Chapter 13:
Responsibility Accounting, Support
Department Allocations, and
Transfer Pricing
Cost Accounting:
Foundations and Evolutions, 8e
Kinney ● Raiborn
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Learning Objectives
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Which factors determine whether a firm should be
decentralized or centralized?
How are decentralization and responsibility accounting
related?
What are the four primary types of responsibility centers, and
what distinguishes them from each other?
How are revenue variances computed?
Why and how are support department costs allocated to
operating departments?
What types of transfer prices are used in organizations, and
why are such prices used?
What difficulties can be encountered by multinational
companies using transfer prices?
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Organizational Structure
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Centralization

Top management
retains the major
portion of authority
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Decentralization

Top management
delegates decisionmaking authority to
subunit managers
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Decentralization Continuum (slide 1 of 2)
Factor
Centralized
Age of firm
Size of firm
Stage of product
development
Growth rate
Impact on profits
of incorrect decisions
Management’s
confidence in
subordinates
Degree of control
Decentralized
Young
Small
Mature
Large
Stable
Slow
Growth
Rapid
High
Low
Low
Tight
High
Moderate/loose
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Decentralization Continuum (slide 2 of 2)
Factor
Centralized
Geographic
diversity
Cost of communications
Ability to resolve
conflicts
Level of employee
motivation
Level of organizational
flexibility
Response time to
changes
Decentralized
Local
Low
Widespread
High
Easy
Difficult
Low
Moderate to high
Low
High
Slow
Rapid
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Advantages and Disadvantages of
Decentralization
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Advantages
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Personnel
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Train and screen aspiring
managers
Develop leadership
qualities, problem-solving
abilities, and decisionmaking skills
Compare managers’ results
Increase job satisfaction
and job enrichment
Effective means of
achieving organizational
goals
Reduces decision-making
time
Allows management by
exception
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Disadvantages
 Lack of goal congruence
 Suboptimization
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Pursuing the subunit
manager’s goals instead of
the company’s goals
Requires more effective
communication skills
Managers must relinquish
control
Expensive

Train managers in decisionmaking skills
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Absorb cost of poor decisions
Requires a sophisticated
planning and reporting system

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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Responsibility Accounting
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Reporting system
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Provides information about subunits
Allows management to measure subunit performance
Consistent with

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Managers delegate decision-making authority
but retain responsibility for outcomes.
Standard costing
Activity-based costing
Monetary and nonmonetary
Adjusted for the planning, controlling, and decisionmaking needs of each unit manager
Separates costs as controllable or noncontrollable
by the unit manager
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Responsibility Report
DEPARTMENT
Itemized Costs
Controllable
Noncontrollable
MANAGER
Budgeted
Costs
Actual
Costs
Variance
Nonmonetary items
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Nonmonetary Measures
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Capacity measures
Target ROI
Desired/actual market share
Throughput
Defects
Backorders
Complaints
On-time delivery
Manufacturing cycle
efficiency
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Reduction of non-valueadded time
Employee suggestions
received/implemented
Unplanned production
interruptions
Schedule changes
Engineering changes
Safety violations
Absenteeism
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Control Process Steps
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Prepare a plan using budgets and standards and
use it to communicate output expectations and
delegate authority
Use responsibility accounting system to record and
summarize data for each organizational unit
Monitor the differences between planned and actual
data at scheduled intervals
Exert influence in response to significant differences
Continue comparing data and responding and then
begin the process again
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Responsibility Reporting
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Upward flow of information
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From operations to top management
Unit level reports are detailed
Upper-level reports are summarized
Encourages management by exception
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Major deviations are highlighted
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Responsibility Reporting System
Division data
are reported
to the CEO
To CEO
Division A Total
Division B Total
Total for Company
Department
data are
reported to
the Division
Division A
Dept Q Totals
Dept R Totals
Total for Division
Dept Q Costs
Itemized
Total for Dept
Dept R Costs
Itemized
Total for Dept
Division B
Dept X Totals
Dept Y Totals
Total for Division
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Disadvantages of Responsibility
Accounting
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Disadvantages of responsibility accounting
include
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Important details may not be visible at upper
management levels
Managers might “promote” their unit while
“blaming” their competitor units
Departmental interdependencies might not be
visible
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Responsibility Centers
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Responsibility
accounting systems
identify, measure, and
report on activities in
responsibility centers
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Cost center
Revenue center
Profit center
Investment center
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Cost Centers
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Authority to incur costs
Evaluated on how well costs are controlled
Revenues
 Do not exist
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Exist but are not under manager’s control
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Example: community libraries
Exist but cannot be measured
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Example: equipment maintenance center
Example: R&D center
Focus on variances outside acceptable range
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Revenue Centers
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Responsible for generating revenue
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No control of selling price or costs
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Example: Individual sales departments in retail stores
Revenue and Limited Cost Center
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Some involvement in planning and controlling
costs
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Profit Centers
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Responsible for generating revenues—set
selling prices
Responsible for controlling expenses—allowed
to purchase at most economical price
Goal is to maximize the center’s profit
Independent units
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Examples:
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Bank branches
Educational divisions
18-wheelers
Evaluate on profit variance
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Investment Centers
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Responsible for generating revenues and
planning and controlling expenses
Responsible for plant assets
Goal is maximize rate of return on assets
Evaluate on rate of return on assets and
other performance measures
Example: Divisions or subsidiaries
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Responsibility Centers
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To control cost center performance,
management may:
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Assign costs incurred in cost centers to revenueproducing areas through service department cost
allocation
“Create” revenue through a system of internal
charges (charge-backs) for the center’s tangible
or intangible output used by other company units
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Service Department Cost Allocation
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Service departments
provide functional tasks
for other internal units
 Purchasing
 Maintenance
 Engineering
 Security
 Warehousing

