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CHAPTER 13
RESPONSIBILITY ACCOUNTING, SUPPORT DEPARTMENT
ALLOCATIONS, AND TRANSFER PRICING
QUESTIONS
1. Fourpotentialadvantagesofdecentralizationare:
Betterexecutedexecutivetraininganddevelopment
Higherlevelofjobsatisfactionforemployees
Effectivenessandspeedofdecisionmakingbylocalmanagerswithintimate
knowledgeofproblems
Reduced management oversight time through use of management by
exceptionprinciple
Threepotentialdisadvantagesofdecentralizationare:
Suboptimizationbyplantoroutletmanagers
Possibility of organizational disruption if top management has difficulty in
relinquishingcontrolorcommunicatingtosubordinates
Potentiallyhighcostsofincorrectdecisionsbysubordinates
Functionsthatmaybehandledcentrally:
Capitalprojectapproval
(1)
Majorcostsforlongtermcommitments
(2)
Specializedknowledge
(3)
Needforcoordinationintheselectionandfundingofmajorprojects
Cashmanagement
(1)
Cash and investment funds are managed more
efficientlyiftheyarepooled.
(2)
When funds are needed, tradition and good business
dictatethattheyareacquiredatthefirmlevelandallocatedtosegmentsas
needed.
(3)
Cash is the most vulnerable asset and merits tight
centralcontrol.
Inventorycontrol
Inventory,beinganearcashasset,issubjecttotheftandmisappropriation.Its
control is also crucial to efficient and effective production, delivery and
customerrelations.
Evaluationofdivisionalprofitability
Topmanagementmustrewardorpenalizedivisionmanagersasamatterof
appropriateorganizationalhierarchicalprerogatives.
2. Thetwobasicfunctionsofresponsibilityreportsareto
provide operational managers with information needed for planning,
controlling,anddecisionmakingfortheirareasofresponsibilityand
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assisttopmanagersinevaluatinghowwelloperationalmanagersfulfilledtheir
responsibilitiestotheorganization.

Itissometimesappropriateforacompanytoprepareasingleresponsibilityreport
for a division. However, many companies prepare two different responsibility
reports for a division: one report, which is used to evaluate a managers
performance,showsonlythecostscontrollablebythatmanager;thesecondreport
showsallcostsincurredbyandassignedtothedivisionsothatanotionofthe
totalperformanceofthedivisioncanbegained.Iftotalcostinformationcanbe
subdividedintocontrollableandnoncontrollablecostsforthedivisionmanager,
thenonereportcaneffectivelyaccomplishbothpurposes.
3. Suboptimization is a condition in which individual managers work to achieve
resultsthatareintheirownandtheirsegmentsbestintereststothedetrimentof
the overall company. Top managers must guard against such behavior by
subordinates when authority is delegated to them in a decentralized setting.
Suboptimizationresultsfromsegmentmanagersmotivationtoappearsuccessful
and gain rewards and recognition. Sometimes, this motivation overrides the
companysbestinterests.
4. Supportdepartmentcostsmaybeallocatedtorevenueproducingdepartmentsfora
varietyofreasons.Themostcommonreasonsaretoencouragemanagerstouse
supportareasinthemostcostbeneficialmanner,makeperformancecomparisons
withindependentorganizations,determinethefullcostofproductiontomakefairand
acceptablepricingdecisions,andsupportdecisionmaking.(Theseareallenumerated
inExhibit13.7.)Suchallocations arenotalwaysusefulfromadecisionmaking
standpointbecausetheyassigncoststhatareuncontrollablebyadepartmenttothat
department.
Inadditiontoallocatingsupportdepartmentcoststoobtainafullcostofproducts
orothercostobjects,therearebehavioralconsequencesassociatedwithallocating
support department costs. Generally, managers become more sensitive to the
assistance provided by the support area, which leads managers to use such
resources in a more costbeneficial way and to recommend cost control
improvements to the support department. However, such cost allocations may
cause dysfunctional behavior if the manager of the revenueproducing area
perceivesthecostallocationtobeunfair.
5. Thefourcriteria(benefitsreceived,causation,equity,andabilitytobear)areall
relevanttomakingsupportdepartmentallocationsandshould,theoretically,be
appliedequally.However,itisoftennotpracticaltoapplytheequitycriterion
becauseitistoodifficulttoachieveagreementonwhatisfair.Abilitytobearis
oftennotusedbecauseitmayresultinunrealisticorprofitdetrimentalactions.
Therefore,mostsupportdepartmentallocationsarebasedonthebenefitsreceived
andcausationcriteria.
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Chapter 13

6. Thedirectmethodisthesimplestmethodofallocationanddoesnottakeinto
considerationtheassistanceprovidedamongsupportdepartments.Thus,thedirect
methodistheonlymethodthatdoesnotallocateasupportdepartmentscoststo
othersupportdepartments.

