Advanced Management Accounting - Transfer Pricing and Balance Scorecard for a Hotel Chain - Essay Example

Table of Figures

Chart 1: Transfer pricing methods for decentralized organizations7

Table 2: Hotel's visions and objectives10

Table 3: Financial targets and initiatives11

Table 4: Guest perspective targets and initiatives12

Table 5: Employee management targets and initiatives13

Table 6: Innovation initiatives and targets14

Chart 7: Combined Balanced Scorecard for the Hotel Chain14

Part A

A System of Transfer Pricing Is Often Used By Decentralized Organization

Introduction

Decentralized organizations feature subunits that operate as separate entities. Each unit becomes a responsibility centre, which includes cost, profit, revenue, and investments outlets. The management of responsibility centres requires evaluation based on various accounting numbers. The organizations use transfer prices to help the subunits make proper coordination of products bought or sold to other divisions (Bhimani et al., 2015, p.565). The establishments require transfer prices for optimal coordination, profit allocation, and elimination of conflicting objectives. The firms can use market-based, cost-based, or negotiated transfer pricing method but the system may evoke practical and commercial issues.

Why Decentralized Organizations Require Transfer Prices

Coordination Function

An appropriate choice of transfer prices improves coordination of production, sales, and pricing of different divisions. A divisional manager becomes aware of the value of the products or services in other segments of the organization. Consequently, the manager undertakes any necessary revision of production or sales units to ensure that the performance and overall value of the products are in line with the set standards. According to Bhimani et al. (2015, p.566), managers coordinate efforts to utilize resources injected in the divisions to maximize their profits. While the decisions of each division may give rise to externalities, transfer prices provide a view for assessing the company. Managers further utilize transfer prices to determine the extent their divisions are favourable or profitable from the perspective of another unit.

Profit Allocation Purposes

Decentralized organizations require transfer prices for profit allocation purposes (Scarlett, 2008). The determination of profits for each division comes in handy in linking performances between subunits. Managers use transfer price as an internal revenue of the supplying unit and as an internal purchasing fee of the buying division. The divisional profits generated from the decisions forms a basis for budget allocation among other strategic activities carried out by the company’s upper management. The profit distribution of each division requires apparent determination alongside responsibilities, cost awareness and transparency, which further facilitates performance assessment (Schuster, 2015, p.10). The results of the performance evaluation define allocation of divisional profits. However, accurate demarcation of success component for each unit is critical to avoid issues of interweaving between related divisions.

Resolving Conflicts of Objectives

Transfer prices help to eliminate the conflict of objectives between profit allocation and coordination or any other two functions (Schuster, 2015, p.12). Divisions come up with competitive transfer prices, which perform diverse functions for example, tax-determination. Having a system of transfer prices that performs a separate function ensures that a division achieves performance standards efficiently but it results in conflicts. In addition, transfer prices shape the strategic decisions that determine divisional profits, but it may result in conflicting reactions in the coordination and control systems. Decentralized organizations come up with one transfer price to balance the effects of the varied transfer prices, which perform respective functions in different divisions. The companies employ different general methods of transfer pricing to promote performance, which includes market-based, negotiated, and cost-based transfer pricing.

General Methods Used In Transfer Pricing

Market-Based Transfer Pricing

Decentralized organizations use transfer price as an external market price to respond to competitive and established external markets for the transferred products or service (Drury, 2008, p.503). Devising a transfer pricing policy for a firm is critical in the external markets because it defines the sourcing rules for the divisions. The principal role of the upper management is to select a price befitting the prevailing prices listed on a trade association website or any other source with public price listings. Saudagaran (2009, p.135) argues that the essence of market-based transfer prices is to ensure that internal and external prices align with charges that customers find in the market.

However, market-based transfer pricing may distort revenue expectations when the external market is neither competitive nor stable. According to Emmanuel, Otley and Merchant (2013, p.428), such instances may result in distorted internal decision making for companies that rely on market-based transfer prices. Therefore, a decentralized organization must be aware of competitors selling at distress prices or employing on special pricing strategies such as price discrimination. Additionally, market prices may distort the protection of an infant division.

Negotiated Transfer Pricing

Divisions can negotiate their own transfer price, which subsequently, shapes the decisions for internal buying or selling, and dealing with the external parties (Weygandt, Kieso, and Kimmel, 2010). Negotiated transfer pricing prompts subunits to consider costs and market prices, but they may not have any significance in the transfer prices chosen ultimately. Divisions negotiate transfer prices when the market has high price volatility and experiences constant changes. The bargaining process of selling and buying between subunits gives rise to the negotiated transfer prices. The divisional managers must make optimal decisions based on the established transfer price to align with the standards of the entire organization. Competitive prices do not affect negotiated transfer pricing when compared to market-based transfer pricing.

