ASIGNMENT QUESTION 1

Topic 1: Environmental accounting and management control system.

Environmental accounting
Environmental accounting is an inclusive field of accounting. It provides reports for both
internal use and external use. For instance, it is generating environmental information to help
in making management decisions on pricing, controlling overhead and capital budgeting, and
disclosing environmental information of interest to the public and to the financial community
(Yakhou & Dorweiler, 2004). At the beginning, environmental accounting went through a
period of uncertainty. Mathews (1997) describes the development in four stages, according to
Figure 1.1 (Yakhou & Dorweiler, 2004 Stanciu Joldos, & Stanciu, 2011). The
conclusion is that researches in environmental accounting have grown considerably due to the
importance that environmental issues started to have over entities and over society.
Figure 1.1: Development of Environmental accounting in four stages
1970-

It represents the beginning of the first researches in the area of environmental

1980

accounting, which had a more descriptive character.

1981-

During this period, the interest of researchers for this area increases; the

1994

managers and even accountants start to pay more attention to the issue of
environmental accounting.

1995-

Maturing of environmental accounting, in making environmental disclosures,

2001

and in launching environmental auditing; environmental accounting is beginning

to be widely discussed, especially in developed countries. The studies from this
period are starting to grow, this period being named the cornerstone of
environmental accounting.

2002-

The role of environmental accounting is viewed as measuring environmental

2010

performance exceeding regulatory standards. The studies in this field are more
numerous and bring important contributions to the development of this research
area.

It is very important to clarify environmental accounting and its relationship with the financial
and management accounting systems since accountancy is a very practical science.

Environmental accounting has two branches included Environmental Financial Accounting

(EFA), which focuses on reporting the cost of environmental liabilities and other significant
environmental costs for external audiences using Generally Accepted Accounting Principles
and Environmental Management Accounting (EMA), which addresses mainly to the
information about material and energy flow, and provides information for internal decision
makers of a corporation (Stanciu et al., 2011).
In recent years, there are many companies in different business sectors are competing among
their competitors. This make them consider the safeguard of the environment as an essential
part of their business strategy because concern about environmental protection has become a
global issue. They start exploiting the improvement of the environmental performance to
create a competitive advantage (Arena, Conte, & Malacini, 2015).
According to Arena et al. (2015), the choice of linking the environmental accounting to a
monetary reward system allowed the employees to start participating in the gains or cost
savings obtained by the company through environmental management. This choice was
effective to raise the attention of the store's managers on the environmental performance and
motivate a company's employees to embrace more environmentally friendly behaviors.
Besides, there are many advantages of using environmental accounting. Firstly, the flows of
energy and materials management including the quantity of wastes, their type and their
destination will become more efficient. Secondly, general costs and environmental costs will
be estimating, identifying and managing in a better way. Thirdly, precise information for
starting will be obtained and programs for improving environment performance will be
sustained. Lastly, the necessary information for measuring and reporting the environment
performance will be obtained, for the purpose of improving the reputation with all those
interested in its activity (Stanciu et al., 2011).

Management control system

A management control systems (MCS) is a system which gathers and uses information to
evaluate the performance of different organizational resources like human, physical, financial
and also the organization as a whole considering the organizational strategies (Armesh, Dr.
Salarzehi, & Dr. Kord, 2010). There are four categories in management control systems
which are diagnostic control systems, boundary control systems, interactive systems and

belief systems. These four different management control systems are identified recently by
companies as effective categories of controlling system. Companies must apply them in a
way that maximizes operational effectiveness without limiting employee creativity (Armesh
et al., 2010). MCS ensures that overall strategic planning and operational functions will work
together and Figure 1.2 showed the MCS package (Aziz, Foong, Ong, & Attan, 2015).
Figure 1.2: Management control systems package

