Chapter 13103CHAPTER 13RESPONSIBILITY ACCOUNTING, SUPPORT DEPARTMENTALLOCATIONS, AND TRANSFER PRICINGQUESTIONS1. Four potential advantages of decentralization are: Better executed executive training and development Higher level of job satisfaction for employees Effectiveness and speed of decision making by local managers with intimateknowledge of problems Reduced management oversight time through use of management byexception principleThree potential disadvantages of decentralization are: Suboptimization by plant or outlet managers Possibilityof organizational disruptionif topmanagement hasdifficultyinrelinquishing control or communicating to subordinates Potentially high costs of incorrect decisions by subordinatesFunctions that may be handled centrally: Capital project approval(1) Major costs for long-term commitments(2) Specialized knowledge(3) Need for coordination in the selection and funding of major projects Cash management(1) Cash and investment funds are managed moreefficiently if they are pooled.(2) Whenfunds areneeded, traditionandgoodbusinessdictate that they are acquired at the firm level and allocated to segments asneeded.(3) Cash is the most vulnerable asset and merits tightcentral control. Inventory controlInventory, being a near-cash asset, is subject to theft and misappropriation. Itscontrol is alsocrucial toefficient andeffective production, deliveryandcustomer relations. Evaluation of divisional profitabilityTop management must reward or penalize division managers as a matter ofappropriate organizational hierarchical prerogatives.2. The two basic functions of responsibility reports are to provide operational managers with information needed for planning,controlling, and decision making for their areas of responsibility and 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.10Chapter 13 assist top managers in evaluating how well operational managers fulfilled theirresponsibilities to the organization.It is sometimes appropriate for a company to prepare a single responsibility reportfor adivision. However, manycompanies preparetwodifferent responsibilityreports for a division: one report, which is used to evaluate a managersperformance, shows only the costs controllable by that manager; the second reportshows all costs incurred by and assigned to the division so that a notion of thetotal performance of the division can be gained. If total cost information can besubdivided into controllable and noncontrollable costs for the division manager,then one report can effectively accomplish both purposes.3. Suboptimizationisaconditioninwhichindividual managersworktoachieveresults that are in their own and their segments best interests to the detriment ofthe overall company. Top managers must guard against such behavior bysubordinates whenauthority is delegated tothemin a decentralized setting.Suboptimization results from segment managers motivation to appear successfuland gain rewards and recognition. Sometimes, this motivation overrides thecompanys best interests.4. Support department costs may be allocated to revenue-producing departments for avarietyofreasons. Themostcommonreasonsaretoencouragemanagerstousesupport areasin themostcost-beneficialmanner,makeperformance comparisonswith independent organizations, determine the full cost of production to make fair andacceptable pricing decisions, and support decision making. (These are all enumeratedinExhibit 13.7.)Suchallocationsarenot alwaysuseful fromadecision-makingstandpoint because they assign costs that are uncontrollable by a department to thatdepartment.In addition to allocating support department costs to obtain a full cost of productsor other cost objects, there are behavioral consequences associated with allocatingsupport department costs. Generally, managers become moresensitive totheassistance provided bythe support area, which leads managers to use suchresources in a more cost-beneficial way and to recommend cost controlimprovements tothesupport department. However, suchcost allocations maycause dysfunctional behavior if the manager of the revenue-producing areaperceives the cost allocation to be unfair.5. The four criteria (benefits received, causation, equity, and ability-to-bear) are allrelevant tomakingsupportdepartment allocationsandshould, theoretically, beappliedequally. However, itisoftennotpractical toapplytheequitycriterionbecause it is too difficult to achieve agreement on what is fair. Ability-to-bear isoften not used because it may result in unrealistic or profit-detrimental actions.Therefore, most support department allocations are based on the benefits-receivedand causation criteria. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 1310!6. Thedirect methodisthesimplest methodofallocationanddoesnottakeintoconsideration the assistance provided among support departments. Thus, the directmethod is the only method that does not allocate a support departments costs toother support departments.The step method does take into consideration assistance provided between supportdepartments, but does so sequentially based ona benefits-provided ranking.Because of the necessity to rank benefits, all support department interaction is notaccounted for using the step method. This method is more difficult than the directmethod, but less difficult than the algebraic method.The algebraic method, unlike the other methods, recognizes reciprocal (give-and-take) exchanges of assistance among the support departments by providing a set ofsimultaneous equations to solve for the effects of such exchanges. However, thismethod is very difficult to use without the aid of a computer when more than twoor three departments are involved.If formulae are correct, the algebraic methodprovides the most accurate measure of the usage of assistance among departments.The only similarity among the methods is their ultimate objective: the assignmentof support department costs to revenue-producing areas.7. The added costs arean artifact ofthe cross-allocation process of solvingsimultaneous equations. These fictional costs are ignored in the revenue-producing areas for the purpose of developing an overhead application rate.8. Transfer prices are internallyset andagreedonprices withwhicha sellingdivision transfers goods or services to a buying division. The objectives are goalcongruence, autonomy, motivation toward effectiveness and efficiency,practicality, and credibility as a basis for performance evaluation.In negotiating transfer prices among segment managers, the managers areexpected to work together (1) to make choices that will maximize the efficiencyandeffectiveness oftheir respectivedivisionsand(2) tocontributetooverallcompany performance. For example, when it is in the companys best interest fora buying division to purchase goods or services internally from a selling division,segment managers are expected to agree on a price to encourage such purchases.If top management has properly trained, motivated, and evaluated segmentmanagers, the transfer price can be a device to promote such goal congruence.In contrast, sometimes segment managers become myopic in their zeal to maximizethe apparent performance of their own divisions. For example, sometimes buyingsegment managers will choose to buy externally at a price lower than the transferprice because such purchases makes the division look better even though analysiswould reveal that the whole company would do better if the acquisitions were madeinternally. This example illustrates the concept of suboptimization.9. Thebiggest probleminvolves howthetermcostisdefined. Acost canbedefined as any of the following: incremental or variable; absorption (product costsonly); or absorptionplus someportionof thesegments nonproductioncosts 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.10"Chapter 13(selling and administrative). An amount for estimated opportunity costs for use ofthe facilities can be added to any of the above. In some cases, arguments can bemade for reducing absorption costs by estimated savings in production ordistribution costs on internal sales.Another problem is that if actual costs include inefficiencies, the transfer pricesset on the basis of such inefficiencies may lead to incorrect managementdecisions.Problems of using market-based transfer prices include: the possibility that no objective price can be found because the product has noexact counterpart in the market; market price ignores any production or distribution savings on internallytransferred goods; and the possibility that current prices are temporarily not representative of a long-run price.10.Type of Center Recommended Type of Transfer Price & UsageCost-Selling Segment Cost-based: consistent withthe objective of thistype of center,thisuseisawayofallocatingthecenters cost to other centers.Cost-Buying SegmentPreferably cost-based: consistent with the objectiveofthis typeofcenter, however, dependingontheselling segments demands, the transfer price couldbe at any point between the lower limit(incremental costs plus opportunity cost offacilities) and the upper limit (lowest market pricethe buying segment would have to pay externally);goods or services received by the center are carriedat the transfer price for internal reporting purposes.Revenue-SellingSegmentMarket price: revenuefromtransfersofgoodsorservices is recorded at the transfer price for internalreporting purposes.Revenue-BuyingSegmentTransfer prices for goods or services should bebetween the lower and