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Curriculum Center Browse Bibliography Build EPacket Pricing Structure Distribution Process Management Control in Nonprofit Organizations
 
Note on Transfer Pricing
Author(s):
Young, David W.
Functional Area(s):
   General Management
   Management Control Systems
Setting(s):
   For Profit
   Nonprofit
Difficulty Level: Beginner
Pages: 9
Teaching Note: Not Available. 
Copyright Clearance Fee:  $9.00  Sign in to find out if you are eligible for an Academic Price of $5.00 
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First Page and the Assignment Questions:
    The concepts of “fairness” and “goal congruence” are important elements in the design of a good responsibility accounting structure. Fairness holds that if a manager is to be held responsible for certain financial items (revenues or expenses), he or she should have a reasonable ability to control them. Goal congruence is the idea aligning the goals of managers of individual responsibility centers with the goals of the organization as a whole. The term is borrowed from social psychology, and is an important consideration in designing a management control system. A lack of goal congruence ordinarily can be seen in the form of dysfunctional behavior on the part of responsibility center managers, i.e., behavior that is not in the best interests of the organization as a whole. Its presence, or an absence of fairness, ordinarily means that some changes are needed in the nature of the organization’s responsibility centers.

     One of the most common areas where there is a lack of either fairness or goal congruence—or both—is with transfer prices. Specifically, if a management control structure contains several responsibility centers that are not completely independent of each other, they almost certainly will engage in “buying and selling” transactions among themselves. As a result, the prices at which these transactions take place—the transfer prices— become important elements of the management control structure.

FAIRNESS PROBLEMS

    To illustrate how transfer prices can affect fairness in a responsibility accounting system, let’s begin with a relative simple but quite common situation.
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Problem: The department chairs in a school of management were being strongly encouraged to have their faculty use the school’s copy center for the reproduction of research papers and other copying needs. At a meeting of the department chairs, one chair reported that the cost of making 100 copies of a research paper was $20 more using the school’s copy center than it would have been if the work were done at a private copy center located about one block from the department’s offices. This kind of situation happened several times a week in each department, totaling many thousands of dollars a year. The school’s copy center had prepared a detailed breakdown of its costs for the above research paper:

    Direct materials                    $ 90
    Direct labor                               25
    Variable overhead        2
    Fixed overhead           17         19    
    Total costs                            $134
    Markup                                      13
    Price                                       $147

    The private copy center did work that was both of equal quality and speed as the school’s copy center. It had informed the chair that it would have charged $127 for the above job. The chairs knew that the school’s copy center had the capacity to produce about 300,000 copies a week, but was operating at a level of only about 250,000 a week.

    What is the lowest price that the school’s copy center should charge for this job? What is the highest price that the department should pay? What should be done about the schools transfer pricing policy for its copy center? Write your answers on the next page.


Lowest price to charge

Highest price to pay

Changes to school’s policy: