RESPONSIBILITY ACCOUNTING AND TRANSFER PRICING

© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin

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RESPONSIBILITY ACCOUNTING AND TRANSFER PRICING

Chapter

22


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Responsibility Centers

Large complex businesses are divided into

responsibility centers enabling

managers to have a smaller effective span of control.


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The accounting system provides information about resources used and outputs achieved.

The Need for Information About Responsibility Center Performance

This information is used to:Plan and allocate resources.Control operations.Evaluate the performance

of center managers.


22-4Cost Centers, Profit Centers, and Investments Centers

Cost Center A business section that has control over

the incurrence of costs, but no control

over revenues or investment funds.



Profit Center A part of the business

that has control over both costs and

revenues, but no control over

investment funds.

RevenuesSalesInterestOther

CostsMfg. costsCommissionsSalariesOther



Investment Center A profit center where management also makes capital

investment decisions. Corporate Headquarters


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CostCenter

Cost controlQuantity and qualityof services

ProfitCenter

InvestmentCenter

Return on assets (ROA) Residual income (RI)

Evaluation Measures

Profitability

Cost Centers, Profit Centers, and Investments Centers


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An accounting system thatprovides information . . .

Responsibility Accounting Systems

Relating to theresponsibilities of

individual managers.

To evaluatemanagers on

controllable items.


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Prepare budgets for each responsibility center.

Prepare timely performance reportscomparing actual amounts with budgeted amounts.

Measure performance ofeach responsibility center.



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Successful implementation of responsibility accounting may use organization charts with

clear lines of authority and clearly defined levels of responsibility.

Vice Presidentof F inance

Departm ent M anager

Store M anager

Vice Presidentof O perations

Vice Presidentof M arketing

President

B oard of D irectors


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Amount of detail varies according to level in organization.

A department manager receives detailed

reports.

A store manager receives summarized information from each department.



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The vice president of operations receives summarized information

from each store.

Management by exception: Upper-level management

does not receive operating detail unless problems arise.

Amount of detail varies according to level in organization.



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To be of maximum benefit, responsibility reports should . . .Be timely.Be issued regularly.Be understandable.Compare budgeted

and actual amounts.


22-14Assigning Revenue and Costs to Business Centers

Revenue is easily and automatically assigned to specific departments using

point of sale entries from cash registers.

ServiceDepartment


22-15Assigning Revenue and Costs to Business Centers

Two guidelines should be followed in allocating costs to the various parts

of a business . . .According to cost behavior patterns:

Fixed or variable.According to whether the costs are

directly traceable to the centers involved.


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Profit Center Reporting

Webber, Inc. has two divisions.

Com puter Division Television Division

W ebber, Inc.

Let’s look more closely at the Television Division’s income statement.


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Income StatementContribution Margin Format

Television DivisionSales 300,000$Variable COGS 120,000$Other variable costs 30,000 Total variable costs 150,000$Contribution margin 150,000$Traceable fixed costs 90,000 Responsibility margin 60,000$

Cost of goodssold consists of

variablemanufacturing

costs.



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Fixed andvariable costsare listed in

separatesections.



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Responsibility marginis the Television

Division’s contributionto overall operations.



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No computer No computer division means . . .division means . . .

No computerNo computerdivision manager.division manager.

Traceable Fixed Costs

Traceable fixed costs Traceable fixed costs would disappear over time if the center itself disappeared.


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Common fixed costs Common fixed costs arise because of arise because of overall operation of the company and are not overall operation of the company and are not due to the existence of a particular center.due to the existence of a particular center.

We still have aWe still have acompany president.company president.

Common Fixed Costs

No computer No computer division means . . .division means . . .


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Let’s see how the TelevisionDivision fits into Webber, Inc.



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Income StatementCompany Television Computer

Sales 500,000$ 300,000$ 200,000$ Variable costs (230,000) (150,000) (80,000) CM 270,000$ 150,000$ 120,000$ Traceable FC (170,000) (90,000) (80,000) Responsibility margin 100,000$ 60,000$ 40,000$ Common costs (25,000) Net income 75,000$

Common costs arise because of overall Common costs arise because of overall operating activities and are not due to the operating activities and are not due to the

existence of a particular division.existence of a particular division.



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Let’s see how this works!Let’s see how this works!

Traceable Costs Can Become Common Costs

Fixed costs that are traceable on one level can become common if the

business is divided into smaller smaller parts.


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Income StatementTelevision

Division Color HDTVSales 300,000$ 200,000$ 100,000$ Variable costs (150,000) (95,000) (55,000) CM 150,000$ 105,000$ 45,000$ Traceable FC (80,000) (45,000) (35,000) Responsibility margin 70,000$ 60,000$ 10,000$ Common costs 10,000 Net income 60,000$



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Income StatementTelevision

Division Color HDTVSales 300,000$ 200,000$ 100,000$ Variable costs (150,000) (95,000) (55,000) CM 150,000$ 105,000$ 45,000$ Traceable FC (80,000) (45,000) (35,000) Responsibility margin 70,000$ 60,000$ 10,000$ Common costs 10,000 Net income 60,000$

45,000$ To Color35,000 To HDTV10,000 Common90,000$ TV Division

$90,000 cost directly tracedto the Television Division.