upper limits with the lowerlimit giving this segment the greatest gross marginonits internal sales; whichever transfer price ischosen will be the cost of goods or servicespurchased for this segment for internal reporting.Profit or Investment-Selling SegmentTransfer prices should be set between the lower andupper limits; since these types of centers aresupposed to earn a profit, their managers will try tonegotiate a price closer to the upper limit; 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 1310#whichever price is set becomes the revenue measurefor internal sales for internal reporting purposes.Profit or Investment-Buying SegmentTransfer prices should fall between lower and upperlimits with managers of these segments arguing forprices closer to the lower limits to afford theirsegments the highest gross margin; whichever priceis set becomes the cost of goods or servicesacquired by the center for internal reportingpurposes.11. Dual pricing exists when the selling division is permitted to record one transferprice (higher) and the buying division to record another (lower). This practice isintendedtominimizesuboptimizationandcreategoal-congruent incentivesforboth divisions.12. Support departments can use transfer prices when (1) user departments of the supportdepartment have significant control over the quantityandqualityof assistanceprovided and (2) a reasonable surrogate measure of assistance benefits provided tousers exists. Insuchcircumstances, transfer prices canbeaneffective wayofpromoting a more efficient use of resources and of reassigning support departmentcosts. Setting the transfer price depends on the nature of the (1) support department(cost or profit center) and (2) assistance itself (whether it can be acquired externally,is recurring and uniform, and is expensive).Advantages of transfer prices over allocation include: motivation of user departments to suggest improvements and monitor usage; inclusion of costs in user departments performance report (if user departmentcontrols the amount of assistance it buys); potential to generate suggestions for services more beneficial to users; the fact that the rationale for the transfer prices must be provided to the buyingdepartment; and transformation of a support department fromcost center to profit center;provides additional performance measures for the center and its manager.13. Inamultinational setting, transfer prices canaffect theprofits andinventoryvalues reported in multiple countries as well as the taxes paid to variousjurisdictions. Assuch, managersmust bemoreawareofsettingprices, withinlegal and ethical limits, to minimize income taxes and tariffs. Also, in amultinational setting, therewouldbevarious taxingauthorities withwhichtocome to agreements on advance purchase agreementsshould the companydecide to enter into those.14. Anycompanysgreenagendamust beaglobal undertaking; activities inonesegment maycreatecostsandbenefitsforpartorall ofanorganization. Such 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.10$Chapter 13interactions impact thefunction, asset, andriskprofileof an!"and, thus,modify intraorganizational transactions or create ne# value interactions that mustbe considered from a transfer pricing perspective.An important impact of the green agenda is the incorporation of environmentalcosts that havepreviouslybeenavoidedor undervaluedbysomecompanies.Substantive pollution and #aste costs that once #ere included in publice$penditures or ignored are no# being passed along to companies. In a cap%and%trade environment, companies are given a specified pollution limit &the 'cap() forcarbon and other emissions; pollution above that limit is only legally allo#ed ifthe offendingcompanybuys another companys surplus credits**creating anorganizational cost for emissions.+he active markets in emissions credits provide a 'selling,buying( value for them.-o#ever, these values can be variable and volatile because cap%and%trade schemesare localized, and as #ith any market, prices may change because of prevalence orabsence of activity and ne# markets can emerge. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 1310%Intraorganizational sharing of carbon or emissions credits re.uires an appropriatepricing mechanismfor a companys transfer pricing policy and #ill createchallenges and opportunities in identifying an arms%length price. Additionally, thetransferpricingpolicymust accommodatepricefluctuations, differingregionalmarket values, and different values in various parts of the business so that valuecan be optimized for ta$ purposes.PricewaterhouseCoopers,Transfer Pricing and the Green Agenda(2008), pp. 12;http://www.pwc.com/en_GX/gx/tax-management-strategy/pdf/pwc_tax_transfer_pricing_and_the_green_agenda.pdf (last accessed 12/30/11). 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.110Chapter 13E&ERCISES15. a. Cb. Dc. Cd. De. Cf. Cg. Ch. Di. Dj. Ck. Dl. Dm. Cn. D16. a. Ab. Nc. Ad. Ae. Af. Dg. Dh. Ai. N (authority can be delegated, but not responsibility)j. A 17. Each student will have a different answer; however, some importantconsiderations follow.Centralized model: all IT functions (strategy and planning, applicationdevelopment and maintenance, and operations) report directly to a seniorexecutive.All assets (hardware, software, human resources and the budget) arecontrolled by this organization.Advantages of Centralization: Hardwareandsoftwarecanbeobtainedwiththelargesteconomiesofscale(often resulting in a 10 to 15 percent cost savings). Redundant functions, such as multiple help desk support groups, are eliminated. Organizational communications are simpler. Activities are more aligned with overall company strategies. A unified presence is provided to customers and suppliers.Disadvantages of Centralization: If operated as a cost center, ITs enormous budget is often a point of contention. If costs are allocated back to other areas, managers in those areas may believethey are being overcharged. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 13 A very effective decision and resource allocation process is needed since eachbusiness unit can have different or conflicting IT needs. IT outages could cause an entire company to be crippled.The key to a centralized organizations success is its ability to be responsive. Ifthe big, centralized operation can be responsive to the needs of the business, thenthat approachcanmakesense. Whencompanies decide tomoveawayfromdecentralizationbacktocentralizedfunctions, the most commonreasons areusually cost savings and ability to manage the function more effectively.Decentralized model: created when companies adopt specific client/serverarchitectures or occurredduringamerger becauseseparateness was oftenthequickest way to solve the problem of integrating disparate hardware and softwareinfrastructures.Advantages of Decentralization: The ability to integrate disparities after a merger is improved. Managers have their choice of hardware and software acquisition. Managers have the ability to allocate IT resources. There is a perception of faster, more flexible responses to change.Disadvantages of Decentralization: There will be higher total hardware and software costs for the organization. There will be duplication of support needs. There is the possibility of incompatibility of systems. There can be a lack of accountability for problems.Other important information: Type and size of company Level of geographical dispersion Management characteristics Employee levels of motivation and responsiveness18. Each student will have a different answer. No solution is provided.19. a. Pb. Rc. Id. R or Pe. If. Cg. R or Ph. R or Pi. R or Pj. R or Pk. C l. R (or revenue and limited cost)m. C or P (if recoveries were assigned to the unit) 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.11'Chapter 1320. Each student will have a different answer. However, following are some of theunits that may be included.Cost centers: Career services,campus security,financial aid, informationtechnology, custodial, human resources, and accountingProfit centers: Athletics, bookstore, residence halls, cafeterias, internationalprograms, university newspaper/radio station, and community workshops21. a. The EM group is centralized.b. The EM group is probably a profit center; however, it could be an investmentcenter if its manager has control over the groups asset base.c. Having the operating divisions solicit and pay for the EM group projects couldmean that fewer projects are generated than would be likely if the EM groupinitiatedtheproject work; fewerEMprojectswouldmeanfewercostsandhigherprofits. RequiringtheEMgrouptochargeamarket-basedpriceforservices could mean that different divisions, because of their operating locales,are charged different amounts for the same projects. Additionally, whereas amarket price allows the EM group to show profitability, such a price is moreonerous to the operating divisions than a cost-based price would beleadingto a lowered likelihood of usage because of reduced profitability.22. Each student will have a different answer; however some important considerationsfollow.a. In multiple-doctor medical practices, setting up the recordkeeping system toreflect eachdoctor as his/her ownprofit center will giveinsight intotheexpenses each doctor is absorbingagainst revenue directly generated byhim/her. The data generated from this exercise give management another toolin evaluating performance for salary adjustments, bonuses, and promotions.b. The typical software accounting packages used bymedical practices arePeachtree, QuickBooks and Creative Solutions.c. Somedirectlytraceablecosts includesalary, malpracticeinsurance, fringebenefits, conferences and seminars, vehicle expense, meals and entertainment,patient refunds, insurance refunds, travel and lodging, licenses, supplies andvaccines that are used by a specialist, and dues and fees.d. Indirect expenses include building rent, depreciation, equipment leasepayments, interest expense, legal and accounting fees, office supplies, medicalwaste disposal, pension expense, utilities, and staff salaries, taxes and fringebenefits. Allocations bases would include gross revenues generated by doctor,percent of cashreceipts generatedbydoctor, percent of patients seenbydoctor, percent of occupancy space used by doctor, or equal allocation amongall doctors. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 13 23.ASP ASV BSP ASVBSP BSV$38 473,000 $39 473,000$39 460,000$17,974,000 $18,447,000 $17,940,000$473,000 U $507,000 FSales Price Variance Sales Volume Variance$34,000 FTotal Revenue VarianceBecausethecompanysoldunitsat alowerthanplannedprice, $473,000lessrevenue was generated. However, the decrease in selling price was offset by thefact that 13,000 more units were sold than were budgeted. The net result of thesetwo differences created a $34,000 favorable revenue variance.24. ASP ASVBSP ASV BSP BSV$0.68 682,000 $0.70 682,000 $0.70 675,000$463,760 $477,400 $472,500$13,640 U $4,900 FSales Price Variance Sales Volume Variance $8,740 UTotal Revenue VarianceThe company sold 7,000 units more than budget but sold those units at $0.02 lessthanthe budgeted sellingprice, creatinganunfavorable $13,640sales pricevariance. However, since 7,000 more than budgeted were sold, a $4,900 favorablesales volume variance occurred. The combination of these two factors created the$8,740 revenue shortfall.25. a. 30 1.3 = 39 seminars in 2013; 39 $4,200 = $163,800b.ASP ASV BSP ASV BSP BSV$3,675* 42 $4,000 42 $4,000 39 $154,350 $168,000 $156,000$13,650 U $12,000 FSales Price Variance Sales Volume Variance $1,650 UTotal Revenue Variance*$154,350 42 = $3,675 per seminarc. Yi did not achieve his expected revenue because, although he gave three moreseminars than he budgeted, the average price he received for each seminar wasonly $3,675 rather than the budgeted $4,000.26. a. From HR to Fabricating [(0.35 0.80) $630,000]$275,625From Admin. to Fabricating [(0.50 0.90) $450,000]250,000Total $525,625b. From HR to Finishing [(0.45 0.80) $630,000]$354,375From Admin. to Finishing [(0.40 0.90) $450,000] 200,000 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.11Chapter 13Total $554,37527. Checking:Administration (0.30 0.80) $540,000 $ 202,500Human resources (0.30 0.80) $360,000 135,000Accounting (0.40 0.80) $300,000 150,000Direct costs 630,000 $1,117,500Savings:Administration (0.40 0.80) $540,000 $270,000Human resources (0.20 0.80) $360,000 90,000Accounting (0.20 0.80) $300,000 75,000Direct costs337,500 $772,500Loans:Administration (0.10 0.80) $540,000 $67,500Human resources (0.30 0.80) $360,000 135,000Accounting (0.20 0.80) $300,000 75,000Direct costs675,000 $952,50028. Administration ($540,000)Human resources ($540,000 0.10) $54,000Accounting ($540,000 0.10) 54,000Checking ($540,000 0.30) 162,000Savings ($540,000 0.40) 216,000Loans ($540,000 0.10) 54,000$540,000Human resources ($360,000 + $54,000 = $414,000)Accounting $414,000 (0.10 0.90) $46,000Checking $414,000 (0.30 0.90) 138,000Savings $414,000 (0.20 0.90) 92,000Loans $414,000 (0.30 0.90) 138,000$414,000Accounting ($300,000 + $54,000 + $46,000 = $400,000)Checking $400,000 (0.40 0.80) $200,000Savings $400,000 (0.20 0.80) 100,000Loans $400,000 (0.20 0.80) 100,000$400,000Checking: $630,000 + $162,000 + $138,000 + $200,000 = $1,130,000Savings: $337,500 + $216,000 + $92,000 + $100,000 = $ 745,500Loans: $675,000 + $54,000 + $138,000 + $100,000 = $ 967,00029. a. Human resources ($360,000) 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 13 Administration ($360,000 0.10) $36,000Maintenance ($360,000 0.15) 54,000Assembly ($360,000 0.40) 144,000Finishing ($360,000 0.35) 126,000$360,000Administration ($558,000 + $36,000 = $594,000)Maintenance $594,000 (0.10 0.90) $66,000Assembly $594,000 (0.50 0.90) 330,000Finishing $594,000 (0.30 0.90) 198,000$594,000Maintenance ($170,000 + $54,000 + $66,000 = $290,000)Assembly $290,000 (0.45 0.80) $163,125Finishing $290,000 (0.35 0.80) 126,875$290,000b. Assembly:(0.40 $360,000) + [(0.5 0.9) $594,000] + [(0.45 0.8) $290,000] =$144,000 + $330,000 + $163,125 = $637,125Finishing:(0.35 $360,000) + [(0.3 0.9) $594,000] + [(0.35 0.8) $290,000] =$126,000 + $198,000 + $126,875 = $450,875c. The cost allocationis affected bythe order inwhichcosts are assignedbecause the cost allocated from a particular service department depends on theamount of cost allocated to that service department fromother servicedepartments. Theamount ofcostsallocatedfromotherservicedepartmentsdepends on the benefits-provided ranking.30. Admin. HR Acctg.Administration 0.10 0.10Human resources 0.10 0.10Accounting 0.10 0.10 Checking 0.30 0.30 0.40Savings 0.40 0.20 0.20Loans 0.10 0.30 0.20(A) Administration = $540,000 + 0.10B + 0.10C(B) Human resources= $360,000 + 0.10A + 0.10C(C) Accounting = $300,000 + 0.10A + 0.10BB = $360,000 + 0.10($540,000 + 0.10B + 0.10C) + 0.10CC = $300,000 + 0.10($540,000 + 0.10B + 0.10C) + 0.10BB = $360,000 + $54,000 + 0.01B + 0.01C + 0.10CB = $414,000 + 0.01B + 0.11C 0.99B = $414,000 + 0.11CC = $300,000 + $54,000 + 0.01B + 0.01C + 0.10B 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.11"Chapter 13C = $354,000 + 0.11B + 0.01C 0.99C = $354,000 + 0.11BC = $357,576 + 0.1111B 0.99B = $414,000 + 0.11($357,576 + 0.1111B) 0.99B = $414,000 + $39,333 + 0.0122B 0.9778B = $453,333B = $463,625C = $357,576 + 0.1111($463,625)= $357,578 + 51,509= $409,085A = $540,000 + 0.10($463,625) + 0.10($409,085)= $540,000 + $46,362.50 + $40,908.50= $627,271 Admin. HRAcctg. Check. Sav. LoansDirect costs $ 540,000 $ 360,000 $ 300,000 $ 630,000 $337,500$675,000Admin. (627,271) 62,727 62,727 188,181 250,908 62,727HR 46,363 (463,625) 46,363 139,088 92,725 139,088Acctg. 40,90940,909 (409,085)163,634 81,81781,817Total costs$0 $0 $0 $1,120,903 $762,950 $958,632Note: TheAdministration, HumanResources, andAccountingcolumnsdonotsum to $0 because of rounding.31. S1 = $170,000 + 0.40S2 + 0.20S3S2 = $360,000 + 0.10S1 + 0.30S3S3 = $600,000 + 0.20S1 + 0.30S2Substitute S3 into the equations for S1 and S2:(1) S1 = $170,000 + 0.40S2 + 0.20($600,000 + 0.20S1 + 0.30S2)(2) S2 = $360,000 + 0.10S1 + 0.30($600,000 + 0.20S1 + 0.30S2)Simplifying:(1) S1 = $170,000 + 0.40S2 + $120,000 + 0.04S1 + 0.06S2 0.96S1 = $290,000 + 0.46S2S1 = $302,083 + 0.48S2(2) S2 = $360,000 + 0.10S1 + $180,000 + 0.06S1 + 0.09S2 0.91S2 = $540,000 + 0.16S1S2 = $593,407 + 0.18S1Substitute S2 into the equation for S1:S1 = $302,083 + 0.48($593,407 + 0.18S1)S1 = $302,083 + $284,835 + 0.09S10.91 S1 = $586,918S1 = $644,965Substitute S1 ($644,965) into the original S2 and S3 equations:(1) S2 = $360,000 + 0.10($644,965) + 0.30S3(2) S3 = $600,000 + 0.20($644,965) + 0.30S2 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 13 Simplifying:1! S2 = $360,000 + $64,497 + 0.30S3S2 = $424,497 + 0.30S32! S3 = $600,000 + $128,993 + 0.30S2S3 = $728,993 + 0.30S2Substitute S3 into the equation for S2:S2 = $424,497 + 0.30($728,993 + 0.30S2)S2 = $424,497 + $218,698 + 0.09S2 0.91S2 = $643,195S2 = $706,808Substitute S1 and S2 into the original equations and solve for S3:S3 = $600,000 + 0.20($644,965) + 0.30($706,808)S3 = $600,000 + $128,993 + $212,042S3 = $941,035Allocate the service department costs to the other departments:S1 S2 S3RP1 RP2Direct costs $170,000 $360,000 $ 600,000S1 (644,965) 64,497 128,993 $193,490 $257,986S2 282,723(706,808) 212,042 141,362 70,681S3 188,207282,311 (941,035) 376,414 94,104To RP $(4,035)* $0 $0 $711,266 $422,771*off due to rounding32. a. Db. Ac. Dd. Ae. Df. Ag. Ah. Di. Nj. Ak. Al. D33. a. $3 1.80 = $5.40b. ($3 + $2) = $5; $5 1.30 = $6.50c. $10 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.11$Chapter 13d. Sales (40,000 $55) $ 2,200,000Internal cost (25,000 $32) $800,000External cost (15,000 $47) 705,000 (1,505,000)$695,000Operating profit = 15,000 $15 = $225,00034. a. External purchase cost (30,000 $4.50) $ 135,000Internal cost [(30,000 $4.00) + $0 opportunity cost] (120,000)Advantage of purchasing internally $ 15,000b. External purchase cost (30,000 $4.50) $ 135,000Internal cost [($30,000 $4.00) + $25,000 opportunity cost] (145,000)Disadvantage of purchasing internally $(10,000)c. Should the Assembly Divisions external suppliers raise prices in the future,purchasingcosts wouldincreasefor Squish. Aquestionarises as towhathappened to the fixed costs being incurred by the Production Division. Wereall costs eliminated when the division was closed? If not, some or all of theProduction Divisions monthly fixed costs of $30,000 would still have to bepaid by Squishreducing the $25,000 of rental income. If some of the fixedcostswerepersonnel costs, theremaybeacommunityissueofincreasingunemployment or the possibility of terminating long-term, more senior-agedemployees (age discrimination?). 