105

Thestepmethoddoestakeintoconsiderationassistanceprovidedbetweensupport
departments, but does so sequentially based on a benefitsprovided ranking.
Becauseofthenecessitytorankbenefits,allsupportdepartmentinteractionisnot
accountedforusingthestepmethod.Thismethodismoredifficultthanthedirect
method,butlessdifficultthanthealgebraicmethod.
Thealgebraicmethod,unliketheothermethods,recognizesreciprocal(giveand
take)exchangesofassistanceamongthesupportdepartmentsbyprovidingasetof
simultaneousequationstosolvefortheeffectsofsuchexchanges.However,this
methodisverydifficulttousewithouttheaidofacomputerwhenmorethantwo
orthreedepartmentsareinvolved. If formulae are correct, thealgebraicmethod
providesthemostaccuratemeasureoftheusageofassistanceamongdepartments.
Theonlysimilarityamongthemethodsistheirultimateobjective:theassignment
ofsupportdepartmentcoststorevenueproducingareas.
7. The added costs are an artifact of the crossallocation process of solving
simultaneous equations. These fictional costs are ignored in the revenue
producingareasforthepurposeofdevelopinganoverheadapplicationrate.
8. Transfer prices are internally set and agreed on prices with which a selling
divisiontransfersgoodsorservicestoabuyingdivision.Theobjectivesaregoal
congruence, autonomy, motivation toward effectiveness and efficiency,
practicality,andcredibilityasabasisforperformanceevaluation.
In negotiating transfer prices among segment managers, the managers are
expectedtoworktogether(1)tomakechoicesthatwillmaximizetheefficiency
and effectiveness of their respective divisions and (2) to contribute to overall
companyperformance.Forexample,whenitisinthecompanysbestinterestfor
abuyingdivisiontopurchasegoodsorservicesinternallyfromasellingdivision,
segmentmanagersareexpectedtoagreeonapricetoencouragesuch purchases.
If top management has properly trained, motivated, and evaluated segment
managers,thetransferpricecanbeadevicetopromotesuchgoalcongruence.
Incontrast,sometimessegmentmanagersbecomemyopicintheirzealtomaximize
theapparentperformanceoftheirowndivisions.Forexample,sometimesbuying
segmentmanagerswillchoosetobuyexternallyatapricelowerthanthetransfer
pricebecausesuchpurchasesmakesthedivisionlookbettereventhoughanalysis
wouldrevealthatthewholecompanywoulddobetteriftheacquisitionsweremade
internally.Thisexampleillustratestheconceptofsuboptimization.
9. The biggest problem involves how the term cost is defined. A cost can be
definedasanyofthefollowing:incrementalorvariable;absorption(productcosts
only); or absorption plus some portion of the segments nonproduction costs
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(sellingandadministrative).Anamountforestimatedopportunitycostsforuseof
thefacilitiescanbeaddedtoanyoftheabove.Insomecases,argumentscanbe
made for reducing absorption costs by estimated savings in production or
distributioncostsoninternalsales.
Anotherproblemisthatifactualcostsincludeinefficiencies,thetransferprices
set on the basis of such inefficiencies may lead to incorrect management
decisions.
Problemsofusingmarketbasedtransferpricesinclude:
thepossibilitythatnoobjectivepricecanbefoundbecausetheproducthasno
exactcounterpartinthemarket;
market price ignores any production or distribution savings on internally
transferredgoods;and
thepossibilitythatcurrentpricesaretemporarilynotrepresentativeofalong
runprice.
10.
TypeofCenter
RecommendedTypeofTransferPrice&Usage
CostSellingSegment Costbased: consistent with the objective of this
typeofcenter,thisuseisawayofallocatingthe
centerscosttoothercenters.
CostBuying
Segment

Preferablycostbased:consistentwiththeobjective
ofthistypeofcenter,however,dependingonthe
sellingsegmentsdemands,thetransferpricecould
be at any point between the lower limit
(incremental costs plus opportunity cost of
facilities)andtheupperlimit(lowestmarketprice
thebuyingsegmentwouldhavetopayexternally);
goodsorservicesreceivedbythecenterarecarried
atthetransferpriceforinternalreportingpurposes.

RevenueSelling
Segment

Market price: revenue from transfers ofgoods or

servicesisrecordedatthetransferpriceforinternal
reportingpurposes.

RevenueBuying
Segment

Transfer prices for goods or services should be

betweenthelowerandupperlimitswiththelower
limitgivingthissegmentthegreatestgrossmargin
on its internal sales; whichever transfer price is
chosen will be the cost of goods or services
purchasedforthissegmentforinternalreporting.

ProfitorInvestment Transferpricesshouldbesetbetweenthelowerand
SellingSegment
upper limits; since these types of centers are
supposedtoearnaprofit,theirmanagerswilltryto
negotiate a price closer to the upper limit;
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Chapter 13

107

whicheverpriceissetbecomestherevenuemeasure
forinternalsalesforinternalreportingpurposes.
ProfitorInvestment Transferpricesshouldfallbetweenlowerandupper
BuyingSegment
limitswithmanagersofthesesegmentsarguingfor
prices closer to the lower limits to afford their
segmentsthehighestgrossmargin;whicheverprice
is set becomes the cost of goods or services
acquired by the center for internal reporting
purposes.

