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>> Okay.
Today's lecture is called Responsibility Accounting
and Decentralized Operations.
I mean, we've got a couple of topics at the tail end,
about the balance score card and transfer pricing.
But these first two are our main topics here.
Companies can be very centralized.
They can be very decentralized and anywhere in between.
Most companies have an organization chart that looks like a triangle.
I didn't put it on the top here, but you would see on the top,
especially of publicly-held companies, Board of Directors.
They'd be at the top of the triangle because they're the ones who make all the long term,
what we call "strategic decisions", in terms of the path the company is going to take,
what they're trying to accomplish, their mission statement.
And they can also hire and fire top-level management,
including the Chief Executive Officer who's at the tip of the organizational chart.
Okay, now, in a centralized operation, you see many layers of management.
And in a centralized operation, all big decisions and some
of the not-as-big decisions will be made towards the top.
Okay?
You have to run it up the chain of command, as they say.
Whereas in a decentralized operation, it's a flatter organization chart.
You have less layers of management.
And that's because they've delegated responsibility
and decision-making to lower levels of management.
Now, when you have a decentralized operation, there's greater risk involved,
because you have more people who are now making decisions on utilization of resources
--
money, purchasing, investing in equipment, that type of thing.
So when you decentralize, you need to make sure
that the people you are delegating authority
to have been properly trained and have demonstrated the ability
for sound decision making and that they can handle an increased level of responsibility.
Okay, so there is risk involved in decentralizing,
because more people are making decisions, but overall, companies that do a good job
of decentralizing, have several advantages.
Let's just take a look at the slide.
Some of the advantages of decentralization --
it says, notice, it allows managers closest
to the operations to make decisions.
That means you can turn quicker.
You can make decisions based on market data, customer feedback, competition
and you're not waiting to hear back from headquarters,
which may be in a different city or a different country.
So you can move faster.
And that's really important.
It provides excellent training for managers.
It allows them to become experts because they're allowed to make decisions
and they fully invest in the operation.
It helps retain good quality people.
Good quality people want to take on the challenge of more management authority.
They want to make more money.
They want to feel like they're part of it.
Okay?
It improves creativity, customer relations, because you can respond quicker
to customers and very few organizations have one
person who comes up with all the creative ideas.
The more people involved, the more variety, and you're just going to have better creativity
and better problem-solving when you have good quality people
who are able to make those decisions.
A couple of disadvantages of decentralization is that, depending upon how you reward managers,
you could create something called goal conflict.
Okay, and we talked about this in a previous lecture.
Decisions made by managers may negatively affect the profits of the company.
For example, if you simply define sales commissions based on sales, without saying,
"Yeah, but they have to be to qualified customers who then will pay us."
So if you just say -- you make a sale, you get
a commission, they're going to go out there
and they're going to run up the sales, but if they're not qualifying them
as being creditworthy, then you may not convert to cash and ultimately,
your cash flow will suffer and so that's a problem
for the accounting department and the overall business.
Another example we talked about was, if you cut the budget of your tech support team --
for example, their phone budget -- the quality of tech support is going to go down
and that's going to hurt your overall business.
So companies have to be mindful of this and set
goals, in terms of performance compensation,
make sure they're carefully measuring it so it doesn't create this goal conflict.
Okay?
And there's some inevitable duplication of assets, procedures,
resources, when you delegate authority.
Okay?
So sometimes we will centralize certain types of operations.
Other times, you'll simply duplicate some of the operations.
And that's simply inevitable, when you delegate authority.
Okay, now, in responsibility accounting, we have
three areas in which we evaluate performance.
We have cost centers, profit centers and investment centers.
Let's just look at the definitions for each of these.
Cost center -- as the name "cost" would suggest, you're responsible for costs or expenses only.
So the maintenance department, if you're maintaining a fleet of vehicles,
it's a critical function but you're not generating revenue.
So you shouldn't be evaluated based on revenue.
How well you contain costs and how efficiently you operate your particular department is
how
you should be evaluated.
Okay?
And so responsible for costs only, some example of cost centers.
A profit center is responsible for revenues and costs and, therefore, profit.
Revenue minus expense.
Examples: a department within a department store.
Like the men's clothing department in JC Penney.
The manager can do certain things, in terms of staffing, training of staff,
how they have the appearance and the cleanliness of an area, how conducive is it for customers.