Cost-Based Transfer Pricing

The costs of production of the upstream division may determine transfer prices. The upper management chooses actual or budgeted costs to establish the definite transfer pricing (Bhimani et al., 2015, p.566). Conversely, companies choose full or variable costs and the amount of markup, which may maximize profit generation of the transferred product. According to Adams and Drtina (2008, p.412), divisional managers use cost-based transfer pricing to sustain the alignment between managerial incentives and the corporate goals. However, a subunit must eliminate the occurrence of the capacity constraints between upstream and downstream divisions to avoid displacing sales. Additionally, practical and commercial issues may arise from a system of transfer pricing.

Chart 1: Transfer pricing methods for decentralized organizations

Practical and Commercial Issues from a System of Transfer Pricing

A decentralized organization with multiple transfer-pricing structures may face practical difficulties in identifying the suitable accounting records. Tax authority requires correct financial disclosures while the company made need a different set to facilitate internal management reporting. According to Bhimani et al. (2015, p.576), tax authorities misconstrue instances where organizations keep separate accounting records. The authorities interpret the records as means for manipulating reported taxable profits to evade tax payment.

Sometimes companies may face issues adjusting the prices of the transferred products to align with the tariffs and customs duties. The problem occurs for multinationals importing goods to a country, which leads to problems of income tax considerations (Clausing, 2009). A company must have proper incentives to lower the transfer prices to decrease the tariffs and duties levied on the products. Such difficulties may impair the projected profits despite an organization incurring additional costs related to time and the labor employed to execute the transfer pricing systems.

Unethical transfer pricing is a commercial issue among multinationals who understand the impact of global tax liabilities on profitability, operations, and overall management control systems (Sikka and Willmott, 2010). Some MNCs resort to transfer mispricing when they are undertaking a trade with unrelated parties. Foreign firms take advantage of developing countries without robust tax regimes, which leads to loss of tax revenues due to the unethical conduct. McGee (2010, p.25) argues that the losses may contribute to the impoverishment in developing and developed economies if not controlled.

Conclusion

A system of transfer pricing is an integral component of a decentralized organization. The companies require transfer prices to prevent conflict of objectives, allocate profits to divisions, and coordinate production in the subunits. The firms employ market-based, cost-based, and negotiated transfer pricing to help in profit maximization. However, practical and commercial concerns may arise from the transfer pricing system. An organization may find it difficult to maintain necessary accounting records to avoid frictions with tax authorities. Some MNCs use illegal transfer pricing to evade tax to maintain operational and profit maximization efficiencies. Adjusting transfer prices to align with tariffs and duties of a foreign country may evoke accounting issues.

Part B

Balance Scorecard (BSC) for a Hotel

The design, development, and outline of the BSC will attempt to create a balance between financial and non-financial measures the hotel chain. The measures drive short-term and long-term performance of any established organization (Broadbent and Cullen, 2012). The BSC will entail management strategy, which will have four different perspectives namely, guest, internal orientation process, financial, and innovation perspectives. Each perspective will have set objectives that will enable the management to measure, target or design initiatives in response to the specific performance standards. Evaluation of any business unit and stakeholder’s issues in a hotel chain increases the performance in the dynamic hotel industry. Therefore, the BSC will consider the internal and external organs to create an all-inclusive framework.

Visions and Objectives

The BSC for the hotel will seek to reinforce internal and external behavior to be in consistent with the pursuit of the hotel’s strategic objectives. According to Guilding (2014, p.214), the sensitivity of performance measures to failure requires consideration of concerns at each organization level. Therefore, the BSC vision and objectives will be the anchor for the four perspectives identified namely, guest, financial, internal orientation process, innovation perspectives. The framework will take a 360-degree view of the hotel chain. The components will encompass all the relevant management concerns at each hotel management level. Other objectives that BSC will encompass include:

Table 2: Hotel's visions and objectives

• To realize profitability by improving services on continuous basis

• To react promptly to the changes in the hospitality market and guest needs while maintaining constant awareness of the rivals

• To provide a distinguishing service to align with the value for money for the guests

• To create a platform for developing knowledge and skills for the employee as a way of advancing their careers in the hospitality industry