11. Dualpricingexistswhenthesellingdivisionispermittedtorecordonetransfer
price(higher)andthebuyingdivisiontorecordanother(lower).Thispracticeis
intended tominimize suboptimization andcreate goalcongruent incentives for
bothdivisions.
12. Supportdepartmentscanusetransferpriceswhen(1)userdepartmentsofthesupport
department have significant control over the quantity and quality of assistance
providedand(2)areasonablesurrogatemeasureofassistancebenefitsprovidedto
users exists. In such circumstances, transfer prices can be an effective way of
promotingamoreefficientuseofresourcesandofreassigningsupportdepartment
costs.Settingthetransferpricedependsonthenatureofthe(1)supportdepartment
(costorprofitcenter)and(2)assistanceitself(whetheritcanbeacquiredexternally,
isrecurringanduniform,andisexpensive).
Advantagesoftransferpricesoverallocationinclude:
motivationofuserdepartmentstosuggestimprovementsandmonitorusage;
inclusionofcostsinuserdepartmentsperformancereport(ifuserdepartment
controlstheamountofassistanceitbuys);
potentialtogeneratesuggestionsforservicesmorebeneficialtousers;
thefactthattherationaleforthetransferpricesmustbeprovidedtothebuying
department;and
transformation of a support department from cost center to profit center;
providesadditionalperformancemeasuresforthecenteranditsmanager.
13. In a multinational setting, transfer prices can affect the profits and inventory
values reported in multiple countries as well as the taxes paid to various
jurisdictions. Assuch,managers mustbemoreawareofsetting prices,within
legal and ethical limits, to minimize income taxes and tariffs. Also, in a
multinational setting, there would be various taxing authorities with which to
come to agreements on advance purchase agreementsshould the company
decidetoenterintothose.
14. Any companys green agenda must be a global undertaking; activities in one
segment may create costs and benefits for part or all of an organization. Such
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interactions impact the function, asset, and risk profile of an MNE and, thus,
modify intraorganizational transactions or create new value interactions that must
be considered from a transfer pricing perspective.
An important impact of the green agenda is the incorporation of environmental
costs that have previously been avoided or undervalued by some companies.
Substantive pollution and waste costs that once were included in public
expenditures or ignored are now being passed along to companies. In a cap-andtrade environment, companies are given a specified pollution limit (the cap) for
carbon and other emissions; pollution above that limit is only legally allowed if
the offending company buys another companys surplus creditscreating an
organizational cost for emissions.
The active markets in emissions credits provide a selling/buying value for them.
However, these values can be variable and volatile because cap-and-trade schemes
are localized, and as with any market, prices may change because of prevalence or
absence of activity and new markets can emerge.

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Chapter 13

Intraorganizational sharing of carbon or emissions credits requires an appropriate

pricing mechanism for a companys transfer pricing policy and will create
challenges and opportunities in identifying an arms-length price. Additionally, the
transfer pricing policy must accommodate price fluctuations, differing regional
market values, and different values in various parts of the business so that value
can be optimized for tax purposes.
PricewaterhouseCoopers, Transfer Pricing and the Green Agenda (2008), pp. 12;
http://www.pwc.com/en_GX/gx/taxmanagementstrategy/pdf/pwc_tax_transfer_pricing_and
_the_green_agenda.pdf(lastaccessed12/30/11).

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109

110

Chapter 13

EXERCISES
15. a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.

D
C
D
C
C
C
D
D
C
D
D
C
D

16. a.
b.
c.
d.
e.
f.
g.
h.
i.
j.

A
N
A
A
A
D
D
A
N(authoritycanbedelegated,butnotresponsibility)
A

17. Each student will have a different answer; however, some important
considerationsfollow.
Centralized model: all IT functions (strategy and planning, application
development and maintenance, and operations) report directly to a senior
executive.Allassets(hardware,software,humanresourcesandthebudget)are
controlledbythisorganization.
AdvantagesofCentralization:
Hardwareandsoftwarecanbeobtainedwiththelargesteconomiesofscale
(oftenresultingina10to15percentcostsavings).
Redundantfunctions,suchasmultiplehelpdesksupportgroups,areeliminated.
Organizationalcommunicationsaresimpler.
Activitiesaremorealignedwithoverallcompanystrategies.
Aunifiedpresenceisprovidedtocustomersandsuppliers.
DisadvantagesofCentralization:
Ifoperatedasacostcenter,ITsenormousbudgetisoftenapointofcontention.
Ifcostsareallocatedbacktootherareas,managersinthoseareasmaybelieve
theyarebeingovercharged.
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accessible website, in whole or in part.

Chapter 13

Averyeffectivedecisionandresourceallocationprocessisneededsinceeach
businessunitcanhavedifferentorconflictingITneeds.
IToutagescouldcauseanentirecompanytobecrippled.
Thekeytoacentralizedorganizationssuccessisitsabilitytoberesponsive.If
thebig,centralizedoperationcanberesponsivetotheneedsofthebusiness,then
that approach can make sense. When companies decide to move away from
decentralization back to centralized functions, the most common reasons are
usuallycostsavingsandabilitytomanagethefunctionmoreeffectively.
Decentralized model: created when companies adopt specific client/server
architectures or occurred during a merger because separateness was often the
quickestwaytosolvetheproblemofintegratingdisparatehardwareandsoftware
infrastructures.
AdvantagesofDecentralization:
Theabilitytointegratedisparitiesafteramergerisimproved.
Managershavetheirchoiceofhardwareandsoftwareacquisition.
ManagershavetheabilitytoallocateITresources.
Thereisaperceptionoffaster,moreflexibleresponsestochange.
DisadvantagesofDecentralization:
Therewillbehighertotalhardwareandsoftwarecostsfortheorganization.
Therewillbeduplicationofsupportneeds.
Thereisthepossibilityofincompatibilityofsystems.
Therecanbealackofaccountabilityforproblems.
Otherimportantinformation:
Typeandsizeofcompany
Levelofgeographicaldispersion
Managementcharacteristics
Employeelevelsofmotivationandresponsiveness
18. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.
19. a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.