MCS plays an important role in managing green issues to achieve sustainability goals. It
enables managers to assess relevant risks and opportunities and provide environmental
information on the usage and cost of resources. Jansson, Nilsson and Rapps (2000) indicate
that green issues need to be integrated into MCS, strategies and management attitudes to be
environmentally driven business (Aziz et al., 2015).
Literature interprets green integration into MCS in many ways. In most cases, green
integration is considered as the adoption of eco-control in organizations (Aziz et al., 2015).
Eco-control is a specific application of management control systems (MCS), it has attracted
growing attention in recent years as a means of driving an environmental strategy throughout
the firm. It helps organizations to measure, control and disclose their environmental
performance. They are used to supply information for decision-making to ensure the
attainment of environmental objectives and to provide persuasive evidence supporting the
benefits of such actions (Henri & Journeault, 2010).
Eco-control refers to the integration of environmental matters within MCS. Like MCS, it is
designed to help an organization adapt to the context in which it is set and to deliver the key
results desired by stakeholder groups (Henri & Journeault, 2010).

In summary, many studies agree that MCS plays an important role in managing
environmental issues. It suggests that the green integration into MCS is better to be
interpreted as integrating green and sustainability with all the systems and devises that
manager use to ensure that the decisions and behaviors of their employees are consistent with
the organizations objectives and strategies. For the extent of green integration into MCS,
despite of its moderate level, it is progressing especially in large and environmental best
practice companies. This review also shows that some business entities do play a role in
society in regards to green issues. They do link their business behaviors towards
environmental practices that lead to the recognition of the role of MCS. This may motivate
other companies to take the same path or use them as a benchmark (Aziz et al., 2015).

Topic 2: Implementation of Management Accounting practices.

Accounting discipline is divided into two areas which are financial accounting and
management accounting. Management accounting is one significant area in accounting. It is a
formal system created to support managers with useful information (Bowens & Abernethy,
2000). It is used to ensure the effectiveness of firm performance. Managers need management
accounting practice in the decision making process as it helps managers to make adjustment
to achieve an effective decision (AbRahman, Omar, Rashid & Ramli, 2015).
According to Arora (2009), management accounting helps managers in identifying,
measuring, analysing and accumulating accounting information in order to have an effective
control over the companys resources. Management accounting practice also is a value added
continuous improvement process as stated by Ederer (2005). In accordance to Kaplan (1984),
management accounting must meets the companys objectives and it cannot exist as a
separate discipline. AbRahman (2015) said that, management accounting practices helps the
company in the area of financial achievement in daily operation. According to the
International Federation of Accountants (1998), there are four stages in evolution of
management accounting.

Stage

Year happened

Evolution

Pre 1950

This stage focused on the cost determination and financial control

through calculating product costs by the use of budget and
financial control of production process.

Pre 1965

This stage focused on information for management planning and

control through decision analysis and responsibility accounting.

By 1985

This stage focused on the reduction of resource waste in business

process

through

analysis

process

and

cost

management

technologies.
4

By 1995

This was the last stage and it focused on creating value through
effective resources use by using technologies to analysis the
drivers of customer value, shareholder value and organization
invention.

In general, management accounting has changed from narrow to broader function in order to
maintain the competitive in the market (Ahmad, 2012). Innovation in management
accounting has been continuous for improvement in order to provide more accurate and
relevant information within a short time period (Preda & Watts, 2004). Therefore, there are
some innovation on management accounting practice techniques as the outcome of
improvement such as Activity-based Costing (ABC), Strategic Management Accounting
(SMA), Balanced Scorecard (BSC) and Total Quality Management (TQM) (Ahmad, 2012).
According to Chenhall (2003), the innovation in management accounting practice extends the
function to informal, external and no-financial information.
Management accounting practices are divided into five categories which are budgeting
systems, decision support systems, product costing, performance evaluation and strategy
management accounting. Budgeting is an essential control system (Hansen & Stede, 2004) in
planning future performance, financial position, cash flows and controlling costs (Kader &
Luther, 2006). Besides, Budgeting is also used in to evaluate managers performance,
communication in formatting goals and strategy to direct the activities across business units
(Fruitticher et al., 2005). There are few specific types of budgeting techniques that are used
by organization such as operational budgets, flexible budgets and rolling budgets (Ahmad,
2012). According to Hansen et al. (2003), he stated that majority of U.S. firms still remaining
the formal budgeting process in their daily operation.
Wu et al. (2007) mentioned that an effective decision making is important for companies to
survive in todays competition environment. Decision support systems are divided into two
parts which are short term analysis and long term analysis. In short term decision analysis,
managers can use product profitability analysis, stock control models, customer profitability
analysis and cost-volume-profit (CVP) analysis (Kader & Luther, 2006) while in long term
investment decision analysis, managers can review accounting rates of return, payback period
and information based on discounted cash flow (Ahmad, 2012). In accordance to Klammer et
al. (1991), net present value (NPV) and interest rate of return (IRR) analysis are suitable
under a certainty situation while game theory, increased rates of return and sensitivity
analysis can be used under uncertainty situation.
Product costing systems are useful in pricing decision, estimation on production processes,
cost control and transfer pricing (Triest & Elshahat, 2007). There are two primary costing
techniques in product costing which is absorption costing and direct (variable) costing.