So they can do certain things to enhance revenues,
as well as containing costs within their department.
That would be a profit center.
A restaurant: for example, Applebee's.
Now, Applebee's has hundreds of restaurants all over the country.
So a particular restaurant in your location --
that's a profit center, because the manager didn't pick the location.
They didn't pick the size of the store, in terms of square footage,
as well as some of the big equipment decisions, okay,
but they're involved in day-to-day operations.
Okay?
So they can control revenues and expenses to an extent.
But they're not an investment center.
Another example will be a Service Department in an auto dealership, is a profit center.
Okay?
And you may be saying -- well, what a second.
How do they affect revenue?
Well, after you buy a car and after it's beyond warranty, if they do good quality service
and quick turnaround time, you bring your car
back to them, as opposed to somebody else.
An investment center is responsible not only for revenues and costs,
but investments and assets, like fixed assets.
Notice it says -- usually this is at the subsidiary or division level.
So a division or subsidiary of General Electric, for example, the Jet Engine Division.
That's a separate company within General Electric.
When GE prepares financial statements, they consolidate all the divisions and subsidiaries
into one consolidated set of financial statements,
but the Jet Engine Division is evaluated as a separate company.
Same thing with Chevrolet or Disney Land versus Disney World.
So these are investment centers.
The people in charge of investment centers have a lot of authority.
This is high-level management.
Because they can make big decisions, in terms of where we drop a location, how much it's
going
to cost to build that factory, that theme park, whatever it may be.
Okay.
Cost center.
You're responsible for costs.
Notice we have to differentiate between a controllable cost and a non-controllable cost.
And when we say "controllable" versus "non-controllable",
we're referring to a particular manager.
Now, at the top level of management, all costs are controllable
because at an Investment Center, all costs are controllable.
But at a more local level, department manager, restaurant manager, certain costs
--
like property tax, insurance on the property, depreciation of the property --
are out of their control because they didn't pick the location, the size of the store,
etc.
But cost of labor, cost of utility, materials, etc, that is within their control.
So we differentiate between controllable and non-controllable costs
and you should only evaluate performance using controllable costs.
Okay?
And as we saw previously, we'll compare budget
to actual performance and we'll explore variances.
In a profit center, since we're evaluating revenues and expenses,
we have a more involved evaluation.
Let's take a look at the slide here.
Okay.
Controllable revenues and costs.
Now, some revenues are within their control.
Other types of revenue based on, for example, a national advertising campaign,
is not really within the local store manager's control.
Okay.
Common costs, such as service department costs, we have to ask --
are they traceable to that particular department?
Or are they what's called a common cost, which is a cost that services multiple departments?
And we'll give you a examples momentarily.
Traceable service department costs should be allocated,
based on the amount of usage by a profit center.
Examples: payroll, employee training, purchasing, quality control, testing, etc,
where they're servicing multiple product lines or departments, then we can say, "Well,
how much time and energy and activity did quality control testing incur
to service this product line or this department?"
Same thing with payroll, for instance, the number of paychecks cut for employees.
Common costs, generally speaking, are not traceable,
should not be allocated to a profit center.
Examples: property taxes, insurance on a factory,
which may manufacture several different products.
So we're going to incur that cost; whether we discontinue a product or not,
we're still going to have the big factory and the related costs.
Okay, so common costs, generally speaking, don't get allocated to profit centers.
All right, let's take a closer look at service department costs.
The allocation of service department costs are based on the usage
of the activity or service provided to them.
Okay, so some examples here: ABC Service Departments
and the expenses they incur for the year are as follows.
The purchasing department.
We purchase raw materials and parts for all the different divisions and product lines.
We centralize payroll.
Okay.
And then we send checks to the different departments.
So, if a department has 500 employees, payroll's going to spend more time servicing them
on this department than if this department only has 75 employees.
So we would charge more payroll to this, the larger department.
Same thing with legal -- if legal is spending more time
on legal issues affecting one department or division than another,
we should charge the division, which required more time and energy from the legal department.
So how do we do that?
We have to identify what's called an activity base.
Now our company, ABC Company, has Divisions X
and Division Z.
We'll try to keep it simple.
Now, for purchasing.
Purchasing places purchase orders, so we would use either purchase orders
or purchase requisitions.
A requisition is a request for the Purchasing Department to place an order.
Each purchase order is supported by a purchase requisition.
So we can use either one.