35. a. Upper limit is the best external price = $112.50Lower limit is variable production cost = $54 + Any opportunity costb. Minimum price is current selling price = $16236. a. (1) Variable production cost $40.00Variable selling cost 16.00Total variable cost $56.00 per unit2! Variable production cost $40.00FOH ($1,800,000 1,200,000) 1.50Full production cost $41.50 per unit3! Variable production cost $40.00Fixed selling [$2,400,000 (0.25 1,200,000)]8.00+otal variable production / necessary selling $48.00 per unit(4) Market price $67.00 per unitb. The highest price Elba should choose to sell the units for $63 per unit since noadvertising costs would need to be paid relative to internal sales. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 13 37. a. Lower limit is theincremental variablecost ($9.00+$11.40+$4.80) +Opportunity cost of $43.80 per unit lost CM = $69.00(Lost CM = $72.00 $9.00 $11.40 $4.80 $3.00 = $43.80)This is the normal selling price less the normal variable costs excluding the$3.00 variable selling expense.b. Under these conditions, Peyvandi Co. could accept any price that at least coversvariable production costs: DM $9.00 + DL $11.40 + VOH $4.80 = $25.20 c. $2,606,250 1.25 = $2,085,000 for 50,000 units = $41.70 per unit DM $9.00+ DL $11.40 + VOH $4.80 + FOH $16.50 = $41.70$1,575,000 1.25 = $1,260,000 for 50,000 units = $25.20 per unit DM $9.00+ DL $11.40 + VOH $4.80 = $25.20Joe Dhir was defining cost as variable cost, while Peyvandi Co. was definingcost as absorption cost.38. a. The rapid increase in food costs has created a significant difference between thehistorical cost of items and the replacement cost of items. Because transfersbetweenstoresaremadeathistorical costs, thetransferringstorelosesinthetransaction because it must replace the transferred item at replacement cost. Thissituation creates an incentive for stores to misrepresent the actual inventories onhand when transfers are requested by sister stores.b. The transfer pricing policy could be changed to allow transfers to take place atreplacement cost rather than historical cost. Such a change would remove thedisincentive of the existing policy.39. a. $665,000 700,000 minutes = $0.95 per minuteb. $665,000 1,000,000 minutes = $0.665 per minutec. Expected: 730,000 $0.95 = $693,500Total variance = $689,400 $693,500 = $4,100 FTheoretical: 730,000 $0.665 = $485,450Total variance = $689,400 $485,450 = $203,950 UThe variance could have been caused by volume of activity being above theexpectedlevel or byoperatingcosts exceedingthe expectedlevel. Moreinformation is needed to determine the actual causes.40. Each student will have a different answer. No solution is provided. One recent casethat could be discussed involved GlaxoSmithKline, which settled a transfer pricingdispute with the U.S. Internal Revenue Service in September 2006 for $3+ billionand, asofearly2007, waspreparingforlitigationintheUnitedKingdom. Thecompanys 2006 annual report indicated the problem was related to the years 1994andforward. Seehttp://www.irs.gov/newsroom/article/0,,id=162359,00.html (last 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.1'0Chapter 13accessed 1/2/12). Another case involved computer chip company Xilinx(http://www.taxgirl.com/landmark-transfer-pricing-case-is-it-a-different-world/).Also see http://ustransferpricing.com/decisions.html. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 131'1PROBLEMS41. a. The ethical problems are created when short-run gains can be maximized bydoing what is unethical rather than what is ethical. This situation is created bythe companys incentive system. By narrowly focusing performanceevaluationonprofit-relatedmeasures, thefirmisignoringother importantcritical successfactors. Bymeasuringachievement acrossabroaderset ofcritical success factors, the company could induce the managers to behave in amore ethically acceptable manner. The managers are merely reacting, albeit inan ethically questionable way, to the incentives that have been put in place bythe company.b. By refocusing the performance evaluation measures on a broader set of criticalsuccessfactors, topmanagers caninducelower managerstobehavemoreethically. Top managers need to develop performance measures that are morelong term; focus on customer satisfaction, product quality, and socialresponsibility; and provide managerial training in ethical behavior.(CMA adapted)42. a. The primary cause of the trend was the availability of new technology thatwas supposed to enhance communications such as wireless phones, notebookcomputers, and handheld monitoring devices.b. One of the major problems is still communications because the patients entiremedical team still needs to collaborate and interact. The decentralized stationscreated a problem in that they often replaced the centralized stations, so nursesandphysicians hadtomeet inhallways for discussions oftenwithinthehearing range of a patient who was not the patient being discussed, which couldcreate ethical dilemmas . . . and increasing the noise level that could disturb apatients rest andabilitytorecover. Additionally, thedecentralizedstationsdistancedthenursesfromtheircolleagues, whichlimitedtheabilitytoshareprofessional expertise with one another as well as engage in the socialization thatis important to job enhancement and development of a team perspective. Theisolation made it hard to help out in emergencies or even to know if a nursesstation on the same floor might be short-handed. To adjust the situation, hospitalsarenowreconfiguringfloorlayoutstohavedecentralizedstationsaswell ascentralized stations; the latter tend to be designed as data centers for a variety ofequipment, interactive communication stations, medicine-storage facilities,supplyintakeoperations, andloungeareas. Combiningthedecentralizedandcentralized concepts retain the patient benefit of close contact, but eliminate thenoise and overhearing possibilities as well as encourage nurse interactions andpromote team spirit.43. a. The report is not in accordance with the concept of responsibility accounting, inwhich each managers performance is judged by how well he/she manages thoseitems directly under his/her control. Responsibility accounting does not recognizethe allocation of common costs to segments. While including the corporate costs 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.1''Chapter 13may be useful in calling attention to these activities, differences betweenbudgetedand actualfortheseitems are beyondthe control ofthe MachiningDepartment supervisor and are not properly chargeable to him/her. Thus,corporate costs should not be included in the report.The report comparesactualperformance to a staticbudget.Astaticbudgetfails todistinguish between the supervisors production control andcostcontrol responsibilities. Cost control isinvolvedwithseeingthat output isproducedat theleast possiblecost, consistent withqualitystandards. Alldollar amounts in the report deal with cost control and tell nothing about howwell variable costs were controlled during the month. Budget costs are basedon a 3,000 units-per-month activity level, whereas actual costs were incurredat an activity level of 3,185 units per month. The report should use a flexiblebudget because it can be tailored for any level of activity within a relevantrange. This would result in the meaningful comparison of the actual cost ofproducing 3,185 units with the budgeted cost of producing 3,185 units.Without additional information, it cannot be known which of the fixedmanufacturingOHitemsarecontrollableat thedepartment level. Onlythecosts over which the department has control should be included in the report.Also, inclusion of the FOH costs indicates that they are a necessary part of themanufacturing activity, which may not be true.b.Machining Department Performance ReportFor the Month Ended October 31, 2013BUDGET ACTUAL VARIANCEUnits 3,185 3,1850Controllable costsVar. mfg. costsDM $9.00$28,665$8.80 $28,028 $0.20$ 637 FDL 9.5030,258 9.4530,098 0.05 160 FVOH 11.1035,354 11.0035,035 0.10 319 FTotal $29.60$94,277 $29.25$93,161 $0.35$1,116 FNoncontrollable costsIndirect labor $3,300 $3,334 $ (34) UDepreciation 1,500 1,5000Taxes 300 3000Insurance 240 2400Other930 1,027(97) UTotal fixed OH $6,270 $6,401 $ (131) UTotal mfg. costs $100,547 $99,562$985Fc. Reviewfavorable unit andcomponent variances todetermine if realisticbudgets were set. Note that all of the controllable manufacturing costvariances werefavorable. Theonlyvarianceexceeding5percent was thesmall $97variance for the other category, andperhaps this shouldbeanalyzed. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 131'3 (CMAadapted)44. a. The most significant problem is that variances have been computed by comparinga static budget to actual expenses. To evaluate cost control, variances should becomputed by comparing a flexible budget at the actual activity level to actualcosts. Also, the performance evaluation does not contain auxiliary performancemeasures such as measures of customer service, win/loss records, etc.Flexible Budget Actual VarianceActivity # of cases 2,9702,970Variable costsProfessional labor $2,970,000 $2,820,000$150,000 FTravel 148,500120,00028,500 FSupplies 297,000270,00027,000 FFixed costsProfessional labor 1,200,0001,215,000 15,000 UFacilities 750,000795,000 45,000 UInsurance240,000234,0006,000 FTotal $5,605,500 $5,454,000$151,500 Fc. Thevariancesthat aremost likelytobeinvestigatedaretheonesthat arematerialandmaybe attributedtocontrollable factors.The most significantvariancesareforthoseforprofessional labor(5percent undertheflexiblebudget), travel (19 percent under the flexible budget), facilities (6 percent overthe flexible budget), and supplies &0 percent under the fle$ible budget).45. a. Budget Actual VarianceDirect labor $ 375,000 $300,000 $ 75,000 FRepairs 75,000 80,000 5,000 UMaintenance 450,000 325,000125,000 FIndirect labor 75,000 77,500 2,500 UPower150,000 157,500 7,500 UTotals $1,125,000 $940,000$185,000 Fb. Althoughthebottomlineispositive, questionsneedtobeaskedabouttheextremelyfavorablevariancesexistinginthedirect laborandmaintenancecategories. Were less experienced (and, thus, lower paid) workers used duringthe period, andif so, howwas productionquality? Was thedecrease inmaintenance spending appropriate, or will it cause machine failures in futureperiods?c. Promotiondecisions shouldbedeferreduntil theanswerstothequestionsposed in (b) can be answered in depth.d. It is possible that many, if not all,of the costs shown on the responsibilityreport are not under Rigeras control. The costs of direct and indirect labormayberelatedtolabor unioncontractsorraterenegotiations; repairsand 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.1'Chapter 13maintenance may be related to the costs of supplies or machinery failures; andpower may be related to utility company rate adjustments. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 131'!46. a. Revenues ($900 100)$90,000Variable costs:Meals ($10 9 106)$9,540Lodging ($75 3 106)23,850Supplies ($10 106) 1,060 (34,450)Contribution margin $55,550Direct fixed costs:Speakers ($2,500 each) $15,000Rent on facilities 3,600Advertising 4,000(22,600)Segment margin $32,950Allocated fixed costs (0.25 $90,000) (22,500)Net operating income $10,450b.Revenues ($850 120)$102,000Variable costs:Meals ($10 9 1.15 126)$13,041Lodging ($75 3 126) 28,350Supplies ($10 126) 1,260(42,651)Contribution margin $59,349Direct fixed costs:Speakers ($2,950 6) $17,700Rent on facilities4,200Advertising4,900 (26,800)Segment margin $32,549Allocated fixed costs (0.25 $102,000)(25,500)Net operating income $7,049c. ASP ASV BSP ASV BSP BSV$850 120 $900 120 $900 100$102,000 $108,000 $90,000$6,000 U $18,000 FSales Price Variance Sales Volume Variance$12,000 FTotal Revenue Variance 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.1'"Chapter 13Original Flexible BudgetBudget Actual VarianceRevenues $ 90,000 $108,000 $102,000 $ 6,000 UVariable costs:Meals $ 9,540 $11,340 $13,041 (1,701) ULodging 23,850 28,350 28,350 (0)Supplies1,060 1,260 1,260(0)Contribution margin $ 55,550 $67,050 $59,349Direct fixed costs:Speakers (15,000) (15,000) (17,700) (2,700) URent on facilities (3,600) (3,600) (4,200) (600) UAdvertising (4,000) (4,000) (4,900)(900) USegment margin $ 32,950 $44,450 $32,549Allocated fixed costs (22,500)(27,000) (25,500)(1,500) FNet operating income $ 10,450 $17,450 $7,049 $(10,401) UBy far, given that revenues exceeded the budget, the two biggest contributorsto the seminars decreased profitability were the failure to include thespeakers airfare in the original budget and the failure to include the gratuityon the meals. Also contributing to the reduced profitability were higher thanexpectedfixedcostsforrent andadvertising. However, theflexiblebudgetshowsthat variablecostswerebudgetedcorrectlyperparticipant, withtheexception of the gratuity.47. a. CRMistypicallydefinedastheprocessof finding, getting, andretainingcustomers. CRMisalsodefinedastrackingcustomer behavior todevelopmarketing and relationship-building programs that bond consumers to a brandoftenbydevelopment of software systems toprovide one-on-onecontactbetween the marketing business and their customer. CRM is the core of anycustomer-focusedbusinessstrategyandincludesthepeople, processes, andtechnology associated with sales, marketing, and service.b. Each student will have a different answer. No solution is provided.c. Each student will have a different answer. No solution is provided. However,contact centers that are engaged in answering customer questions andproviding help services will typically be cost centers; those that have beendesigned to engage in product sales will typically be profit centers.d. Each student will have a different answer. No solution is provided. However,contact center costs could be allocated to revenue-producing areas based onnumber of people, timespent onservices relatedtoaparticular product,dollars of revenues, etc.e. Each student will have a different answer. No solution is provided. However,the following measurements may be useful: Average time to answer calls Percent of calls abandoned 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 131'# Percent of calls that needed to be referred to another representative Average number of issues handled per call Average call-handling time Employee turnover Number of caller complaints; number of caller complaints peremployee Number of instances of reported identity theft48. a. Viewing child-care facilities as a cost center could create a negativeperspective of such operations from the companys standpoint. As such, thecompany might try to control or reduce the costs of the child-care facilities byengaging in one or more of the following actions: Hiring less-qualified, lower-paid staff personnel Reducing janitorial and/or maintenance activities Limiting the number of staff to less-than-necessary Purchasinglow-qualityequipment, toys, etc. that couldbe potentiallyharmful to the children Setting heating/air conditioning thermostats too high or too low to save onelectrical,gas costs Providing unhealthy or low quality food and snacksb. Each student will have a different answer. No solution is provided. However,it should be pointed out that desiring a particular rate of return on the facilitiescan also create some problems because the facilities may no longer be seen asan employee benefit but, instead, a way for the company to increase its bottomline. Such a perspective could also lead to some of the same actions discussedin (a) or employees could continually find their charges increasing because thecompany did not seek to control costs since they would be passed along in theformof increased charges. It would probably be most beneficial to theemployees for the company to attempt to break even on the child-care facilityrather than view it as a profit enhancer.Another possibility is for the company to allocate the cost of the facility torevenue-producing departments. Such an action, however, might be difficultbecause of the difficulty in finding a reasonable allocation base. For example,number of employees is not appropriate because all employees do not havechildrennorwouldall thosehavingchildrenchoosetheusethechild-carefacilities.c. Each student will have a different answer. No solution is provided.49. a. Footballs: $1,200,000 $60 = 20,000 unitsShoulder pads: $1,800,000 $45 = 40,000 unitsb. Sales volume variance = $60 (21,000 20,000) = $60,000 Fc. Actual volume = 40,000 ($360,000 $45) = 40,000 8,000 = 32,000 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.1'$Chapter 13Actual price = $1,680,000 32,000 = $52.50Sales price variance = 32,000 ($52.50 $45) = 32,000 $7.50 = $240,000 Fd. Total sales price variance ($63,000 U + $240,000 F)$177,000 FTotal sales volume variance ($60,000 F + $360,000 U) 300,000 UTotal sales variance $123,000 UBudgeted revenue exceeded actual revenue by $123,000 for two reasons. First,footballs weresoldat alower price thanbudgeted, andsecond, toofewshoulder pads were sold. These negative effects were partially offset by (1) ahigher price for shoulder pads and (2) a higher-than-planned sales volume offootballs.50. a. Actual sales volumesHD radio tuners: $195,500 $115 = 1,700 unitsSatellite radios: $141,400 $70 = 2,020 unitsMP3 car decks: $228,250 $55 = 4,150 unitsSales price variancesHD radio tuners: 1,700 ($120 $115)= $8,500 USatellite radios: 2,020 ($68 $70) = 4,040 FMP3 car decks:4,150 ($60 $55)= 20,750 UTotal$25,210 Ub. Sales volume variancesHD radio tuners: $120 (1,600 1,700) = $12,000 FSatellite radios:$68 (2,100 2,020) = 5,440 UMP3 car decks:$60 (1,050 4,150) = 186,000 FTotal $192,560 Fc. Overall, the sales price variance was $25,210 unfavorable and, approximately82 percent of this was caused by negative price variance of the MPS car decks.These results could be attributed to short-term economic pressures or marketingtactics used by Taub. Assuming the results reflect a rational strategy, Taub mayhave accepted lower prices to increase the overall volume of saleswhich isindicatedby the highvolume ofMP3cardecksales. Theresults could alsoindicateatrendthat morecustomersareoptingtopurchaseMP3cardecksbecause theyprefer tolisten tothe music theyhave selected rather thansomeone elses choices as would be the case with either of the other musicoptions.d. BytellingTaubthat her performance wouldonlybe evaluated onthreespecific products, she would tend to ignore other products in her area, whichcould have been more appropriate to customers needs. Taub might also nothave understood whether she was being evaluated on the basis of volume orrevenue. If she believed that the company was concerned about the volume ofproductsales,Taubcan pointto thefactthat volumes for two of thethreeproducts werehigher thanbudgeted, whichcouldhavebeenforced byreducing selling prices. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 131'%51. a. Actual sales price = $235,000 5,000 = $47Budgeted sales price = $300,000 6,000 = $50ASP ASV BSP ASV BSP BSV$47 5,000 $50 5,000 $50 6,000$235,000 $250,000 $300,000$15,000 U $50,000 USales Price Variance Sales Volume Varianceb. Thebudgetedcontributionmarginwas$120,0006,000or $20per unit.Sincethecompanyssalesvolumewas1,000unitslessthanbudgeted, thetotal impact on the companys contribution margin would be a reduction of$20,000 from what was budgeted.c. To isolate the effect on operating income of an increase or decrease in marketshare, thecompanymust knowitsbudgetedandactual market shares, theactual size of the market share for November 2013, and the budgetedweighted- averageunit contributionmargin. Thesecomputations mayhelpFolsoms managers determine whether the decline in sales was due to a loss ofcompetitiveness or a shrinkage of the overall market.d. Performance evaluation would be limited, because in most instances,managersarealsoresponsibleformanagingsomecostsintheircenters. InFolsomscase,evaluationofthecontrol overvariableandfixedcostsgoesbeyond the sales price and sales volume variances. 52. Assets # of Hours ofEmployed % Employees % Operation %Surgery $3,948,500 53 20 20 24,850 35In-patient 2,458,500 33 36 36 28,400 40Out-patient 1,043,000 14 44 44 17,750 25$7,450,000 100 71,000Administration costs:Surgery: $5,400,000 0.53 = $2,862,000In-patient: $5,400,000 0.33 = $1,782,000Out-patient: $5,400,000 0.14 = $756,000Public relations cost:Surgery: $1,100,000 0.20 = $220,000In-patient: $1,100,000 0.36 = $396,000Out-patient: $1,100,000 0.44 = $484,000Maintenance and janitorial cost:Surgery: $1,700,000 0.35 = $595,000In-patient: $1,700,000 0.40 = $680,000Out-patient: $1,700,000 0.25 = $425,000 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.130Chapter 13Surgery In-Patient Out-PatientAdministration $2,862,000 $1,782,000 $ 756,000Public Relations 220,000 396,000 484,000Maintenance595,000680,000425,000Total $3,677,000 $2,858,000 $1,665,00053. a.Administration: 45 + 210 + 18 = 273Commercial = 45 273 = 16%; 0.16 $1,500,000 = $240,000Residential = 210 273 = 77%; 0.77 $1,500,000 = $1,155,000Property Mgmt. = 18 273 = 7%; 0.07 $1,500,000 = $105,000 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 13131Accounting = $900,000 + $1,440,000 + $540,000 = $2,880,000Commercial = $900,000 $2,880,000 = 31%; 0.31 $990,000 = $306,900Residential = $1,440,000 $2,880,000 = 50%; 0.50 $990,000 = $495,000Property Mgmt. = $540,000 $2,880,000 = 19%; 0.19 $990,000 =$188,100Promotion: $10,000,000 + $18,000,000 + $2,000,000 = $30,000,000Commercial = $10,000,000 $30,000,000 = 33%; 0.33 $720,000 = $237,600Residential = $18,000,000 $30,000,000 = 60%; 0.60 $720,000 = $432,000Property Mgmt. = $2,000,000 $30,000,000 = 7%; 0.07 $720,000 =$50,400b. Comm. Res. Prop. Mgmt.Revenue $ 10,000,000 $18,000,000 $2,000,000Direct costs (10,490,000) (9,179,000) (398,400)Allocated costs:Administration (240,000) (1,155,000) (105,000)Accounting (306,900) (495,000) (188,100)Promotion(237,600)(432,000) (50,400)Operating income $(1,274,500) $6,739,000 $1,258,100 54. a. Administration costs ($1,500,000)Base AllocationAccounting15 300 $ 75,000Promotion12 300 60,000Commercial45 300 225,000Residential210 300 1,050,000Property Mgmt.18 30090,000Total (rounded) $1,500,000Accounting costs ($990,000 + $75,000 = $1,065,000)BaseAllocationPromotion$720,000 $3,600,000 $ 213,000Commercial$900,000 $3,600,000 266,250Residential$1,440,000 $3,600,000 426,000Property Mgmt.$540,000 $3,600,000 159,750Total (rounded) $1,065,000Promotion ($720,000 + $60,000 + $213,000 = $993,000) Base AllocationCommercial $10,000,000 $30,000,000 $331,000Residential $18,000,000 $30,000,000 595,800Property Mgmt. $2,000,000 $30,000,000 66,200$993,000Summary of allocations:Commercial: $225,000 + $266,250 + $331,000 = $822,250Residential: $1,050,000 + $426,000 + $595,800 = $2,071,800Property Mgmt.: $90,000 + $159,750 + $66,200 = $315,950 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.13'Chapter 13 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 13133b. Commercial Residential Property Mgmt.Revenues $ 10,000,000 $18,000,000 $2,000,000Direct costs (10,490,000) (9,179,000)(398,400)Indirect costs(822,250)(2,071,800) (315,950)Income$ (1,312,250) $6,749,200 $1,285,650The Property Management Department is the most profitable with a return onrevenues of 64.3 percent.55. a. Personnel: 72 + 48 = 120Residential = 72 120 = 60%; 0.60 $140,000 = $84,000Commercial = 48 120 = 40%; 0.40 $140,000 = $56,000Administration: $480,000 + $800,000 = $1,280,000Residential = $480,000 $1,280,000 = 37.5%; 0.375 $180,000 = $67,500Commercial = $800,000 $1,280,000 = 62.5%; 0.625 $180,000 = $112,500Total support costs allocated to Residential = $84,000 + $67,500 = $151,500Total support costs allocated to Commercial = $56,000 + $112,500 = $168,500b. # of Empl. % Direct Costs %Administration 30 20%Residential 72 48% $480,000 37.5%Commercial 48 32% 800,000 62.5%150Personnel = $140,000 of costsAdministration = 0.20 $140,000 = $28,000Residential = 0.48 $140,000 = $67,200Commercial = 0.32 $140,000 = $44,800Administration = $180,000 + $28,000 = $208,000 of costsResidential = 0.375 $208,000 = $78,000Commercial = 0.625 $208,000 = $130,000Total support costs allocated to Residential = $67,200 + $78,000 = $145,200Total support costs allocated to Commercial = $44,800 + $130,000 = $174,800c. (1) Direct MethodResidential = $480,000 + $151,500 = $631,500; $631,500 60,000 = $10.53Commercial = $800,000 + $168,500 = $968,500; $968,500 570,000 =$1.70(2) Step MethodResidential = $480,000 + $145,200 = $625,200; $625,200 60,000 = $10.42Commercial = $800,000 + $174,800 = $974,800; $974,800 570,000 =$1.7156. ADMINISTRATION EDITORIALDepartment Base % Base % 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.13Chapter 13Admin. (A) N/A N/A 5 11.11Editorial (E) $ 75,0006.25 N/A N/ACollege Texts 600,00050.00 25 55.56Prof. Pubs.525,00043.75 15 33.33Total $1,200,000 100.00 45100.00 rounded A = $225,000 + 0.1111E E = $175,000 + 0.0625A A = $225,000 + 0.1111($175,000 + 0.0625A) A = $225,000 + $19,443 + 0.0069A0.9931A = $244,443 A = $246,141 E = $175,000 + 0.0625($246,141) E = $175,000 + $15,384 E = $190,384CollegeDept. Admin.Edit. TextsProf. Pubs.Direct costs $ 225,000 $ 175,000 $2,250,000 $ 950,000Admin. (246,141) 15,384 123,071 107,687Edit.21,152 (190,384)105,77763,455Total $0 $0 $2,478,848 $1,121,142Note: The Administration column does not sum to zero because of rounding.57. a. Assets Employed % # of Employees %Adv. $ 381,200 29 632Cir.935,15071 13 68$1,316,350 100% 19100% Adv. Cir.Admin. &1.20 3401,561; 1.57 3401,561) $113,318 $277,433H. Res. &1.42 3289,461; 1.9: 3289,461)78,832 167,518$192,150 $444,951b. Adv.: $478,900 + $192,150 =$ 671,050Cir.: $676,300 + $444,951 =1,121,251$1,792,301 (off due to rounding)c. Admin. ($390,750):BaseAllocationH. Res. $145,850 $1,462,200 $38,976Adv. $381,200 $1,462,200 101,870Cir. $935,150 $1,462,200249,904$390,750H. Res. ($246,350 + $38,976) = $285,326:BaseAllocationAdv. 6 19 $90,103Cir. 13 19 195,223 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 1313!$285,326d. Adv.: $478,900 + $101,870 + $90,103 = $ 670,873Cir.: $676,300 + $249,904 + $195,223 = 1,121,427$1,792,300e.ADMIN.H. RES. Department Base % Base % Admin. (A) N/A N/A 5 21 H. Res. (H) $ 145,850 10 N/A N/A Adv. 381,200 26 6 25 Cir.935,150 64 13 54$1,462,200 24A = $390,750 + 0.21HH = $246,350 + 0.10AA = $390,750 + 0.21($246,350 + 0.10A)= $390,750 + $51,733.50 + 0.021A 0.979A = $442,483.50A = $451,975H = $246,350 + 0.10($451,975)= $246,350 + $45,197.50= $291,548Admin. H. Res. Advertising CirculationDirect costs $ 390,750 $ 246,350 $478,900 $ 676,300Admin.(451,975) 45,198 117,514 289,264H. Res.61,225(291,548) 72,887157,436$0 $0 $669,301 $1,123,00058. a. Administrative Costs ($2,130): (000s omitted) Base AllocationLegal/Acctg. 40 800 $ 106.50Maint./Eng. 60 800 159.75Proc.400 8001,065.00Finish.300 800 798.75 $2,130.00Legal/Acctg. ($1,680 + $106.50 = $1,786.50):BaseAllocationMaint./Eng. 400 4,000 $ 178.65Proc. 1,600 4,000 714.60Finish. 2,000 4,000893.25 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.13"Chapter 13$1,786.50Maint./Eng. ($2,370 + $159.75 + $178.65 = $2,708.40): Base AllocationProc. 136 340 $1,083.36Finish. 204 3401,625.04$2,708.40Summary of allocation:Proc.: $1,065 + $714.60 + $1,083.36 + $7,520 = $10,382.96Finish.: $798.75 + $893.25 + $1,625.04 + $7,200 = $10,517.04 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 1313#Factory overhead rates:Proc.: $10,382.96 400 = $25.96 per direct labor hourFinish.: $10,517.04 300 = $35.06 per direct labor hourb. Floor Space% # of Employees % # of Hours%Proc. 1,600 44 400 57 136 40Finish. 2,000 56 300 43 204 603,600 700 340 Proc. Finish.Admin. $1,214 $ 916Legal/Acctg. 739 941Maint./Eng.948 1,422Total $2,901 $3,279Factory overhead rates:Proc.: ($7,520 + $2,901) 400 = $26.05 per direct labor hourFinish.: ($7,200 + $3,279) 300 = $34.93 per direct labor hourc. ADMIN. LEGAL/ACCTG. MAINT./ENG.Department Base % Base %Base %Admin. (A) N/A N/A 800 16.67 30 7.32Legal/Acctg. (L) 40 5.00 N/A N/A 409.76Maint./Eng. (M) 60 7.50 400 8.33 N/A N/AProc. 400 50.00 1,600 33.33 13633.17Finish. 300 37.50 2,000 41.67 204 49.76800 4,800 410A = $2,130 + 0.17L + 0.07ML= $1,680 + 0.05A + 0.10MM = $2,370 + 0.075A + 0.08LA = $2,130 + 0.17($1,680 + 0.05A + 0.10M) + 0.07MA = $2,130 + $285.60 + 0.0085A + 0.087M 0.9915A = $2,415.60 + 0.087MA = $2,436 + 0.088MM = $2,370 + 0.075A + 0.08($1,680 + 0.05A + 0.10M)M = $2,370 + 0.075A + $134.40 + 0.004A + 0.008M 0.992M = $2,504.40 + 0.079AM = $2,525 + 0.0796ASubstituting M:A = $2,436 + 0.088($2,525 + 0.0796A)A = $2,436 + $222.20 + 0.007A 0.993A = $2,658.20A = $2,677 M = $2,525 + 0.0796($2,677)= $2,525 + $213.09= $2,738 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.13$Chapter 13L = $1,680 + 0.05($2,677) + 0.10($2,738)= $1,680 + $133.85 + $273.80= $2,088Admin. L/AM/E Proc.Fin.Direct costs $2,130 $1,680 $2,370 $7,520 $7,200Admin. (2,677) 134 201 1,339 1,004Legal/Acctg. 