P
R
I
RorP
I
C
RorP
RorP
RorP
RorP
C
R(orrevenueandlimitedcost)
CorP(ifrecoverieswereassignedtotheunit)

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Chapter 13

20. Eachstudentwillhaveadifferentanswer.However,followingaresomeofthe
unitsthatmaybeincluded.
Cost centers: Career services, campus security, financial aid, information
technology,custodial,humanresources,andaccounting
Profit centers: Athletics, bookstore, residence halls, cafeterias, international
programs,universitynewspaper/radiostation,andcommunityworkshops
21. a. TheEMgroupiscentralized.
b. TheEMgroupisprobablyaprofitcenter;however,itcouldbeaninvestment
centerifitsmanagerhascontroloverthegroupsassetbase.
c. HavingtheoperatingdivisionssolicitandpayfortheEMgroupprojectscould
meanthatfewerprojectsaregeneratedthanwouldbelikelyiftheEMgroup
initiatedtheprojectwork;fewerEMprojects wouldmeanfewercostsand
higherprofits.RequiringtheEMgrouptochargeamarketbasedpricefor
servicescouldmeanthatdifferentdivisions,becauseoftheiroperatinglocales,
arechargeddifferentamountsforthesameprojects.Additionally,whereasa
marketpriceallowstheEMgrouptoshowprofitability,suchapriceismore
oneroustotheoperatingdivisionsthanacostbasedpricewouldbeleading
toaloweredlikelihoodofusagebecauseofreducedprofitability.
22. Eachstudentwillhaveadifferentanswer;howeversomeimportantconsiderations
follow.
a. Inmultipledoctormedicalpractices,settinguptherecordkeepingsystemto
reflect each doctor as his/her own profit center will give insight into the
expenses each doctor is absorbing against revenue directly generated by
him/her.Thedatageneratedfromthisexercisegivemanagementanothertool
inevaluatingperformanceforsalaryadjustments,bonuses,andpromotions.
b. The typical software accounting packages used by medical practices are
Peachtree,QuickBooksandCreativeSolutions.
c. Some directly traceable costs include salary, malpractice insurance, fringe
benefits,conferencesandseminars,vehicleexpense,mealsandentertainment,
patientrefunds,insurancerefunds,travelandlodging,licenses,suppliesand
vaccinesthatareusedbyaspecialist,andduesandfees.
d. Indirect expenses include building rent, depreciation, equipment lease
payments,interestexpense,legalandaccountingfees,officesupplies,medical
wastedisposal,pensionexpense,utilities,andstaffsalaries,taxesandfringe
benefits.Allocationsbaseswouldincludegrossrevenuesgeneratedbydoctor,
percent of cash receipts generated by doctor, percent of patients seen by
doctor,percentofoccupancyspaceusedbydoctor,orequalallocationamong
alldoctors.

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Chapter 13

23.

ASPASV
BSPASV
BSPBSV
$38473,000
$39473,000
$39460,000
$17,974,000
$18,447,000
$17,940,000
$473,000U
$507,000F
SalesPriceVariance
SalesVolumeVariance
$34,000F
TotalRevenueVariance
Because the company soldunits at a lower than planned price, $473,000less
revenuewasgenerated.However,thedecreaseinsellingpricewasoffsetbythe
factthat13,000moreunitsweresoldthanwerebudgeted.Thenetresultofthese
twodifferencescreateda$34,000favorablerevenuevariance.

24.

ASPASV
$0.68682,000
$463,760

BSPASV
$0.70682,000
$477,400

BSPBSV
$0.70675,000
$472,500

$13,640U
$4,900F
SalesPriceVariance
SalesVolumeVariance
$8,740U
TotalRevenueVariance

Thecompanysold7,000unitsmorethanbudgetbutsoldthoseunitsat$0.02less
than the budgeted selling price, creating an unfavorable $13,640 sales price
variance.However,since7,000morethanbudgetedweresold,a$4,900favorable
salesvolumevarianceoccurred.Thecombinationofthesetwofactorscreatedthe
$8,740revenueshortfall.
25. a. 301.3=39seminarsin2013;39$4,200=$163,800
b.

ASPASV
$3,675*42
$154,350

BSPASV
$4,00042
$168,000

BSPBSV
$4,00039
$156,000

$13,650U
$12,000F
SalesPriceVariance
SalesVolumeVariance
$1,650U
TotalRevenueVariance
*$154,35042=$3,675perseminar

c. Yididnotachievehisexpectedrevenuebecause,althoughhegavethreemore
seminarsthanhebudgeted,theaveragepricehereceivedforeachseminarwas
only$3,675ratherthanthebudgeted$4,000.
26. a. FromHRtoFabricating[(0.350.80)$630,000]
FromAdmin.toFabricating[(0.500.90)$450,000]
Total
b. FromHRtoFinishing[(0.450.80)$630,000]
FromAdmin.toFinishing[(0.400.90)$450,000]

$275,625
250,000
$525,625
$354,375
200,000

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114

Chapter 13

Total

$554,375

27.Checking:
Administration(0.300.80)$540,000
Humanresources(0.300.80)$360,000
Accounting(0.400.80)$300,000
Directcosts
Savings:
Administration(0.400.80)$540,000
Humanresources(0.200.80)$360,000
Accounting(0.200.80)$300,000
Directcosts
Loans:
Administration(0.100.80)$540,000
Humanresources(0.300.80)$360,000
Accounting(0.200.80)$300,000
Directcosts
28.Administration($540,000)
Humanresources
Accounting
Checking
Savings
Loans