Payroll -- the number of payroll checks they cut or the number
of employees would be the activity base.
Legal -- the number of labor hours or the number of billable hours.
Okay?
And so, this is a good introduction to what we're going to see a little bit later,
called activity-based costing, where we're going to take a closer look at overhead costs
and other costs and analyze them individually, instead of pooling them all together and coming
up with one individual overhead rate.
More on that in a different lecture.
Okay.
So Purchasing has a total of 40,000 purchase requisitions.
25,000 were for Division X; 15,000 were for Division Z.
So what we do is, we say, "Well,
if $500,000 was incurred by the Purchasing Department --
" and this is not for inventory or parts.
This is the salaries of the Purchasing Department employees,
the computers that they have to use, the furniture they use,
the utilities that their department uses,
the square footage they take up in the office building.
All those related costs came to $500,000,
where they placed a total of 40,000 purchase requisitions.
So that comes to a cost, even though it only takes 30 seconds or a minute to place a call
to a vendor, saying, "Hey, Joe, send me five cartons of this product,"
the fact that we have a full time employee with benefits and a computer and a desk,
it costs us $12.50 per purchase requisition.
So I need to allocate this $500,000 to Divisions X and Z.
And I'm going to do
that based upon the number of purchase requisitions required for each division.
So I'm going to multiply 25,000 times $12.50...
and I'm going to multiply 15,000 times $12.50.
Okay?
And we'll see in a later slide what that number is.
I don't have the number offhand.
Okay?
But this is for X and this is for Z.
And that's how we're going to allocate purchasing,
and we're going to do the same thing for the other two service department costs.
Here's payroll accounting.
We cut a total of 15,000 payroll checks -- 12,000 employees in Division X;
3,000 in Division Z.
So, again, X should be charged more of the $150,000 than Z.
So $150,000 -- again, these are the salaries of
my payroll employees, their computers, desks,
utilities, etc. $150,000 divided by a total of 15,000 checks,
we incur a cost of $10.00 to cut each payroll check.
I'm then going to do the same thing.
I'm not going to put it on the board.
We'll see it in a later slide.
I would multiply 12,000 times $10.00.
And I'd multiply 3,000 times $10.00 and that's how I allocate the $150,000.
We'll see the allocation momentarily.
Last service department charge is Legal.
Our Legal Department and the attorneys incurred a cost of $250,000, same analysis
--
cost of labor, office space, etc.
They spent 1,000 hours in the course of the year --
100 hours went to X and 900 hours went to Z.
So now Z is going
to be charged the bulk of this $250,000.
So $250,000 divided by 1,000 labor hours is $250.00 per hour.
I'm going to multiply $250.00 times 100 hours, so 100 hours times $250.00 for X
and 900 times $250,00 for Z, and that's how I'm going to allocate the $250,000
in total service department charges to my two divisions.
Okay.
And here it is.
My purchasing cost of $500,000...
$25,000 times $12.50...
$312,500 goes to X; $15,000 times $12.50,
$187,500 goes to Z. $312,000 plus $187,000, there's the $500,000 allocated.
Okay, payroll -- $150,000.
Based on the cost per paycheck times the number of employees --
I believe it was 12,000 for X. 12,000 times $10.00 was $120,000, and 3,000 employees
for Z times $10.00 per paycheck: $30,000.
$150,000 gets split: $120,000 and $30,000.
Legal Department was $250,000 divided by 1,000 labor hours: $250.000 per labor hour.
Okay?
For X, they used 100 hours -- 100 times $2.50 gives us $25,000.
Z used 900 labor hours -- 900 times $2.50 gives us $225,000
and there's how we split the $250,000: $25,000 and $225,000.
Total service department charges are $900,000.
Division X, you add up the three numbers.
It comes to $457,500.
For Z, add up the three numbers, it comes to $442,500.
Now remember, if this didn't make complete sense
to you, hit pause, rewind, look it over again,
think about it before you move on.
Now, I just made up these numbers to illustrate how we would evaluate each profit center:
Division X and Division Z.
So if revenue for the two divisions were as follows.
Then I have my variable costs, variable cost to goods sold.
Remember, cost to goods sold: direct materials is variable, direct labor is variable.
And then we have variable overhead and fixed overhead.
So with a contribution margin format income statement,
I'm going to put my variable costs first.
So variable cost to goods sold for each division, variable selling
and administrative costs -- my operating expenses --
gives me the contribution margin and then my fixed costs.