355(2,088) 167 689 877Maint./Eng.192274(2,738)904 1,369$ 0 $ 0 $ 0 $10,452 $10,450Factory overhead rates:Proc: $10,452 400 = $26.13 per direct labor hourFinish: $10,450 300 = $34.83 per direct labor hour59. Allocation of computer services costs should be made on an hours used basis topermit amoreefficient useofcompanyresources. Thechargingbasisshouldencourage users to take advantage of the Computer Systems Departmentsservices but not permit the Computer Systems Department to pass on itsinefficiencies. Forinstance, astandardhourlyusagerateshouldbedevelopedbased on past experience, adjusted for efficiency considerations. Divisions wouldbe charged the standard rate for the hours of recorded usage.(CMA adapted)60. a. Case 1 upper limit = $70Case 1 lower limit = [$32 + $12 + $4 + ($6 $1)] + (Lost CM of $26) = $79Lost CM = $80 ($32 + $12 + $4 + $6) = $26Case 2 upper limit = $57Case 2 lower limit = [$22 + $10 + $3 + ($3 $1)] + (Lost CM of $27) = $64Lost CM = $65 ($22 + $10 + $3 + $3) = $27Interpretation: When, as in both cases in this problem, the lower limit exceedsthe upper limit,the intracompany transfers should not be made because thecompany will be worse off.b. Selling price = Variable cost + $12Case 1 selling price = [$32 + $12 + $4 + ($6 $1)] + $12 = $65Case 2 selling price = [$22 + $10 + $3 + ($3 $1)] + $12 = $49c. Dual transfer prices for Case 1: Speakers selling price [from (b)] = $65 SoundSystems purchase price = ($70 $12) = $58Speakers Division manager should demonstrate that the whole company willbe worse off if this is done based on the answer to (a): Contribution margin lost by Speaker Division $ 26Savings to Sound System by purchasingbelow the external purchase price ($70 $58) (12)Loss to company per unit transferred $ 14 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 1313%61. a. Current external selling price, $10,464SellingDivisionfairvaluesincemostareproducedandsoldatthispriceexternally.Buying Divisionprice is higher than outside vendor price so this would makeits performance report appear worse than by buying externally.Total variable production cost ($4,200) + 20% = $5,040Selling Divisioncontributes minimally to covering fixed costs, andtherefore, no profit is shown from these sales as opposed to external sales.There is little incentive to sell internally if the selling division can sell all itsoutput externally.Buying Divisionless than external purchase price, therefore it is morebeneficial to the bottom line of Ludmilla Company.Total product ($6,000) cost + 20% = $7,200SellingDivisioncovers some but not all costs for this division, thereforeincentivetosell internallyisnt thereif EngineDivisioncansell its outputexternally.Buying Divisionpurchase price below external so better for margin in thisdivision.Bid price from external supplier ($9,280)Selling Divisionallows for some profit which is an incentive to sellinternally unless it can sell all its output externally.Buying Divisionno incentive to buy internally since it costs the same as tobuy from an external supplier.b. Upper limit = $9,280Lower limit = costs of $4,800 + Contribution margin of $5,664 = $10,464Since the lower limit exceeds the upper limit, the company would be better offnot making the internal transfers.62. a. Roll-Em-On SkyWheelsA/R (SW Div.) 640,000 Inventory 640,000Intraco. Sales 640,000 A/P (REO Div.) 640,000Worldly TravelersIntraco. CGS368,000Finished Goods368,000[4,000 ($40 + $12 + $16 + $24) = 4,000 $92]b. Variable cost = $40 + $12 + $16 + $8 = $76; $76 + (0.15)($92) = $89.80 Total transfer cost = 4,000 $89.80 = $359,200Roll-Em-On SkyWheelsA/R (SW Div.)359,200 Inventory 359,200Intraco. Sales359,200 A/P (REO Div.) 359,200Worldly Travelers Intraco. CGS 368,000Finished Goods368,000 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.10Chapter 13[4,000 ($40 + $12 + $16 + $24) = 4,000 $92]c. Roll-Em-OnSkyWheels A/R (SW Div.) 272,000 Inventory 272,000Intraco. Sales in Excess of Assigned Cost 368,000A/P (REO Div.) 272,000Intraco. Sales 640,000Worldly TravelersIntraco. CGS368,000Finished Goods 368,000d.Roll-Em-On SkyWheelsA/R (SW Div.) 368,000 Inventory 368,000Intraco. Sales 368,000 A/P (REO Div.) 368,000Worldly Travelers.Intraco. CGS 368,000Finished Goods 368,00063. a. Plain CookiesDecorated Cookies Company TotalSalesTo outsiders $ 6,000 $ 3,200 $ 9,200To other division 0 0Variable costs:Cookies (1,500)(1,600) (3,100)Other costs (600)(600)Contribution margin $ 4,500$ 1,000 $ 5,500Fixed costs (300) (500)(800)Segment margin $ 4,200 $500 $ 4,700Bonus (10%)(420) (50) (470)Operating income $ 3,780 $450 $ 4,230b. SincethePlainCookiesDivisioncurrentlyhasexcesscapacity, thelowesttransfer price should be its variable cost plus the opportunity cost. With excesscapacity, opportunity cost is $0. The lowest transfer price is $0.50 per cookie.Since the manager of the Decorated Cookies Division would buy from outsidevendors at a price in excess of the market price of $2 per cookie, the highesttransfer price would be $2.c. Transfer price of $0.50 per cookiePlain CookiesDecorated CookiesCompany Total SalesTo outsiders $ 6,000 $3,200 $ 9,200To other division 400 0Variable costs:Cookies(1,500) (400)(1,500)Other costs (400) (600)(1,000) 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 1311Contribution margin $ 4,500 $2,200 $ 6,700Fixed costs(300) (500) (800)Segment margin $ 4,200 $1,700 $ 5,900Bonus (10%)(420) (170) (590)Operating income $ 3,780 $1,530 $ 5,310Note: The intracompany revenue of $400 and intracompany cost of $400 havebeen eliminated in the company total income statement. Daviss bonus increases by $120 because of the $1,200 cost savings frombuyingcookies fromPlainCookies Divisionrather thanfromoutsidesuppliers (savings of $1.50 per cookie 800 decorated cookies). Cookie Delights segment margin increases by the same $1,200. Lindens bonusremains that samebecausethePlainCookiesDivisionmakesnoadditional moneyonthetransferofcookiestotheDecoratedCookies Division.Transfer price of $2.00 per cookie Plain Cookies Decorated Cookies Company TotalSalesTo outsiders $ 6,000 $ 3,200 $ 9,200To other division 1,600 0Variable costs:Cookies(1,500)(1,600)(1,500)Other costs (400) (600)(1,000)Contribution margin $ 5,700 $ 1,000 $ 6,700Fixed costs (300) (500) (800)Segment margin $ 5,400 $500 $ 5,900Bonus (10%) (540) (50) (590)Operating income $ 4,860 $450 $ 5,310Note: The intracompany revenue of $1,600 and intracompany cost of $1,600have been eliminated in the company total income statement. Daviss bonus remains at $50 because there is no cost savings from buyingcookies from Plain Cookies Division rather than from outside suppliers. CookieDelightssegment marginstill increasesby$1,200becausethecompanys cost per cookie is $0.50 rather than $2.00. Lindens bonus increases by $120, which is 10 percent of the $1,200 profithis division makes on selling plain cookies to Decorated Cookies Divisionfor $1,200 more than they cost to make.d. The computations show that Cookie Delight Company is better off at any valuebetween the lowest transfer price of $0.50 and the highest transfer price of $2because of the companys cost savings frommakingthe cookies that theDecorated Cookies Division uses rather than buying them from the outside.However, because of the bonus structure, Linden would prefer the $2 transferprice while Davis would prefer the $0.50 transfer price. The optimum solutionis to encourage the division managers to negotiate an acceptable transfer price. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.1'Chapter 13A negotiated transfer price of $1.25 would encourage both division managersto transfer internally and create goal congruence in the company.64. a. Tomaximizeshort-runcontributionmargin, theAlbertonDivisionshouldaccept the contract from New London Company. This conclusion is supportedby the following calculations.(1)Alberton transfer to Summerside:Transfer price (1,500 $1,500)$ 2,250,000Variable costPurch. from OLeary (1,500 $600)$900,000Process by Alberton (1,500 $500)750,000 (1,650,000)Contribution Margin $600,000(2) Alberton accepts New London contract:Selling price (1,750 $1,250)$ 2,187,500Variable costPurch. from OLeary (1,750 $500) $875,000Process by Alberton (1,750 $400)700,000 (1,575,000)Contribution Margin $612,500Conclusion:Contribution margin from New London contract $ 612,500Contribution margin from Summerside sale(600,000)Difference in favor of New London contract$ 12,500b. Alberton Divisions decision to accept the contract from New London Companyis in the companys best interest because the decision increases the companysoverall contribution margin. This conclusion is supportedbythe followingcalculations.Revenues and cost savings to Charlottetown Inc:Sale: Alberton to New London (1,750 $1,250) $2,187,500Sale: OLeary to Montague (1,500 $400) 600,000Cost savings (variable costs avoided by notnot accepting the Summerside order)OLearys savings (1,500 $300) 450,000Albertons savings (1,500 $500) 750,000$ 3,987,500Expenditures incurred by Charlottetown Inc.Variable costs incurred for New London orderAlberton (1,750 $400) $700,000OLeary (1,750 $250) 437,500Variable cost incurred for purchaseSummerside from Montague (1,500 $1,500)2,250,000Montague from OLeary (1,500 $200) 300,000(3,687,500)Positive contribution margin $300,000(CMA adapted) 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 131365. a. Total EDP hours used = 1,220 + 650 + 190 = 2,060Transfer price revenue = 2,060 $80 = $164,800Actual variable EDP costs = $181,280 = $88 transfer priceTotal EDP hours used 2,060The $80 transfer price is inadequate because the EDP Department is left with aloss (for internal evaluation purposes) of ($181,280 $164,800) or $16,480. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.1Chapter 13b. and c. Allocate administrationcosts of $900,000andfixedEDPcosts of$600,000:Lit. FP LC TotalAdministration ($900,000)(10/18, 5/18, 3/18) $ 500,000 $ 250,000 $150,000 $ 900,000EDP-Fixed ($600,000)(80/345,240/345,25/345) 139,130417,392 43,478 600,000Total allocated $ 639,130 $ 667,392 $193,478 $1,500,000Transfer costs 97,600 52,000 15,200 164,800Direct costs400,000510,000 680,000 1,590,000Total $1,136,730 $1,229,392 $888,678 $3,254,80066. To achieve CarryOn!s goals, the division manager should purchase the materialsneeded at the lowest price available to CarryOn! Division at the present time. Thethree possible prices are as follows:Koenigs price $8.00HIDEs price 9.00Thompsons price 7.00CarryOn! Division should purchase from Thompson.For CarryOn! Divisiontoachieve the overall company goals, the followinganalysis is required to compare the costs of the three bidders:Koenigs price $8.00HIDEs price:Sales price Profit margin = $9.00 (0.40 $9.00) 5.40Thompsons price $ 7.00However, the profit margin of Barrows Chemicalshould be deducted = $7.00 (0.30 $2.00) (0.60) 6.40From Eekaydos standpoint, the relevant costs for this decision are the variablecosts per square foot if there is available capacity and no additional fixed costswouldbeincurred. For anydivisiontoachievetheoverall companygoalstomaximize profit,variable organizational costsmust be minimized.In thiscase,CarryOn! must choose the best price available to it. HIDEshouldconsiderlowering its price to meet Thomsons competition. (CMA adapted)67. a. Regular selling price $26.00Regular sellingpricelessvariablesellinganddistributionexpenses ($26.00 $2.40) $23.60Standard manufacturing cost plus 15% ($12.80 + $4.80) 1.15 $20.24Standard variable manufacturing cost plus 20%($12.80 1.20) $15.36 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 131!b. Currently, Gondorf Division management should be positive to each of theseprices in decreasing order because the division apparently has unusedcapacity. As an investment center, the manager of Gondorf Division is likelyto be evaluated based on return on investment, and since each of these pricesexceedsdivisional variablecosts, anyofthepriceswill increaseGondorfsROI.If, at some point, all existing capacity of Gondorf Division is being used, thedivisions manager would want the intercompany transfer price to generate thesame amount of profit as outside business to maximize division ROI.c. Negotiation between the two divisions is the best method to settle on a transferprice. Thecompany ishighlydecentralized, and eachof the following fourconditions necessary for negotiated transfer prices exist: An outside market exists that provides both parties with an alternative. Both parties have access to market price information. Both parties are free to buy and sell outside the company. Top management supports the continuation of the decentralizedmanagement concept.d. No, corporate management should not become involved in this controversy.Becausethedecisionhasbeenmadetooperatethedivisionsasinvestmentcenters, topmanagement mustbelievethat suchanorganizational structurewill maximize long-term profits. Imposing corporate restrictions willadversely affect the current management evaluation system becauseinvestment center managers would no longer have complete control of theirunits profits. Also, the addition of corporate restrictions could have a negativeimpact on division management who are accustomed to an autonomousworking environment. (CMA adapted)68. a. The main advantage that I-O-WoW might have is a cost advantage. It is likely,becausethedivisionsellsmainlyinternally, that thedivisionincurslowermarketing and promotion costs than other divisions. By selling mainlyinternally, thedivisionhasnorequirement tomaintainthesamemarketingcapability as other divisions that sell their products externally. In addition, thedivision may reap substantial savings on distribution costs because it does nothave to ship most of its output to other customer locations.b. Because the division sells mainly internally, it would be possible to make theI-O-WoWDivisiona cost center. Then, output of the divisioncouldbetransferred to other internal divisions at full or variable cost. The other logicalalternativeistoallowtheinternal buyingdivisionstonegotiatewithI-O-WoW for discounts from the usual market price so that the buying divisionsshare in the cost savings.69. Each student will have a different answer. No solution is provided. URLishttp://www.ey.com/GL/en/Services/Tax/International-Tax/Transfer-Pricing-and-Tax-Effective-Supply-Chain-Management/2011-Transfer-pricing-reference-guide 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.1"Chapter 13(Should this link not be accessible, type in Ernst & Young 2011 Transfer PricingReference Guide into search engine.)70. Each student will have a different answer. No solution is provided.71. Each student will have a different answer. No solution is provided. However, thefollowing may be helpful in the discussion.Excerpted fromTransfer Pricing in a Recession: What Companies ShouldConsider (PricewaterhouseCoopers, 2009)With rising unemployment comes reduced personal income taxes, and withreduced corporate profits come reduced corporate revenue. The global tax basehas decreased andprobably will continue toshrink. Even ina recession, adiscussion by any politician of increased taxes is risky. More money is needed tokeep funding current programs, and while taxes of many varieties may increase, aless controversial optionis for theInternal RevenueServicetocollect morerevenue through increased enforcement and other means. Globally, taxingauthorities will increase their efforts to collect taxes needed to fuel theirgovernments spending.A substantial increase in tax audits, including those focused on transfer pricing, isexpected. Inadditiontotheincreasednumberofauditsexpectedglobally, thedifficulty and complexity of such audits are expected to increase as taxingauthorities continue to become more sophisticated and open to sharing taxpayerinformation. Issues that may have been overlooked before will be reconsidered.Settlement positions arrived at in the past may no longer be accepted. Allpossibilities are on the table.In such uncertain economic times, how should multinational companies approachdefending past transfer pricing policies including those established under advancepricing agreements during robust economic times? Howshould companiespreparetogoforwardregardingtheir transfer pricingoptions?Inadditiontoensuring they have adequately documented their transfer pricing to defend historicalpositions, companies also must consider ways to optimize current and future transferpricingpositions. This includes evaluatingcurrent transfer prices under currentstructures as well as opportunities to modify current organizational and tax structures.Multinational companies abilities todevelopandsustaintax-efficient structures(alongside required supply chain modifications) will have significant implications fortheir abilities to reduce costs and remain competitive.From David D. Stewart, Transfer Pricing Practitioners Find Challenges,Opportunities in Economic Climate, Worldwide Tax Daily (May 22, 2009): SteveHasson with PwCs U.K. transfer pricing group discussed difficulties related topricing using comparables and adjusting to the current environment with existingarrangements. Hasson noted that the data being used for determining comparablesare historic and lagged, resulting in a data set that does not reflect the currenteconomic environment. In short, what it means is that the data you are relying onis drawnfromboomyears, andyouprobablydont want tobenchmarkyour 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.Chapter 131#pricing against that position or indeed you may not be able to, Hasson said. Thiswhole question of comparability has gotten a whole lot harder, he added.According to Greg Ossi, a principal with PwCs transfer pricing group, companieswith a current APAwill face challenges in the current environment, butcompanies innegotiations for APAscouldfindopportunities. For companieswith current APAs, Ossi said that while it is unlikely tax authorities would bewilling to renegotiate the agreement based only on a decline in sales, it may bepossible to seek an extension of a current APA with renegotiated terms for theremainder. For companies considering or in negotiations for an APA, Ossiexplainedthat the IRSs APAoffice is opentoa range of techniques andrefinements employed in a new agreement. Among the techniques Ossisuggested were using different pricing over several periods to reflect the currentdownturn and expected recovery, shortening the APA term, or including specialcritical assumptions in the agreement. I would characterize this as a work inprocess at the APA office, Andrus said. They are clearly working on figuring itout, but I dont think there is a fixed menu of things that they are willing to do inany case or in every case thats carved in stone at this point.72. "ach student #ill have a different ans#er. !o solution is provided. -o#ever, thefollo#ing may be helpful in the discussion; '!e#