($540,0000.10)
($540,0000.10)
($540,0000.30)
($540,0000.40)
($540,0000.10)

Humanresources($360,000+$54,000=$414,000)
Accounting
$414,000(0.100.90)
Checking
$414,000(0.300.90)
Savings
$414,000(0.200.90)
Loans
$414,000(0.300.90)
Accounting($300,000+$54,000+$46,000=$400,000)
Checking
$400,000(0.400.80)
Savings
$400,000(0.200.80)
Loans
$400,000(0.200.80)
Checking:
Savings:
Loans:

$202,500
135,000
150,000

630,000
$1,117,500
$270,000
90,000
75,000

337,500
$772,500
$67,500
135,000
75,000

675,000
$952,500

$54,000
54,000
162,000
216,000
54,000
$540,000
$46,000
138,000
92,000
138,000

$414,000
$200,000
100,000
100,000

$400,000

$630,000+$162,000+$138,000+$200,000=$1,130,000
$337,500+$216,000+$92,000+$100,000=$745,500
$675,000+$54,000+$138,000+$100,000=$967,000

29.a. Humanresources($360,000)
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Chapter 13

Administration
Maintenance
Assembly
Finishing

($360,0000.10)
($360,0000.15)
($360,0000.40)
($360,0000.35)

$36,000
54,000
144,000
126,000

$360,000

Administration($558,000+$36,000=$594,000)
Maintenance
$594,000(0.100.90)
Assembly
$594,000(0.500.90)
Finishing
$594,000(0.300.90)
Maintenance($170,000+$54,000+$66,000=$290,000)
Assembly
$290,000(0.450.80)
Finishing
$290,000(0.350.80)

$66,000
330,000
198,000

$594,000
$163,125
126,875

$290,000

b. Assembly:
(0.40$360,000)+[(0.50.9)$594,000]+[(0.450.8)$290,000]=
$144,000+$330,000+$163,125=$637,125
Finishing:
(0.35$360,000)+[(0.30.9)$594,000]+[(0.350.8)$290,000]=
$126,000+$198,000+$126,875=$450,875
c. The cost allocation is affected by the order in which costs are assigned
becausethecostallocatedfromaparticularservicedepartmentdependsonthe
amount of cost allocated to that service department from other service
departments.Theamountofcostsallocatedfromotherservicedepartments
dependsonthebenefitsprovidedranking.
30.
Administration
Humanresources
Accounting
Checking
Savings
Loans

Admin.

0.10
0.10
0.30
0.40
0.10

HR
0.10

0.10
0.30
0.20
0.30

Acctg.
0.10
0.10

0.40
0.20
0.20

(A) Administration
=$540,000+0.10B+0.10C
(B) Humanresources=$360,000+0.10A+0.10C
(C) Accounting
=$300,000+0.10A+0.10B
B=$360,000+0.10($540,000+0.10B+0.10C)+0.10C
C=$300,000+0.10($540,000+0.10B+0.10C)+0.10B
B=$360,000+$54,000+0.01B+0.01C+0.10C
B=$414,000+0.01B+0.11C
0.99B=$414,000+0.11C
C=$300,000+$54,000+0.01B+0.01C+0.10B
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Chapter 13

C=$354,000+0.11B+0.01C
0.99C=$354,000+0.11B
C=$357,576+0.1111B
0.99B=$414,000+0.11($357,576+0.1111B)
0.99B=$414,000+$39,333+0.0122B
0.9778B=$453,333
B=$463,625
C=$357,576+0.1111($463,625)
=$357,578+51,509
=$409,085
A=$540,000+0.10($463,625)+0.10($409,085)
=$540,000+$46,362.50+$40,908.50
=$627,271
Directcosts
Admin.
HR
Acctg.
Totalcosts

Admin.
$540,000
(627,271)
46,363
40,909
$0

HR
$360,000
62,727
(463,625)
40,909
$0

Acctg.
$300,000
62,727
46,363
(409,085)
$0

Check.
$630,000
188,181
139,088
163,634
$1,120,903

Sav.
Loans
$337,500 $675,000
250,908
62,727
92,725
139,088
81,817
81,817
$762,950 $958,632

Note:TheAdministration,HumanResources,andAccountingcolumns donot
sumto$0becauseofrounding.
31. S1=$170,000+0.40S2+0.20S3
S2=$360,000+0.10S1+0.30S3
S3=$600,000+0.20S1+0.30S2
SubstituteS3intotheequationsforS1andS2:
(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+0.46S2
S1=$302,083+0.48S2
(2)
S2=$360,000+0.10S1+$180,000+0.06S1+0.09S2
0.91S2=$540,000+0.16S1
S2=$593,407+0.18S1
SubstituteS2intotheequationforS1:
S1=$302,083+0.48($593,407+0.18S1)
S1=$302,083+$284,835+0.09S1
0.91S1=$586,918
S1=$644,965
SubstituteS1($644,965)intotheoriginalS2andS3equations:
(1) S2=$360,000+0.10($644,965)+0.30S3
(2) S3=$600,000+0.20($644,965)+0.30S2
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Chapter 13