According to Drury et al. (1993), absorption costing system is more general used in
companies. Activity-based costing (ABC), job costing and process costing are costing
methods that are widely used by companies.
Performance evaluation is an important function in management accounting said by
Emmanuelet al. (1990). Performance evaluation provides useful information to managers in
order to achieve the organizations strategy objective (Jusoh & Parnell, 2008). Charted
Institute of Management Accounting (CIMA) stated that ABC and activity-based
management, benchmarking, value-based management (VBM), balanced scorecard and
strategic enterprise management (SEM) are proper used to measure management performance.
There are two types of performance measurements which are financial measurement such as
return on investment (ROI), Economic value-added (EVA) and profit measures and nonfinancial measurement. Banker et al. (2000) stated that non-profit measurement is mostly
used to examining and motivating managerial performance. There were some studies
conducted supported that non-financial measurement was important in measuring product
quality, customer satisfaction, delivery and supplier reliability.
Moreover, strategy management accounting is a tool used to analyse the financial information
on product markets, competitors costs, cost structures and monitor the companys strategies
(Bromwich, 1990). Drury (1994) stated that traditional management accounting does not
provide information in monitoring strategies and support strategy formulation. This can be
improve by strategy management accounting which helps managers to collect competitors
information, identical accounting with strategy position and development of cost reduction
opportunities (Lord, 1996). Cadez and Guilding (2008) divided strategy management
accounting into five concepts which are costing, planning, control and performance
measurement, strategic decision making, competitor accounting and customer accounting.
In conclusion, management accounting plays an important role in companys management.
Management accounting roles as a management process in providing important information
in planning future strategies and operations, controlling business activities, enhancing the use
of resouces, improving the internal and external communication, improve the effectiveness in
decision making process and measuring and evaluating performance (International Federation
of Accountants, 1989). Garrison and Noreen (200) supported that management accounting
practices provide useful management accounting information in order to help managers to
perform their duty of planning, directing, monitoring and controlling. Bhinani (2002) also

stated that management accounting practices help organization to plan and monitor
performance through internal analysis processes. This statement has supported by Chenhall
and Smith (2007). Many studies has been conducted by vary researchers to support that
management accounting practices would improve the firms performance (Mitchell & Reid,
2000; Reid & Smith, 2002).

These studies showed that implementation of budgeting,

performance measurement, non-financial performance measurement and activity-based

costing (ABC) will enhance the firms performance.

ASIGNMENT QUESTION 2
1.
Since Electrical Division is currently operated at capacity which means that all the A2
electrical fitting that produced will be sold to its regular customers. Therefore, Electrical
Division is required to foregone an equal number of sales to the external customers in order
to fulfill the demand of A2 electrical fitting that needed by Brake Division. In other words,
Electrical Division has to give up the profit it can earn from the sales of A2 electrical fitting
to its external customers. By applying the transfer pricing formula, the minimum transfer
price for Electrical Division to internally supply A2 electrical fitting to Brake Division is:

Transfer price Variable cost per unit + Contribution margin of sales lost per unit transferred
Transfer price RM4.25 + (RM7.50 RM4.25)
Transfer price RM4.25 + RM3.25
Transfer price RM7.50

In this situation, the minimum transfer price is RM7.50 which is equal to the selling price to
the regular customers. Therefore, Electrical Division should not supply the A2 electrical
fitting to the Brake Division for RM5 each as requested. If Electrical Division internally
supplies the A2 electrical fitting to Brake Division at RM5 each, it must give up revenue of
RM2.50 on each fitting that it supplied internally.
Additionally, W Industries is using return on investment (ROI) to measure the divisional
performance. If the division decides to supply the A2 electrical fitting to the Brake Division
for RM5 each, the performance of Electrical Division would be adversely affected as the
sales revenue of Electrical Division is reduced.