Financial Perspective

The financial perspective will focus on profitability, revenue sources, decreasing costs while optimizing resources, guest value proposition, and sustaining productivity growth. The focus of any hotel chain is exploiting the space available to maximize financial performance (Chen, Hsu, and Tzeng, 2011). Revenue and cost per room will be a financial metric that will determine the measurement of growth. Hospitality organizations aim at increasing guest value proposition considering that they determine all the internal and external operations (Tesone, 2010). Therefore, the BSC will have a strong orientation towards the financials to help in the management of revenues and costs related from rooms, food, and beverage sections. A BSC with a financial perspective enables hotel managers to take necessary actions to sustain growth and achieve competitive advantage. Therefore, the management of the hotel chain will use the BSC as an effective performance evaluation framework. The financial perspective will comprise of the following targets, and initiatives:

Table 3: Financial targets and initiatives

• Improve current profitability levels by monitoring productivity and revenue growth

• Sustain customer value proposition by conducting regular audit on satisfaction levels

• Minimizing costs through resource maximization

• Developing new hospitality products and resources in line with the market trends

The hotel will utilize lagging indicators namely service cost per room and average room rate, which Chi and Gursoy (2009) acknowledge as effective tools for measuring strategic financial objectives.

Guest Perspective

Guests are important components of long-term hotel management. The BSC will pursue guest satisfaction as a long-term and holistic perspective. Guest satisfaction and loyalty will be the key elements of the framework, because in accordance with Ramanathan and Ramanathan (2011), findings in UK hotel industry they shape revenues and room occupancy rates. In addition, the BSC will focus on the various partners of the hotel who contribute to the growth of the organization. Hotels guests generate high profitability when the management concentrates on increasing their value and responding to their needs (Han and Ryu, 2009). Conversely, achieve win-win partner relations is the foundation for a successful hospitality organization because it reinforces the pursuit of objectives despite the increasing fragmentation in the industry. Achieving strong partnerships with the government, hotels, and restaurateurs will reinforce the financial objectives of the hotel. In addition, the inevitable link between the products or the services offered to the hotel guests and revenue as well costs enables a hospitality institution to forge essential relationships. Guided by the essential role of the guests, the guest perspective will entail the following targets and initiatives:

Table 4: Guest perspective targets and initiatives

• To provide competitive room, food, and beverage prices

• To achieve optimal room quality and excellence

• To establish and retain valuable guests and partners

• Improve the overall brand of the hotel chain

The hotel will monitor booking website score, room excellence, and reviews on popular social media sites, which are feasible lagging metrics in the current hospitality market.

Internal Orientation Perspective

The BSC will focus on employee management considering their integral role in the internal processes of any establishment. The nature of any hotel product such as rooms requires the optimal presence or participation of an employee (Kusluvan et al., 2010). The predominant nature of the human capital in the provision of quality hotel services cements the role of the employees in the hospitality industry. From a guests’ standpoint, employees determine the extent a hotel institution generates reviews, satisfaction levels, and booking levels (Tarí et al., 2010). The current market calls for well-educated employees to achieve the desired quality in the dynamic hospitality market. Evidently, employee management has sustainable implications at organizational and industry level. The BSC will take into account, the measures, competencies, development, and service delivery plans. In addition, the framework will treat workers as an asset of the hotel chain. The internal operations will encompass the following targets and initiatives:

Table 5: Employee management targets and initiatives

• To engage employees to streamline room and restaurant operations

• To achieve quality standards in the revenue centers

• To develop skills and competencies of the employees at organizational levels

The lagging indicators will include a survey on customer retention rates, feedback, and employee satisfaction rates. Supervisors will monitor trends on the website among other online outlets to gain insights on how to streamline employee management.

Innovation Perspective

The BSC will take into account the development of the hospitality industry in the past and future, which will determine performance and the overall need for quality. Any hotel chain with a strategic vision must consider constant transformation, and re-engineering of the departments of production as well as service to sustain quality hotel experiences (Theodosiou and Katsikea, 2012). On the other hand, gaining competitive advantage entails constant product development so that the outcomes align with the relevance and necessity in the hospitality industry (Law, Leung, and Buhalis, 2009). The ability to sustain economic and social progress in the ever-changing hospitality industry will be a key foundation for the hotel chain strategic vision. The BSC will consider new technologies particularly the in e-hospitality sector, revamping the websites, and implementing technologies, which increase room as well as restaurant excellence. The technologies will focus on rejuvenating the current effort in the hotel chain. The innovation perspective will pursue the following targets and initiatives:

Table 6: Innovation initiatives and targets

• To use relevant innovation to achieve high-quality service

• To streamline internal operations in the revenue centers

• To facilitate acquisition of the competitive technologies to edge out rivalry

The lagging indicators or measures will include tracking website bookings, customer feedback, the rate of operational excellence and making comparisons with the prevailing trends in the industry.

The following chart summarizes the BSC for the hotel chain:

Chart 7: Combined Balanced Scorecard for the Hotel Chain