Simplifying:
(1) S2=$360,000+$64,497+0.30S3
S2=$424,497+0.30S3
(2) S3=$600,000+$128,993+0.30S2
S3=$728,993+0.30S2

SubstituteS3intotheequationforS2:
S2=$424,497+0.30($728,993+0.30S2)
S2=$424,497+$218,698+0.09S2
0.91S2=$643,195
S2=$706,808
SubstituteS1andS2intotheoriginalequationsandsolveforS3:
S3=$600,000+0.20($644,965)+0.30($706,808)
S3=$600,000+$128,993+$212,042
S3=$941,035
Allocatetheservicedepartmentcoststotheotherdepartments:
S1
S2
S3
Directcosts
$170,000
$360,000
$600,000
S1
(644,965)
64,497
128,993
S2
282,723 (706,808)
212,042
S3

188,207

282,311 (941,035)
ToRP
$(4,035)* $0
$0

RP1

RP2

$193,490 $257,986
141,362
70,681
376,414

94,104
$711,266 $422,771

*offduetorounding
32. a. D
b. A
c. D
d. A
e. D
f. A
g. A
h. D
i. N
j. A
k. A
l. D
33.a. $31.80=$5.40
b. ($3+$2)=$5;$51.30=$6.50
c.

$10

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d. Sales(40,000$55)
Internalcost(25,000$32)
Externalcost(15,000$47)

$2,200,000
$800,000
705,000 (1,505,000)
$695,000

Operatingprofit=15,000$15=$225,000
34. a. Externalpurchasecost(30,000$4.50)
Internalcost[(30,000$4.00)+$0opportunitycost]
Advantageofpurchasinginternally

$135,000
(120,000)
$15,000

b. Externalpurchasecost(30,000$4.50)
Internalcost[($30,000$4.00)+$25,000opportunitycost]
Disadvantageofpurchasinginternally

$135,000
(145,000)
$(10,000)

c. ShouldtheAssemblyDivisionsexternalsuppliersraisepricesinthefuture,
purchasing costs would increase for Squish. A question arises as to what
happenedtothefixedcostsbeingincurredbytheProductionDivision.Were
allcostseliminatedwhenthedivisionwasclosed?Ifnot,someorallofthe
ProductionDivisionsmonthlyfixedcostsof$30,000wouldstillhavetobe
paidbySquishreducingthe$25,000ofrentalincome.Ifsomeofthefixed
costs werepersonnelcosts,theremaybeacommunity issueofincreasing
unemploymentorthepossibilityofterminatinglongterm,moresenioraged
employees(agediscrimination?).
35. a. Upperlimitisthebestexternalprice=$112.50
Lowerlimitisvariableproductioncost=$54+Anyopportunitycost
b. Minimumpriceiscurrentsellingprice=$162
36.a. (1)Variableproductioncost
Variablesellingcost
Totalvariablecost

$40.00
16.00

$56.00perunit

(2)

Variableproductioncost
FOH($1,800,0001,200,000)
Fullproductioncost

$40.00
1.50
$41.50perunit

(3)

Variableproductioncost
Fixedselling[$2,400,000(0.251,200,000)]
Total variable production + necessary selling

$40.00

8.00
$48.00perunit

(4)Marketprice

$67.00perunit

b. ThehighestpriceElbashouldchoosetoselltheunitsfor$63perunitsinceno
advertisingcostswouldneedtobepaidrelativetointernalsales.

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Chapter 13

37. a. Lower limit is the incremental variable cost ($9.00 + $11.40 + $4.80) +
Opportunitycostof$43.80perunitlostCM=$69.00
(LostCM=$72.00$9.00$11.40$4.80$3.00=$43.80)
Thisisthenormalsellingpricelessthenormalvariablecostsexcludingthe
$3.00variablesellingexpense.
b. Undertheseconditions,PeyvandiCo.couldacceptanypricethatatleastcovers
variableproductioncosts:DM$9.00+DL$11.40+VOH$4.80=$25.20
c. $2,606,2501.25=$2,085,000for50,000units=$41.70perunitDM$9.00
+DL$11.40+VOH$4.80+FOH$16.50=$41.70
$1,575,0001.25=$1,260,000for50,000units=$25.20perunitDM$9.00
+DL$11.40+VOH$4.80=$25.20
JoeDhirwasdefiningcostasvariablecost,whilePeyvandiCo.wasdefining
costasabsorptioncost.
38. a. Therapidincreaseinfoodcostshascreatedasignificantdifferencebetweenthe
historicalcostofitemsandthereplacementcostofitems.Becausetransfers
betweenstoresaremadeathistoricalcosts,thetransferringstorelosesinthe
transactionbecauseitmustreplacethetransferreditematreplacementcost.This
situationcreatesanincentiveforstorestomisrepresenttheactualinventorieson
handwhentransfersarerequestedbysisterstores.
b. Thetransferpricingpolicycouldbechangedtoallowtransferstotakeplaceat
replacementcostratherthanhistoricalcost.Suchachangewouldremovethe
disincentiveoftheexistingpolicy.
39. a. $665,000700,000minutes=$0.95perminute
b. $665,0001,000,000minutes=$0.665perminute
c. Expected:730,000$0.95=$693,500
Totalvariance=$689,400$693,500=$4,100F
Theoretical:730,000$0.665=$485,450
Totalvariance=$689,400$485,450=$203,950U
Thevariancecouldhavebeencausedbyvolumeofactivitybeingabovethe
expected level or by operating costs exceeding the expected level. More
informationisneededtodeterminetheactualcauses.
40. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.Onerecentcase
thatcouldbediscussedinvolvedGlaxoSmithKline,whichsettledatransferpricing
disputewiththeU.S.InternalRevenueServiceinSeptember2006for$3+billion
and,asofearly2007,waspreparingforlitigationintheUnitedKingdom.The
companys2006annualreportindicatedtheproblemwasrelatedtotheyears1994
andforward.Seehttp://www.irs.gov/newsroom/article/0,,id=162359,00.html(last
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accessed 1/2/12). Another case involved computer chip company Xilinx