2.
The variable manufacturing cost for A2 electrical fitting of RM4.25 in Electrical Division is
irrelevant as the production cost of the fittings will be remained no matter the fittings are used
in the airplane brakes unit or being sold to the external customers. Thus, this production cost
of fitting in Electrical Division should not be taken into account on the effects of the contract
on the companys profit.
Besides, the fixed overhead and administration cost of RM8.00 included in the cost of brake
unit incurred in Brake Division is also not relevant as these are sunk cost. This cost should be
ignored in determining the effects of the contract on the companys profit as this fixed cost
would continuously exist regardless the Electrical Division winning the contract or not.
The only relevant cost should be taken into account on the companys profit is the
opportunity cost of the outside sales revenue forgone when the fittings are internally supplied
from Electrical Division to Brake Division.
The contribution per brake unit as follow:
RM
Selling price per airplane brakes unit

RM
50.00

Less:
Purchase parts (from outside vendors)

22.50

A2 electrical fittings (assumed at minimum transfer

7.50

price)
Other variable costs

14.00
44.00

Contribution per airplane brake unit

6.00

Yes, W Industries will be profitable as a whole for the Electrical Division to supply the A2
electrical fittings to the Brake Division if the airplane brakes can be sold for RM50. By doing
so, the company as a whole would be better off by earning a profit of RM6.00 for each unit of
airplane brake sold. In contrast, if the company sold the A2 electrical fitting to the outside
customers instead of supplying it to the Brake Division, the company can only earn a
contribution of RM3.25 for each unit of A2 electrical fitting sold.

3.
As shown in part (1) above, the minimum transfer price for the Electrical Division to supply
the A2 electrical fittings to Brake Division is at least RM7.50 each. On the other hand, the
contribution margin for brake unit in Brake Division is RM6.00 per unit when the A2
electrical fitting is transfer at minimum transfer price of RM7.50 as shown in part (2) above.
In short, it means that the Brake Division will be ahead by RM6.00 per brake unit sold if it
accepts the A2 electrical fittings at the minimum transfer price of RM7.50.
Then, the maximum transfer price for the Brake Division to buy one unit of A2 electrical
fitting internally from Electrical Division is:
Maximum transfer price minimum transfer price + maximum contribution margin
Maximum transfer price RM7.50 + RM6.00
Maximum transfer price RM 13.50
The contribution per brake unit as follow:
RM
Selling price per airplane brakes unit

RM
50.00

Less:
Purchase parts (from outside vendors)

22.50

A2 electrical fittings (assumed at maximum transfer

13.50

price)
Other variable costs

14.00
50.00

Contribution per airplane brake unit

The range of transfer price is the minimum transfer price and the maximum transfer price that
can influences the optimal behavior among the managers. Thus, the range of transfer price for
each A2 electrical fitting is from RM7.50 to RM13.50, with contribution margin for each
brake unit ranging from RM6.00 to RM0 which will benefit the company as a whole. In
principle, yes, the two managers of Electrical Division and Brake Division should agree to
the transfer price in this particular situation.

