying with the three criteria of goal congruence,
autonomy, and accurate performance evaluation
Objective 610-22
Setting Transfer Prices
Objective 610-23
Setting Transfer Prices
Objective 610-24
End of Chapter 10