Administrative
departments provide
management activities
for the organization
 Human resources
 Accounting
 Legal
 Insurance
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Allocating Service Costs: Full Cost
Objective
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Reasons for:
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Cost recovery
Awareness of
support costs
“Fair share” of costs
Regulations for some
pricing instances
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Reasons against:
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Managers cannot
control costs
Arbitrary costs not
useful in decision
making
Confuses costing and
pricing issues
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Allocating Service Costs: Motivation
for Managers Objective
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Reasons for:
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Awareness of support
costs in production
managers
Relates unit’s profit to
total company profits
Reflects usage of
services
Encourages cost control
Encourages usage of
certain services
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Reasons against:
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Distorts profits with
subjective allocations
Managers cannot control
costs
Not material to profits
Creates interdivisional ill
will
Not cost beneficial
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Allocating Service Costs: Compare
Alternate Courses of Action Objective
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Reasons for:
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Relevant information
helps compare
alternatives
Provides best cost
estimates when
comparing alternatives
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Reasons against:
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Unnecessary if costs do
not change among
alternatives
Arbitrary allocations
distort cash flow and
profits for alternatives
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Allocation Bases for Service
Department Costs
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Rational and systematic base
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Benefit received by revenue-producing department
Causal relationship
Fairness or equity of the allocations
Ability of revenue-producing department to bear the
allocated cost
Methods
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Direct method
Step method
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Benefits-provided ranking
Algebraic method
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Simultaneous equations
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Direct Method
Assigns costs straight to revenue-producing areas
Revenue
Service
1
2
A
B
C
Step 1 $
Step 2
$
Does not recognize service provided
to other service departments
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Service Method
Partially recognizes relationships
among service departments
Revenue
Service
1
2
A
B
C
Step 1 $
Step 2
$
Does not recognize the two-way exchange of
services between service departments
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Algebraic Method
Provides the best
allocation
information
Revenue
Service
1
At the
same
time
2
A
B
C
$
$
Recognizes all interrelationships among departments
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Service Cost Allocation
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Allocated service department costs are
included in the overhead application rate for
the revenue-producing areas
Service department costs are allocated to
products or jobs through normal overhead
assignment procedures
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Transfer Pricing
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Internal charges for the
 Advantages
exchange of goods or
 Encourage development
services within the
of beneficial services
organization
 Promote cost
Promote goal congruence
consciousness of
Make performance
services provided
evaluation among segments
 Promote making a
more comparable
service department a
Transform a cost center into
profit center
a pseudo-profit center
Transfer prices are for internal use only.
Encourages managers to They are eliminated on external
be entrepreneurial
financial reports.
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Setting the Transfer Price
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Maximum—no higher than the lowest
market price
Minimum—no less than the sum of
 Selling segment’s incremental costs plus
 The opportunity cost of the facilities used
Ease of determining the transfer price
Managers should understand how to
compute and evaluate the transfer price
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Cost-Based Transfer Prices
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
Definition of cost
 Variable cost vs. absorption cost
 Actual vs. standard
Standard cost is superior to actual cost
 Actual costs vary according to season and
production volume
 Standard costs are stable measures of
production costs
 Variances are attributed to selling division
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Market-Based Transfer Prices
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Objective, arm’s-length measure
Potential problems when the market
determines the transfer price
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No exact counterpart in the external market
Ignores internal cost savings
Market price varies

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Current depressed price vs. long-run market price
Different prices, discounts, and credit terms for
different buyers
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Negotiated Transfer Prices
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Below market purchase price
Above the incremental and opportunity costs
of the selling unit
If negotiation fails

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Managers can purchase on the market
Arbitration by top management
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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in
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Dual Pricing
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Seller transfers at market or negotiated price
Buyer records transfer at cost-based amount
Eliminates need to divide profits artificially
Provides relevant information for decision
making and performance evaluation
Requires internal reconciliation
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Advantages and Disadvantages of
Transfer Pricing Systems
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Advantages
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Permit evaluation of
segment performance
Allow for rational acquisition
of goods and services
between corporate divisions
Provide flexibility to respond
to changes
Encourage and reward goal
congruence

Disadvantages
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May cause disagreement
among managers
Adds costs and takes time
May not work for all
departments
May cause underutilization
or overutilization of services
May cause dysfunctional
organizational behavior
Causes a need for year-end
entries to eliminate transfer
prices
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Multinational Transfer Pricing
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Differences in

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Tax systems
Customs duties
Freight and insurance costs
Import/export regulations
Foreign-exchange controls

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Develop guidelines that are
followed on a consistent
basis
Set transfer prices that
reflect an arm’s-length
transaction
Be prepared for transfer
pricing audits
Consider Advance Pricing
Agreements—binding
contracts between a
company and taxing
authorities that set an
acceptable transfer pricing
methodology
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Transfer Pricing Audit
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Multinational Transfer Pricing
Objectives

Internal

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Better goal congruence
Better performance
evaluations
More motivated
managers
Better cash management

External




Less taxes and tariffs
Less foreign exchange
risks
Better competitive
positions
Better relations with
government
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Questions



What are some advantages and
disadvantages of decentralization?
What are the four types of responsibility
centers?
Why are transfer prices used?
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a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Potential Ethical Issues
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Managers who make decisions to benefit
themselves but not always the firm
Burying important details in responsibility reports
Allocating costs using “ability-to-bear” criterion
Shifting support department costs to inappropriate
departments
Not allowing managers to buy or sell externally in a
transfer pricing situation
Using transfer pricing to shift costs to low- or no-tax
locations
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in
a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.