First I'm going to list my service department costs because those are traceable.
Traceable to each division.
So if I can trace them to a division, I charge the division.
Okay, and there they are.
You saw those numbers from the previous slide.
And that gives us -- sometimes, we call this segment margin, or controllable margin,
or simply income before common costs.
Common are non-traceable costs.
And notice how we treat the common costs.
We don't allocate the $300,000.
We charge it to the company as a whole.
So if I'm going to evaluate performance on Division X and Z,
I use income before common costs or segment margin, controllable margin,
whatever your textbook may call it.
Okay?
Total operating income for the company is $2.3 million in this example.
But, again, I did not allocate the non-traceable common costs,
because that's out of the manager's control.
And that could have a demoralizing impact on
our managers, who are seeing their bonuses
and commissions drop, or salaries, because of charges that are out of their control.
Okay, so you have to bear in mind the morale of your employees,
and this is a better management method of evaluating performance.
Okay, now, the largest type of responsibility center is an investment center.
They're responsible for not only revenues and expenses, but investments
and assets, like building a factory.
That could cost tens or hundreds of millions of dollars.
When Intel makes a fabrication plant, it costs them $2 billion per plant.
That's a big investment.
When United Airlines has to invest in planes, this is typically in the hundreds of millions
of dollars, since they don't usually buy one plane at a time.
Okay?
So again, this is typically a subsidiary or a division, but notice,
it could also be by product line.
It could be by geography.
If I'm Apple, I have the iPad line, the iPhone line, the iPod line, the iTunes.
These could all be investment centers.
We're going to use two methods to evaluate performance:
the rate of return and residual income.
Rate of Return.
And it's a formula, so you want to know this formula:
operating income divided by investment in assets.
Now, I'm going to read this note here and make a comment.
Depending on your textbook, investment in assets can be defined differently.
Okay?
So investment in assets or invested assets.
It could be end-of-year assets.
It could be average assets, which is beginning January 1,
plus December 31, ending, divided by two.
Notice it might be total operating assets, which excludes investments in land held
for speculative purposes or equipment that's still on the books
that is not currently being used.
So that formula can differ.
And if you remember back from financial accounting, rate of rate with net income divided
by average assets, or whatever you're textbook you used might have had.
So in the world of financial ratios, you're going to see a lot of flexibility.
The good news is, whatever book you're using, use the definition in your textbook
and you will be tested on that particular formula.
Okay, let's take a closer look at the rate of return.
We said the rate of return was operating income divided by investment
in assets or invested assets, either way.
Let's break it down further, into the profit margin times the asset turnover ratio,
which is net sales over assets.
Okay?
And look at the formula.
Profit margin is operating income divided by net sales.
Now, again, back in financial accounting, we said net income.
Here, we're going to use operating income.
Operating income divided by your net sales.
That's your profit margin.
Asset turnover ratio is net sales divided by invested assets.
Okay?
Notice how net sales cancels out, leaving us with the numerator, operating income,
and the denominator, invested assets.
Okay?
The profit margin tells us, for each $1.00 of revenue, how much profit did we make?
The asset turnover ratio says for each $1.00 we invested in assets,
how much revenue do those assets generate?
And by combining the two, we say for each dollar invested in assets,
how much profit are they generating?
Okay.
Let's take a quick example.
Net sales $2 million.
Operating income, $400,000.
Investment in assets, $800,000.
So my profit margin would be -- it might have gotten cut off on your slide there -- let's
see.
Operation income, $400,000 divided by net sales of $2 million: 20 percent.
Asset turnover ratio -- net sales of $2 million divided by invested assets
of $800,000: 2.5 times or 2.5 over 1.
And rate of return is my operating income of $400,000 divided by assets of $800,500,
and we notice, .2 times 2.5 will give us .5.
Okay?
So your rate of return is profit margin times the asset turnover ratio.
Something worth knowing.
All right.
Now the second method we look at is called residual income.
And let's read this slide here.
I'm going to talk about this.
If a company uses a minimum required rate of return, which is a percentage,
the company may say, "Overall, we expect 12 percent as a minimum required return
on an investment, or else, don't invest."
So for example, some companies might say, the cost of capital, which is the cost for
us
to borrow money from the bank, is one possible definition.
"If we cannot at least cover our interest costs, why would we want to invest in this?"
