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Management Control Systems, Transfer Pricing, and Multinational Considerations. Chapter 22. Overview. What is a Management Control System? Centralized vs. decentralized control structure Transfer pricing: Function Setting TPs Dual TPs Negotiated TPs (Calculating Min. & Max. range)

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management control systems transfer pricing and multinational considerations

Management Control Systems,Transfer Pricing, andMultinational Considerations


  • What is a Management Control System?
  • Centralized vs. decentralized control structure
  • Transfer pricing:
    • Function
    • Setting TPs
    • Dual TPs
    • Negotiated TPs (Calculating Min. & Max. range)
    • International tax issues
management control systems
Management Control Systems

A management control system is a means

of gathering and using information.

It guides the behavior of managers and employees.

management control systems1
Management Control Systems

Financial data

Nonfinancial data

Formal control system

Informal control system

evaluating management control systems
Evaluating ManagementControl Systems



Goal congruence

Lead to rewards



organization control structure
Organization (control) Structure

Total decentralization

Total centralization

benefits of decentralization
Benefits of Decentralization

Creates greater responsiveness to local needs

Leads to gains from quicker decision making

Increases motivation of subunit managers

Assists management development and learning

Sharpens the focus of subunit managers

limitations of decentralization
Limitations of Decentralization

Suboptimal decision making may occur

Focuses the manager’s attention on the subunit

rather than the organization as a whole

Increases the costs of gathering information

Results in duplication of activities

decentralization in multinational companies
Decentralization inMultinational Companies

Decentralization enables country managers to

make decisions that exploit their knowledge

of local business and political conditions.

Multinational corporations often rotate

managers between foreign locations

and corporate headquarters.

Control Problem: Barings Bank (200 yrs old)—1995 Nick Leeson caused over ₤1 B loss.

responsibility centers
Responsibility Centers









transfer pricing
Transfer Pricing

A transfer price is the price one subunit charges

for a product or service supplied to another

subunit of the same organization.

Intermediate products are the products

transferred between subunits of an organization.

transfer pricing1
Transfer Pricing

Transfer pricing should: (1) help achieve

a company’s strategies and goals.

(2) fit the organization’s structure

(3) promote goal congruence

(4) promote a sustained high level

of management effort

transfer pricing methods
Transfer-Pricing Methods

Market-based transfer prices

Cost-based transfer prices

Negotiated transfer prices

market based transfer prices
Market-Based Transfer Prices

By using market-based transfer prices

in a perfectly competitive market, a

company can achieve the following:

Goal congruence

Management effort

Subunit performance evaluation

Subunit autonomy

market based transfer prices1
Market-Based Transfer Prices

Market prices also serve to evaluate the

economic viability and profitability

of divisions individually.

market based transfer prices2
Market-Based Transfer Prices

When supply outstrips demand, market prices

may drop well below their historical average.

Distress prices are the drop in prices

expected to be temporary.

Basing transfer prices on depressed market prices will not always lead to optimal decisions for an organization.

cost based transfer prices
Cost-based Transfer Prices

When transfer prices are

based on full cost plus a

markup, suboptimal

decisions can result.

dual transfer prices
Dual Transfer Prices

An example of dual pricing is for Larry & Co.

to credit the Selling Division with

112% of the full cost transfer price of $24.64

per barrel of crude oil.

Debit the Buying Division with the market-based

transfer price of $23 per barrel of crude oil.

And debit a corporate account for the difference!

negotiated transfer prices
Negotiated Transfer Prices

Negotiated transfer prices arise from the

outcome of a bargaining process between

selling and buying divisions.

general guideline min max transfer price
General Guideline: min. & max. transfer price

Maximum transfer price = Market price

Minimum transfer price

= Incremental costs per unit incurred

up to the point of transfer

+ Opportunity costs per unit to the selling division

Incremental cost often times = variable cost

Opportunity costs often times = lost CM

Opportunity costs could = lost savings

min max transfer price examples
Min. & Max. transfer price--examples

Some examples:

(1) Slowcar

(2) S.F. Manufacturing

slowcar company
Slowcar Company
  • The Assembly Division of SLOWCAR Company has offered to purchase 90,000 batteries from the Electrical Division (ED) for $104 per unit. At a normal volume of 250,000 batteries per year, production costs per battery are:
  • Direct materials $40
  • Direct labor 20
  • Variable factory overhead 12
  • Fixed factory overhead 42
  • Total $114
  • The Electrical Division has been selling 250,000 batteries per year to outside buyers for $136 each. Capacity is 350,000 batteries/year. The Assembly Division has been buying batteries from outside suppliers for $130 each.
  • Should the Electrical Division manager accept the offer? Will an internal transfer be of any benefit to the company?
sf manufacturing
SF Manufacturing
  • The SF Manufacturing Co. has two divisions in Iowa, the Supply Division and the BUY Division. Currently, the BUY Division buys a part (3,000 units) from Supply for $12.00 per unit. Supply wants to increase the price to BUY to $15.00. The controller of BUY claims that she cannot afford to go that high, as it will decrease the division’s profit to near zero. BUY can purchase the part from an outside supplier for $14.00. The cost figures for Supply are:
  • Direct Materials$3.25
  • Direct Labor4.75
  • Variable Overhead0.60
  • Fixed Overhead1.20
  • A. If Supply ceases to produce the parts for BUY, it will be able to avoid one-third of the fixed MOH. Supply has no alternative uses for its facilities. Should BUY continue to get the units from Supply or start to purchase the units from the outside supplier? (From the standpoint of SF as a whole).
  • (What is the min. & max. transfer price if BUY and SUPPLY negotiate?)
sf mfg continued
SF Mfg.—continued
  • Now, assume that Supply could use the facilities currently used to produce the 3,000 units for BUY to make 5,000 units of a different product. The new product will sell for $16.00 and has the following costs:
  • Direct Materials$3.00
  • Direct Labor4.30
  • Variable Overhead5.40
  • B. What is the min. & max. transfer price if BUY and SUPPLY negotiate?
  • C. What should be done from the company’s point of view? Why?
comparison of methods
Comparison of Methods

Achieves Goal Congruence

Market Price:

Yes, if markets competitive


Often, but not always



comparison of methods1
Comparison of Methods

Useful for Evaluating Subunit Performance

Market Price:

Yes, if markets competitive


Difficult, unless transfer

price exceeds full cost



comparison of methods2
Comparison of Methods

Motivates Management Effort

Market Price:



Yes, if based on budgeted

costs; less incentive if

based on actual cost



comparison of methods3
Comparison of Methods

Preserves Subunit Autonomy

Market Price:

Yes, if markets competitive


No, it is rule based



comparison of methods4
Comparison of Methods

Other Factors

Market Price:

No market may exist


Useful for determining

full-cost; easy to implement


Bargaining takes time and

may need to be reviewed

multinational transfer pricing
Multinational Transfer Pricing

IRC Section 482 requires that transfer prices for both tangible and intangible property between a company and its foreign division be set to equal the price that would be charged by an unrelated third party in a comparable transaction (arm’s length).

This still leaves a little “room to wiggle.”