(http://www.taxgirl.com/landmarktransferpricingcaseisitadifferentworld/).
Alsoseehttp://ustransferpricing.com/decisions.html.

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Chapter 13

121

PROBLEMS
41. a. Theethicalproblemsarecreatedwhenshortrungainscanbemaximizedby
doingwhatisunethicalratherthanwhatisethical.Thissituationiscreatedby
the companys incentive system. By narrowly focusing performance
evaluation on profitrelated measures, the firm is ignoring other important
critical successfactors.Bymeasuringachievement acrossabroadersetof
criticalsuccessfactors,thecompanycouldinducethemanagerstobehaveina
moreethicallyacceptablemanner.Themanagersaremerelyreacting,albeitin
anethicallyquestionableway,totheincentivesthathavebeenputinplaceby
thecompany.
b. Byrefocusingtheperformanceevaluationmeasuresonabroadersetofcritical
success factors, top managers can induce lower managers to behave more
ethically.Topmanagersneedtodevelopperformancemeasuresthataremore
long term; focus on customer satisfaction, product quality, and social
responsibility;andprovidemanagerialtraininginethicalbehavior.
(CMAadapted)
42. a. Theprimarycauseofthetrendwastheavailabilityofnewtechnologythat
wassupposedtoenhancecommunicationssuchaswirelessphones,notebook
computers,andhandheldmonitoringdevices.
b. Oneofthemajorproblemsisstillcommunicationsbecausethepatientsentire
medicalteamstillneedstocollaborateandinteract.Thedecentralizedstations
createdaprobleminthattheyoftenreplacedthecentralizedstations,sonurses
and physicians had to meet in hallways for discussions often within the
hearingrangeofapatientwhowasnotthepatientbeingdiscussed,whichcould
createethicaldilemmas...andincreasingthenoiselevelthatcoulddisturba
patients rest and ability to recover. Additionally, the decentralized stations
distancedthenursesfromtheircolleagues,whichlimitedtheabilitytoshare
professionalexpertisewithoneanotheraswellasengageinthesocializationthat
isimportanttojobenhancementanddevelopmentofateamperspective.The
isolationmadeithardtohelpoutinemergenciesoreventoknowifanurses
stationonthesamefloormightbeshorthanded.Toadjustthesituation,hospitals
arenowreconfiguring floorlayouts tohavedecentralized stationsaswellas
centralizedstations;thelattertendtobedesignedasdatacentersforavarietyof
equipment, interactive communication stations, medicinestorage facilities,
supplyintake operations, andloungeareas.Combiningthedecentralized and
centralizedconceptsretainthepatientbenefitofclosecontact,buteliminatethe
noiseandoverhearingpossibilitiesaswellasencouragenurseinteractionsand
promoteteamspirit.
43. a. Thereportisnotinaccordancewiththeconceptofresponsibilityaccounting,in
whicheachmanagersperformanceisjudgedbyhowwellhe/shemanagesthose
itemsdirectlyunderhis/hercontrol.Responsibilityaccountingdoesnotrecognize
theallocationofcommoncoststosegments.Whileincludingthecorporatecosts
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Chapter 13

may be useful in calling attention to these activities, differences between

budgetedandactualfortheseitemsarebeyondthecontroloftheMachining
Department supervisor and are not properly chargeable to him/her. Thus,
corporatecostsshouldnotbeincludedinthereport.
Thereportcomparesactualperformancetoastaticbudget.Astaticbudget
fails to distinguish between the supervisors production control and cost
control responsibilities. Cost control is involved withseeingthat output is
produced at the least possible cost, consistent with quality standards. All
dollaramountsinthereportdealwithcostcontrolandtellnothingabouthow
wellvariablecostswerecontrolledduringthemonth.Budgetcostsarebased
ona3,000unitspermonthactivitylevel,whereasactualcostswereincurred
atanactivitylevelof3,185unitspermonth.Thereportshoulduseaflexible
budgetbecauseitcanbetailoredforanylevelofactivitywithinarelevant
range.Thiswouldresultinthemeaningfulcomparisonoftheactualcostof
producing3,185unitswiththebudgetedcostofproducing3,185units.
Without additional information, it cannot be known which of the fixed
manufacturingOHitemsarecontrollableatthedepartmentlevel.Onlythe
costsoverwhichthedepartmenthascontrolshouldbeincludedinthereport.
Also,inclusionoftheFOHcostsindicatesthattheyareanecessarypartofthe
manufacturingactivity,whichmaynotbetrue.
b.

