Chương I:

Chapter 5
Chuẩn
Financial mực và
Responsibility
tiêu Centers
chuẩn trong
kiểm toán hoạt động

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 Learning outcomes
5.1. Advantages of financial results control systems

5.2. Types of financial responsibility centers

5.3. Choice of financial responsibility centers

5.4. Transfer pricing problem

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 Objectives

After studying this chapter, you should be able to:

1. Understand the advantages of financial results control systems.

2. Understand the general nature of analytical procedures discusses in

depth one important element of these systems: financial
responsibility centers.

3. Describes one common problem faced by organizations using

multiple financial responsibility centers: the transfer pricing
problem.
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 Financial results controls ...

❖ Three core elements:

▪ Financial responsibility centers
• The apportioning of accountability for financial
results within the organization.

▪ Formal management processes (planning & budgeting)

• To define performance expectations and
standards for evaluating performance.
▪ Motivational contracts
• To define the links between results and various
organizational incentives.

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 5.1. Advantages of financial
results controls systems
❖ The ubiquity of financial results control systems in
organizations
▪ financial objectives are paramount in for-profit firms
▪ financial measures provide a summary measure of
performance
▪ most financial measures are relatively precise and objective
▪ the cost of implementing financial results controls is often
small relative to that of other forms of management control

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 5.2. Types of financial
responsibility centers

❖ Financial responsibility centers are a core element

of a financial results control system

❖ Financial responsibility centers are responsibility

centers in which the assigned responsibilities are
defined at least partially in financial terms

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 Types of financial responsibility
centers...
❖ Responsibility center ...
▪ Organization unit that is headed by a responsible manager;
▪ It denotes the apportioning of responsibility for a particular
set of inputs and/or outputs to an organization unit.
❖ Responsibilities can be expressed in terms of ...
▪ Physical units of outputs;
▪ Particular characteristics of the services provided;
• e.g., schedule attainment, customer satisfaction, etc.
▪ Quantities of inputs consumed;
▪ Financial indicators of sets of performance in these areas.
❖ Financial responsibility centers ...
▪ Responsibility centers in which the manager's responsibilities
are defined at least partially in financial terms.

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 Types of financial
responsibility centers...

❖ There are four basic types of financial responsibility

centers:
▪ investment centers,

▪ profit centers,

▪ revenue centers, and

▪ cost centers

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Types of financial responsibility centers...

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 Revenue centers ...
Managers of revenue centers are held accountable for generating
revenues, which is a financial measure of outputs.
– e.g., Sales departments in commercial organizations;
– e.g., Fundraising managers in not-for-profit organizations.

No formal attempt is made to relate inputs (measured as expenses) to

outputs.
– However, most revenue center managers are also held
accountable
for some expenses (e.g., salespeople's salaries and
commissions);
– But, still they are not profit centers because:
» These costs are only a tiny fraction of the revenues generated;
» Revenue centers are not charged for the costs of the goods
they sell. - 10 -
 Expense centers ...
Managers of expense (cost) centers are held accountable
for expenses, which are a financial measure of the inputs
consumed by the responsibility center.
Two types:
– Standard cost centers or engineered expense centers
» Inputs can be measured in monetary terms;
» Outputs can be measured in physical terms; and,
» Causal relationship between inputs-outputs is direct / stable;
e.g., manufacturing departments, but also, warehousing,
distribution, personnel administration, catering.
– Managed cost centers or discretionary expense centers
» Outputs produced are difficult to measure; and,
» Relationship between inputs-outputs is not well known;
e.g., R&D, PR, HR, marketing activities. - 11 -
 Control in expense centers ...
Engineered expense centers
– Standard cost vs. actual cost
» i.e., the cost of inputs that should have been consumed in
producing the output vs. the cost that was actually incurred.
– Additional controls
» Volume produced; quality; training; etc.