Usually, the minimum required rate of return is going be higher than your cost
of capital or your cost of borrowing.
But that number would be provided to you.
This is the minimum required rate of return on this investment opportunity.
"If we don't think it's going to meet that, we're not going to invest in it.
If we're looking at alternative A, B or C, we're going to compare those
to the minimum required rate of return."
Now, if a company uses minimum required rate of return as a measure of performance,
than a manager may not want to invest in an opportunity that would be profitable
for the company but it may lower that particular division or department's rate of return.
Okay?
And this is why we have the residual income method to evaluate performance,
because it addresses this potential conflict between department and overall company.
Let's take a look.
Residual income is my operating income minus the minimum required income.
How do we define minimum required income?
Now, I gave you two different terms.
I want to make sure you separate them in your mind.
If you have to pause, write it down, whatever, do so.
Minimum required rate of return -- a rate is always a percentage.
Minimum required income -- this is a dollar amount.
The definition for minimum required income is
your invested assets times the minimum required
rate of return, which I just use MRR.
Okay, let's take a look at this example.
A division's return on assets is 20 percent.
This is their actual performance.
They earn 20 percent on assets.
And they may be evaluated based on their rate of return.
The company, overall, the parent company, believes that any investment
that exceeds a minimum required return of 15 percent is desirable.
And we have an opportunity to invest in -- maybe it's buying another company, building a factory.
We believe that we're going to have an expected rate of return of 18 percent
and this would be good for the overall company.
But if that investment is going to fall under the responsibility of this particular manager,
there saying to themselves, "Wait a second.
We expect an 18 percent return.
I'm already earning a 20 percent return.
That's going to drag my overall performance down and my performance is going to suffer.
They're going to say, "Hey, your performance dropped.
I may not achieve a bonus, a raise," whatever it may be.
"That's going to discourage me from investing in an opportunity
which the company believes is a good one."
Using residual income will encourage this manager to take advantage of the opportunity.
Okay.
So my minimum required rate of return is 15 percent.
That's the company-wide MRR.
Now, the expected cost of this investment is $250,000.
And based upon my projections, I expect income from operations
from this investment to be around $45,000.
Now I have to give you this information.
Notice -- expected income from operations, $45,000.
My minimum required income, which we know is investment
in assets times the minimum required return, MRR, would be $37,500.
$250,000 times .15.
Therefore, my -- this investment would beat that minimum threshold of performance.
My residual or leftover income or income in excess of the minimum required return is $7,500.
Okay, again, I think I'm going to make $45,000.
I have to make at least $37,500 and the way I calculate that is I take the cost
of the investment times the minimum rate of return, and I would get $37,500.
Since we beat that, we say, "Hey, this is a good investment."
So this manager is evaluated based on residual income.
They're going to take advantage of this, whereas if they're evaluated based on rate of return,
and this investment would drag their performance down, they would hesitate.
This is why we have residual income as an alternate measure of performance.
Okay.
So you should know both those methods.
Last couple of items.
More and more companies now are recognizing that,
although you have to ultimately have financial performance,
it's kind of like the tail wagging the dog.
And what I mean by that is, you don't say, "This is how I want performance.
Make it happen."
You say, "Let's make sure we're building a quality product or service.
We're giving excellent customer service.
The way in which we develop our services and products enhances growth.
We treat our employees fairly.
We train them properly.
We are always investing in new ideas and exploring creativity and encourage people
to take risks, because this is where new ideas come from."
And so the concept of a balanced scorecard says,
"Let's break down performance evaluation into different areas."
Now, different companies may choose different categories
and how they define these areas may differ from
Company A to Company B. But in broad terms,
generally speaking, we have these areas.
Then again, different textbooks may call them a little bit differently,
but you should be able to recognize.
So in the area of learning, growth and innovation, things such as our investment
in R&D
and our hiring and training practices, make sure
our employees really know what they're doing,
have access to resources, so that they can do their job the best they can.
How often do we come up with new products, etc.
Okay?
This is an important area.
Because new products are the life's blood of any companies,
especially high tech and pharmaceutical companies.
Your internal business processes.
Okay?
How quickly we go from manufacturing, starting the product to finishing it
to getting it into the hands of the customers.
Okay?
How much waste or scrap we generate.
The less the better.
Waste is inefficient.
Inefficiency costs us money.
