18_OverheadsForChen0 - Objectivesfortoday Overview...

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ACCY 302 (Chen) Fall 2009, Class 18 1 Objectives for today Overview the setting and the problems possible solution: transfer prices Establishing a transfer pricing policy what does management at headquarters, divisions want? constraint Computing transfer prices methods and their limitations underlying principle of all methods general guidelines for choosing a method Takeaways
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ACCY 302 (Chen) Fall 2009, Class 18 2 The setting A decentralized organization in which the work flows of the divisions within it are interdependent * . Managers are evaluated based on divisional performance. * Within the same organization, the outputs of one division are the inputs of another.
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ACCY 302 (Chen) Fall 2009, Class 18 3 The problems Example: Illini Lumber Co. has two divisions: Raw Lumber (RL), which can either: sell its product to FL, where it can be processed further sell its product to outside customers Finished Lumber (FL), which can sell its product to outside customers
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ACCY 302 (Chen) Fall 2009, Class 18 4 The problems  (continued) Illini Lumber  Company Raw Lumber (RL)  Division Finished  Lumber  (FL) Division outside customers  who want to buy  boards outside customers who  want to buy paneling
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ACCY 302 (Chen) Fall 2009, Class 18 5 The problems  (continued) What problems arise? 1) Measuring performance is problematic The organization as a whole needs to place a value on interdependent work flows so management can determine whether value is being created But because this is an internal market: transactions are not at arms-length the prices placed on those work flows are distorted
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ACCY 302 (Chen) Fall 2009, Class 18 6 The problems  (continued) What problems arise? 1) Measuring performance is problematic - Example If the selling division is receiving too little revenue from the buying division relative to the "true" value of the product/service, then: - the selling division's profit will be too low - the buying division's profit will be too high
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ACCY 302 (Chen) Fall 2009, Class 18 7 The problems  (continued) What problems arise? (continued) : 2) In response, resource allocation decisions will change Because the divisions and their managers are evaluated based on divisional performance. . ..the managers have no incentive to work together, and will adjust their decisions in response to the distortions created by their performance evaluation. . ..even if those decisions are not in the best interest of the organization as a whole ( a moral hazard problem )!
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ACCY 302 (Chen) Fall 2009, Class 18 8 Divisional Manager’s Perspective
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ACCY 302 (Chen) Fall 2009, Class 18 9 The problems  (continued) What problems arise?
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18_OverheadsForChen0 - Objectivesfortoday Overview...

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