Discretionary expense centers

– Ensuring that managers adhere to the budgeted level of expenditures
while successfully accomplishing the tasks of their center.
– Subjective, non-financial controls
» e.g., quality of service as perceived / evaluated by users.
– Personnel controls
– Tools: benchmarking

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 Profit centers ...
Managers of profit centers are held accountable for generating
profits, which is a financial measure of the difference between
revenues and costs.
– As a measure of performance, profit is ...
» Comprehensive
i.e., it incorporates many aspects of performance;
» Unobtrusive
i.e., the profit center manager makes the revenue/cost
tradeoffs.
Main question / problem in practice:
– Has the manager significant influence over both revenues and
costs?
» Charge standard cost of goods sold to sales-focused entities;
» Assign revenues to cost-focused entities;
» Pseudo profit centers. - 13 -
 Investment centers ...
Managers of investment centers are held accountable
for
the accounting returns (profits) on the investment
made
to generate those returns.
– Measures: ROI, ROE, ROCE, RONA, etc.

In fact, managers have two performance objectives:

– Generate maximum profits from the resources at
their disposal;
– Invest in additional resources only when such an
investment will produce an adequate return.

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 Measuring profitability ...
Gross margin center managers may be salespeople
who sell products of varying margins and who are
charged with the standard cost of the goods they sell
The incomplete profit center managers may be
managers of product divisions but without authority
for all of the functions that affect the success of their
products or product lines, such as research and
development or advertising.
Complete profit center managers may be business unit
managers who are accountable for all aspects of the
worldwide performance of their business segment.

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 Measuring profitability ...

Gross Incomplete Before-tax Complete

Margin Profit Profit Profit
Center Center Center Center

Revenue ⚫ ⚫ ⚫ ⚫
Cost of goods sold ⚫ ⚫ ⚫ ⚫
Gross margin ⚫ ⚫ ⚫ ⚫
Advertising + promotion ⚫ ⚫ ⚫
Research + development ⚫ ⚫
Profit before tax ⚫ ⚫
Income tax ⚫
Profit after tax ⚫

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 5.3. Choices of financial
responsibility centers
❖ The lines between the financial responsibility center
types are not always easy to discern, so responsibility
center labels are not always informative
❖ The decisions that have to be made in designing
financial responsibility structures.
▪ The important question to answer is:
• Which managers should be held accountable for which specific
financial statement line items?

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 Choices of financial
responsibility centers...

❖Firms’ financial responsibility center structures

are coincident with the managers’ areas of
authority
▪ Areas of authority are defined by organization structures
and policies that define managers’ decision rights

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 Choices of
financial responsibility centers...

- 19 -
 Choices of
financial responsibility centers...

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 Choices of financial
responsibility centers...

❖ Specific strategic concerns sometimes also affect the

choice of responsibility center structure.

❖ Some strategies might even suggest that managers not

be held accountable for line items over which they clearly
have influence

❖ As business models change, so should responsibility

center structures

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 5.4. THE TRANSFER PRICING
PROBLEM

❖ Transfer prices directly affect the revenues of the selling

(supplying) profit center, the costs of the buying
(receiving) profit center and, consequently, the profits of
both entities, thus essentially making transfer prices
subject to “zero-sum” considerations

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 Purpose of transfer pricing

❖ Transfer prices have multiple organizational purposes

▪ to provide the proper economic signals so that the
managers affected will make good decisions

▪ provide information that is useful for evaluating the

performances of both the profit centers and their
managers

▪ transfer prices can be set to purposely move profits

between firm locations
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 Purpose of transfer pricing...

❖ Multiple transfer pricing purposes often conflict

▪ No single transfer pricing method serves all the purposes well.

▪ The usual desire to have transfer pricing mechanisms operate

automatically between entities, without frequent interventions from
corporate management, provides another transfer pricing complication

▪ Transfer pricing interventions undermine the benefits of decentralization

• They reduce profit center (entity) autonomy and cause decision-

making complexity and delay

• They also increase organizational costs

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 Transfer pricing alternatives

❖ Five primary types of transfer prices

▪ based on market prices
▪ based on marginal costs
▪ based on the full costs of providing the product or
service
▪ full cost plus a markup
▪ negotiated between the managers of the selling and
buying profit centers

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 Transfer pricing alternatives...

❖ Market-based transfer prices

▪ In the relatively rare situation where a perfectly (or at least
highly) competitive external market exists for internally
traded goods or services, it is optimal for both decision-
making and performance evaluation purposes to set
transfer prices at competitive market prices
• A perfectly competitive market exists where the product is
homogenous and no individual buyer or seller can unilaterally
affect its price.
▪ The case for using market-based transfer prices under
competitive conditions is apparent.
▪ many firms use quasi market-based transfer prices by
allowing deviations from the observed market prices
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 Transfer pricing alternatives...

❖ Marginal-cost transfer prices

▪ The total contribution is simply equal to the selling
price of the final product or service minus the marginal
cost of the last production or service process stage
▪ Companies rarely use marginal-cost transfers
▪ Marginal-cost transfer prices also are sometimes
difficult to implement

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 Transfer pricing alternatives...

❖ Full-cost transfer prices

▪ Full cost rarely reflects the actual, cur- rent cost of
producing the products or the services being transferred
▪ Transfers at full cost or full cost plus a markup are more
widely used
▪ Full-cost transfer prices offer several advantages
• provide a measure of long-run viability
• easy to implement because firms have systems in place to calculate
the full costs of production (goods) or provision (services)
• not as distorting for evaluation purposes since the selling profit
center is allowed to recover at least the full cost of production or
provision.

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 Transfer pricing alternatives...

❖ Full cost plus a markup

▪ do allow the selling profit centers to earn a profit on
internally transferred products or services
▪ provide a crude approximation of the market price that
can be used in situations where no competitive
external market price exists
▪ such transfer prices are not responsive to changes in
mar- ket conditions.

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 Transfer pricing alternatives...

❖ Negotiated Transfer Prices

▪ to allow the selling and buying profit center managers to
negotiate between themselves
▪ negotiated transfer prices often cause several other
problems
• Costly in terms of management time
• The outcome of the negotiations often depends on the negotiating
skills and bargaining power of the managers involved, rather than
its likely being economically optimal
• If one of the entities has reasonably good outside selling or
sourcing possibilities but the other does not, the bargaining power
will be unequal

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 Transfer pricing alternatives...

❖ Variations
▪ Several variations of one or more of the primary transfer
pricing methods
▪ 2 popular types
• One possibility is to transfer at marginal costs plus a fixed
lump-sum fee
• Dual-rate transfer prices

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 Transfer pricing alternatives...

❖ Variations
▪ One possibility is to transfer at marginal costs plus a fixed
lump-sum fee
• The lump-sum fee is designed to compensate the selling profit
center for tying up some of its fixed capacity for producing products
that are transferred internally
• The major problem with the marginal-cost-plus-lump-sum
method is that the managers involved must predetermine the
lump-sum fee based on an estimate of the capacity that each
internal customer will require in the forthcoming period

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 Transfer pricing alternatives...

❖ Variations
▪ Dual-rate transfer prices
• The selling profit center is credited with the market price (or
an approximation of it), but the buying profit center pays only
the marginal (or full) costs of production
• Two basic advantages
– the managers of both the selling and buying profit centers receive the
proper economic signals for their decision-making
– ensures that internal transactions will take place, making it possible to
maintain a vertically integrated production process
• Disadvantages
– destroy the internal entities’ proper economic incentives
– difficult to explain to the profit center managers how the double
counting has overstated their entity profits

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 Transfer pricing alternatives...

❖ Simultaneous use of multiple transfer pricing

methods
▪ use multiple transfer pricing methods at the same
time
▪ use one method for internal purposes – both
decision-making and evaluation – and another
method to affect taxable profits across jurisdictions
• Not accepted in some countries
▪ laws often require an arm’s-length transfer price;
• a price charged to the associated entity as the one
between unrelated parties for the same transactions
under the same circumstances

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