4.
According to part (3) above, the transfer price for each A2 electrical fitting is within the
range from RM7.50 to RM13.50 which may improve the profit for the company as a whole.
The decision of transfer pricing should be made in the best interest of the company. So, both
divisions manager should accept the transfer price within the acceptable range. However,
sometimes the transfer pricing decision cannot be made when the two divisions managers do
not come into agreement.
For example, the managers will not come to an agreement when they are making the decision
based on the best interest for their own division or themselves, especially when the company
measured their divisional performance based on the return on investment (ROI). The rewards
or bonuses will be given to a division manager or the whole division depends on the
divisions performance. In other words, the more profits earned by a division, the more
excellent the performances of that division. In return, more rewards will be given to the
division with the best performance. Thus, managers may not agree to the transfer pricing if
the decision does not gives them the best performance to their own division.
Since, W Industries is a decentralized organization; it means that the managers have the
freedom to make decisions within their own sphere of responsibility. So, it is normal for the
managers to act for their own interest. For example, if the manager of Brake Division has
asked the Electrical Division to supply A2 fittings for only RM5 each by knowing that the
decision will benefit its division more, the manager of Electrical Division on the other hand
will not agree into the transfer pricing as the Electrical Division Manager knows that it will
adversely affected the Electrical Division as refer to part (1) above.
Therefore, the companys president should change their policy of rewards and encourage
frequent communication between divisions. The rewards or bonuses should be given based
on the decision made in the best interest of the company as a whole but not on divisional
performance. Companys president should consider the compromises or sacrifices made by
the divisions which are done for the best interest of organization and reward both divisions
when they made into an agreement that resulted in increased profits of the company as a
whole. Then, frequent communications between divisions will help to create a culture of
teamwork in making collaboration between divisions for the best interest of the company. So,
this may encourage the divisional managers to compromise and agree with the transfer
pricing decision on an acceptable price range that is for the best interest of company.

5.
Transfer pricing is the prices charged to the goods or services which are transferred from
supplying division to receiving division of the same company. Transfer prices across borders
concern on the prices of goods and services transferred between divisions in different
countries.
According to Drury (2012), when divisions are located at different countries with different
tax rates, it would be in the interest of the company when most of the profits are allocated to
the division that operated in the country with lower tax rate. Hence, taxation authorities of
each country are aware of the possibilities that the companies manipulate the taxable profits
declared in different countries in order to avoid paying local taxes through transfer pricing
system (Drury, 2012).
So, as refer to Drury (2012), the Organization for Economic Co-operation and Development
(OECD) has issued a guideline statement in 1995 with the aim of providing a world-wide
consensus on the pricing of international intra-firm transactions, and then, most of the
countries' taxation authorities have used it as the basis of regulating the transfer pricing
behavior of those transactions.
According to Price Waterhouse Coopers (2013), the OECD guidelines are based on the arm's
length price principle where the prices of related party transactions charged must be
equivalent to other independent parties which the circumstances are same. As refer to the UN
Tax Committee's Subcommittee (2011), there are five major transfer pricing methods of this
arms length principle, which are:
i.

Comparable Uncontrolled Price (CUP),

-

This method makes comparison between the price charged on a transferred good
in a controlled transaction (related parties transaction) with the price charged on a
comparable good in a comparable uncontrolled transaction (unrelated/independent
parties transaction).

ii.

Resale Price Method (RPM),

-

This method determined the price a reseller willing to pay for the goods purchased
from associated parties, and then resell to independent parties. The price set must

be able to cover the selling and operating expenses as well as make an appropriate
profit.

iii.

Cost Plus Method (CPM),

-

This method determined the appropriate price charged for a good by supplying
division to receiving division. The price charged should be able to make an
appropriate gross profit margin taking into consideration of the market conditions
and functions where the supplying division performed.

iv.

Profit Split Method (PSM), and

-

This method combines two related parties profit earned from one or a series of
transactions. Then, it was divided on a defined basis in order to replicate the
division of profits that can be earned from an agreement made at arm's length,
where the arm's length pricing is derived through working backwards on profit to
price from both parties.

v.

Transaction Net Margin Method (TNMM).

-

This method compares the level of profits (net profit margin) earned from
controlled transactions to the level of profits earned from uncontrolled
transactions.