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TimeTime

Prof

itsPr

ofits

Responsibility Margin

Responsibility margin is the best gauge best gauge of the long-run profitability of a business center.


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Home Appliance CompanyIncome Statement

Laundry Division Washers Dryers

Sales 300,000$ 200,000$ 100,000$ Variable costs (150,000) (95,000) (55,000) CM 150,000$ 105,000$ 45,000$ Traceable FC (95,000) (45,000) (50,000) Responsibility margin 55,000$ 60,000$ (5,000)$ Common costs (10,000) Net income 45,000$

The Dryer Division is unprofitable becausethe responsibility margin is negative.

When is a BusinessCenter Unprofitable?


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The key issue is controllability.

Evaluating BusinessCenter Managers

Managers should be evaluated on the portion of responsibility margin they control.

Common fixed costs can not be traced to theDryer Division or the Washer Division, so theyare excluded from the responsibility margin.


22-30Arguments Against Allocating Common Fixed Costs

Common fixed costs would not change even if a business center were eliminated.

Common fixed costs are not under the direct control of the center’s managers.

Allocation of common fixed costs may imply changes in profitability that are unrelated to the center’s performance.


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The amount charged when one division sells goods or services to another division.

Battery Division Auto Division

Batteries

Transfer Prices


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A higher transferprice for batteries

means . . .

. . . greaterprofits for the

Battery Division.Auto Division

Transfer Prices

The transfer price affects the profit measure for both buying and selling divisions.

Battery Division


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. . . lowerprofits for theAuto Division.

Auto Division

A higher transferprice for batteries

means . . .

Transfer Prices

The transfer price affects the profit measure for both buying and selling divisions.

Battery Division


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Many companies use the external market value of goods transferredas the transfer price.

Transfer Prices

Transfer prices have no direct effect uponthe company’s overall net income.


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Transfer prices have no direct effect uponthe company’s overall net income.

When the external market value of goods

transferred is unavailable . . .

Transfer Prices

Negotiatedtransfer

price

Cost-plustransfer

price


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Product Quality PersonnelNumber of defective parts Number of sick days takenNumber of customer returns Employee turnoverNumber of customer complaints Number of grievances filed

Marketing Efficiency and CapacityNumber of new customers Cycle time (manufacturing)Number of sales calls initiated Occupancy rates (hotels)Market share Passenger miles (airlines)Number of product stockouts Patient days (hospitals)

Transactions processed (banks)

Nonfinancial Performance Measures


22-37Overview of Traditional and Variable Costing

Direct Materials

Direct Labor

Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Variable Selling and Administrative Expenses

Fixed Selling and Administrative Expenses

TraditionalCosting

VariableCosting

ProductCosts

PeriodCosts

ProductCosts

PeriodCosts


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Unit Cost Computations

Dana, Inc. produces a single product with the following information available:


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Unit Cost Computations

Unit product cost is determined as follows:

Selling and administrative expenses arealways treated as period expenses and

deducted from revenue.


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Traditional CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory -$ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 320,000 Gross margin 280,000 Less selling & admin. exp. Variable FixedNet operating income

Income Comparison of Traditional and Variable Costing

Dana had no beginning inventory, produced 25,000 units and sold 20,000 units this year.


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Traditional CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory -$ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 320,000 Gross margin 280,000 Less selling & admin. exp. Variable (20,000 × $3) 60,000$ Fixed 100,000 160,000 Net operating income 120,000$


Dana had no beginning inventory, produced 25,000 units and sold 20,000 units this year.


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Variable CostingSales (20,000 × $30) 600,000$ Less variable expenses: Beginning inventory -$ Add COGM (25,000 × $10) 250,000 Goods available for sale 250,000 Less ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 200,000 Variable selling & administrative expenses (20,000 × $3) 60,000 260,000 Contribution margin 340,000 Less fixed expenses: Manufacturing overhead 150,000$ Selling & administrative expenses 100,000 250,000 Net operating income 90,000$


Now let’s look at variable costing by Dana, Inc.Variable

costsonly.

All fixedmanufacturing

overhead isexpensed.


22-43Income Comparison of Absorption and Variable Costing

Let’s compare the methods.


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Reconciliation

Variable costing net operating income 90,000$ Add: Fixed mfg. overhead costs deferred in inventory (5,000 units × $6 per unit) 30,000 Traditional costing net opearting income 120,000$

Fixed mfg. overhead $150,000 Units produced 25,000 units= = $6.00 per unit

We can reconcile the difference betweenabsorption and variable income as follows:


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End of Chapter 22

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RESPONSIBILITY ACCOUNTING AND TRANSFER PRICING