The number of defects, rejects -- remember, internal failure when we have problems
that we identify, either in work in process --
raw materials, work in process or finished goods, if we can address that and minimize
or even better, eliminate it, then we're improving the efficiency and quality
of our product, getting it to our customer more quickly, how fast we get it to them.
Okay.
This all has an impact on how well our business does.
Customer satisfaction.
This is really the big area.
Because the customer satisfaction is a function of the learning growth and innovation
and your internal business processes.
And of course, downstream, after we've made the sale, are we supporting them?
Tech support, any maintenance.
Okay, for example, Toyota's service department.
How often do you need to bring your car in?
How quickly do they service it?
Okay?
If you have a computer problem, getting it resolved.
Your server's not working, you have to get it re-linked to the internet.
Whatever it may be, is it a frustrating experience?
Hopefully, it doesn't happen often, and when it does,
they get you back up and running relatively quickly.
Okay?
That affects your reputation.
Reputation and customer service, also affect customer loyalty.
Do you have repeat customers?
And then, all three of these ultimately impact financial performance.
If you do the first three well, the financial performance should follow suit.
Unless you're charging too much or unless it's a luxury item --
and this is where economics and marketing kind
of all mix in, there's no guaranteed formulas.
Generally speaking, though, a company with good customer satisfaction, good processes,
attention to innovation and growth, will generate good, solid financial performance,
which we can -- we've seen some of the measures --
profit margin, residual income, rate of return, etc.
Okay?
So the balanced scorecard says -- we don't just measure financial performance,
we consider the non-financial or qualitative factors that impact financial performance.
Last area of discussion is the concept of transfer pricing and what this means is,
how much should Division A sell either raw materials or a part or component to Division
B,
instead of Division B buying it from an outside company?
Example: if General Motors owns Chevrolet, as well as AC Delco batteries, then GM,
the parent company, would rather Chevrolet buy
the batteries from AC Delco than from Sears,
Diehards, or whatever other batteries are out there that are not related to GM,
because this way we carve out that middle man profit.
The problem is -- and not really a problem --
the challenge is that Chevrolet and AC Delco are investment centers.
They're evaluated independently as if they're their own company.
So Chevrolet, of course, they wish AC Delco well, but when push comes to shove,
it's their own bottom line that they're concerned with and vice versa.
So GM has to provide an environment in which both companies can satisfy AC Delco's desire
to make a profit, Chevrolet's desire to make a profit and GM, overall,
saving money by having those two work with each other,
rather than going to an outside third party.
So a negotiated price should be somewhere between AC Delco's variable costs on the low
end
and the market price for batteries on the high end.
Okay?
And think about it.
If AC Delco has a big factory, then if they are operating at 100 percent of capacity,
then they should not sell batteries to Chevrolet at lower-than-market price or else,
they're going to be giving up sales to Ford, Chrysler, Toyota, Honda or whoever --
Chief Auto Parts, whatever auto parts companies are out there.
So when they're operating at full capacity, you have to sell it at market price,
or else you're going to lose money.
But if they have excess capacity -- they're not operating at 100 percent capacity --
then they can afford -- they're not going to
hurt, so they're not going to cannibalize,
is the term they use, they're not going to hurt their existing sales.
And they want -- of course, they'd love to sell Chevrolet batteries at market price,
but Chevrolet doesn't want to pay market price or else, why buy it from them?
Buy it from somebody else.
So if Chevrolet insists on paying too low a
price, it doesn't make sense for AC Delco.
So AC Delco says to themselves, "Well, our factory is not going anywhere,
so we're going to incur all those fixed costs.
Okay?
We have all these sunk costs.
The factory, the machines, property tax, insurance, straight line depreciation,
etc.
However, to sell Chevrolet batteries, I'm going to incur direct material costs,
direct labor costs and variable overhead costs.
So those are my variable costs.
I have to charge them at least what my variable cost is to make those batteries,
or else it doesn't make sense for me.
Now, I'd like to charge more than that, because I'd like to make some profit.
So somewhere in between AC Delco's variable cost and the market price --
what they would sell to other companies -- is what we call the transfer price.
And how a company determines transfer price differs from Company A to Company B
to Company C. And I'm not going to ask you to
come up with an appropriate transfer price,
other than to say for you to recognize that it needs to be greater than variable cost
for the provider, or the seller and it has to
be less than the market price for that product,
so that both parties will come to terms.
Okay.
That will do it for this lecture.