Then, according to the UN Tax Committee's Subcommittee (2011), the first three methods
(CUP, RPM, and CPM) are often known as "traditional transaction" methods, while the last
two methods (PSM and TNMM) are known as "profit-based" methods. However, according
to the OECD Guidelines (Chap 2 and 3, para. 2.49, 3.49 and 3.50), the traditional transaction
methods are more preferable to be used, while the profit-based methods are only used when
the traditional transaction methods cannot be applied (Canada Revenue Agency, 1999).
This is because CUP method provided the highest degree of comparability as it focuses
directly on the price of a transaction and requires the comparability of both functional and
product (Canada Revenue Agency, 1999). However, when there is no sufficient quality
information with respect to the independent transactions are provided or when it is impossible
to reliably quantify the differences between related and independent transactions, other

traditional transaction methods should be used instead of CUP methods (Canada Revenue
Agency, 1999).
Then, the differences between CUP method and RPM or CPM method are CUP method uses
prices of comparable good to compare, while RPM or CPM method establishes the gross
profit margin where a taxpayer expected to get from the functions performed, risks assumed,
and assets used (Canada Revenue Agency, 1999). Since, RPM or CPM method operates at
margin level, the product differences will have a lesser impact on the reliability of the results
as compared to CUP method. However, more reliable result will be generated with closer
comparability of the products (Canada Revenue Agency, 1999).
After that, as per Canada Revenue Agency (1999), the choice between RPM or CPM method
relies on the comparability of quality data have for each of the transaction's parties, where the
least complex party will normally able to generate the quality comparable information.
However, when there is no quality information available or the available information have
material differences that cannot be reliably adjusted to apply the RPM or CPM method,
profit-based method should be used (Canada Revenue Agency, 1999). In fact, there is no
clear preference for either PRM or TNMM method by the OECD Guidelines as they do not
encourage the usage of both methods (Canada Revenue Agency, 1999).
In W Industries case, arms length price should be used when setting the transfer pricing for
the goods across border. Then, W Industries should choose the most appropriate transfer
pricing method ranking from CUP method, to RPM or CPM method, and lastly to PRM or
TNMM method by considering the availability of quality required information and the
complexity of its divisions.
Lastly, there are five factors that W industries should take into account while setting
international transfer price:
I.

Taxation
Normally the purpose of setting transfer pricing is to minimize the global taxation.
This is because there are different taxation rates between countries, the allocation of
profits will affect the tax paid, so the transfer prices play an indispensable role in
multinational company.

In order not to get attention from taxation authorities which the company tends to
manipulate the profit to avoid taxation, normally multinational companies will use
same transfer pricing method for taxation purpose and internal purpose. (Drury, 2006)
Therefore, W Industries should concern about the taxation rates for the countries of
supplying (electrical) and receiving (brake) divisions. For example, if the country of
supplying division has a lower tax rates, charged high transfer prices and maximize
the profit but tax paid is low, vice versa.
II.

Import Tariff
When import duties are charged to intra-company, transfer prices will resulting a
lower tariff. This is because normally low tariff has high income tax rates. So to avoid
high tax, lower transfer price is preferable.
Therefore, if there is an import tariff in receiving divisions county, W Industries
should minimize the cost by maintain the low transfer price.

III.

Exchange Controls
Exchange control is the restrictions on the transferring of profit earned to foreign
countries. If the restriction is strict, the profitable division is not able to transfer large
amount of profit to another country.
Therefore, W Industries should concerns on the exchange controls of both divisions in
two countries. This is because if one of the division earned high profit but the funds
are just turning around domestic and cannot reached head office. The consequence is
the dividend to shareholders of the head office will be decreased. Besides, the funds
which flow in one county cannot make better investment that can earned more profit.

IV.

Anti-dumping Legislation
This is the action of local government prevent the firm receiving under costing price
goods into their country. This would require subsidiary to adopt fair value for the
prices. This means if the receiving division buys goods in low transfer prices, the
local authorities might charge more higher tariff on the goods transferred. This is
because the local authorities wish to protect the competitiveness of domestic market.

Therefore, W Industries should aware of this legislation in order to avoid paying extra
tariff on the goods transferred.
V.

Exchange Rate Fluctuation

When the goods are sold at high inflation transfer price from parent company,
subsidiaries profit will reduce. However, funds will be repatriated as parent company
sold at high price, thus value is saved.
Therefore, W Industries should determine the inflation of both divisions countries in
order to set transfer price.