MachiningDepartment
PerformanceReport
FortheMonthEndedOctober31,2013
BUDGET
ACTUAL
VARIANCE
Units
3,185
3,185
0
Controllablecosts
Var.mfg.costs
DM
$9.00 $28,665 $8.80 $28,028 $0.20 $637F
DL
9.50
30,258
9.45
30,098
0.05 160F
VOH
11.10

35,354

11.00

35,035

0.10

319F
Total
$29.60 $94,277 $29.25 $93,161 $0.35 $1,116F
Noncontrollablecosts
Indirectlabor
Depreciation
Taxes
Insurance
Other
TotalfixedOH
Totalmfg.costs

$3,300
1,500
300
240
930
$6,270
$100,547

$3,334
1,500
300
240
1,027
$6,401
$99,562

$(34)U
0
0
0

(97)U
$(131)U
$985F

c. Review favorable unit and component variances to determine if realistic

budgets were set. Note that all of the controllable manufacturing cost
variances were favorable. The only variance exceeding 5 percent was the
small $97 variance for the other category, and perhaps this should be
analyzed.
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Chapter 13

123

(CMA
adapted)

44. a. Themostsignificantproblemisthatvarianceshavebeencomputedbycomparing
astaticbudgettoactualexpenses.Toevaluatecostcontrol,variancesshouldbe
computedbycomparingaflexiblebudgetattheactualactivityleveltoactual
costs.Also,theperformanceevaluationdoesnotcontainauxiliaryperformance
measuressuchasmeasuresofcustomerservice,win/lossrecords,etc.

Activity#ofcases
Variablecosts
Professionallabor
Travel
Supplies
Fixedcosts
Professionallabor
Facilities
Insurance
Total

Flexible
Budget
2,970

Actual
2,970

Variance

$2,970,000
148,500
297,000

$2,820,000
120,000
270,000

$150,000F
28,500F
27,000F

1,200,000
1,215,000
750,000
795,000
240,000 234,000
$5,605,500 $5,454,000

15,000U
45,000U

6,000F
$151,500F

c. Thevariances thataremostlikelytobeinvestigatedaretheonesthatare
materialandmaybeattributedtocontrollablefactors.Themostsignificant
variances areforthoseforprofessionallabor(5percentundertheflexible
budget),travel(19percentundertheflexiblebudget),facilities(6percentover
theflexiblebudget), and supplies (9 percent under the flexible budget).
45.a.
Directlabor
Repairs
Maintenance
Indirectlabor
Power
Totals

Budget
$375,000
75,000
450,000
75,000
150,000
$1,125,000

Actual
$300,000
80,000
325,000
77,500
157,500

$940,000

Variance
$75,000F
5,000U
125,000F
2,500U
7,500U
$185,000F

b. Althoughthebottomlineispositive,questionsneedtobeaskedaboutthe
extremely favorable variances existing inthedirect laborandmaintenance
categories.Werelessexperienced(and,thus,lowerpaid)workersusedduring
the period, and if so, how was production quality? Was the decrease in
maintenancespendingappropriate,orwillitcausemachinefailuresinfuture
periods?
c. Promotion decisions should be deferred until the answers to the questions
posedin(b)canbeansweredindepth.
d. Itispossiblethatmany,ifnotall,ofthecostsshownontheresponsibility
reportarenotunderRigerascontrol.Thecostsofdirectandindirectlabor
may be related to labor union contracts or rate renegotiations; repairs and
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Chapter 13

maintenancemayberelatedtothecostsofsuppliesormachineryfailures;and
powermayberelatedtoutilitycompanyrateadjustments.

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Chapter 13

125

46.a. Revenues($900100)
Variablecosts:
Meals($109106)
Lodging($753106)
Supplies($10106)
Contributionmargin

$90,000
$9,540
23,850
1,060

Directfixedcosts:
Speakers($2,500each)
Rentonfacilities
Advertising
Segmentmargin
Allocatedfixedcosts(0.25$90,000)
Netoperatingincome
b. Revenues($850120)
Variablecosts:
Meals($1091.15126)
Lodging($753126)
Supplies($10126)
Contributionmargin
Directfixedcosts:
Speakers($2,9506)
Rentonfacilities
Advertising
Segmentmargin
Allocatedfixedcosts(0.25$102,000)
Netoperatingincome
c.

ASPASV
$850120
$102,000

BSPASV
$900120
$108,000

$15,000
3,600

4,000

(34,450)
$55,550

(22,600)
$32,950
(22,500)
$10,450
$102,000

$13,041
28,350

1,260

$17,700
4,200

4,900

(42,651)
$59,349

(26,800)
$32,549

(25,500)
$7,049
BSPBSV
$900100
$90,000

$6,000U
SalesPriceVariance

$18,000F
SalesVolumeVariance
$12,000F
TotalRevenueVariance

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Chapter 13

Revenues
Variablecosts:
Meals
Lodging
Supplies
Contributionmargin
Directfixedcosts:
Speakers
Rentonfacilities
Advertising
Segmentmargin
Allocatedfixedcosts
Netoperatingincome

Original Flexible
Budget
Budget
$90,000 $108,000

Actual
$102,000

$9,540
23,850
1,060
$55,550

$13,041
28,350
1,260
$59,349

$11,340
28,350
1,260
$67,050

(15,000) (15,000) (17,700)

(3,600) (3,600) (4,200)

(4,000) (4,000)
(4,900)
$32,950 $44,450
$32,549
(22,500) (27,000) (25,500)

$10,450 $17,450
$7,049

Variance
$6,000U
(1,701)U
(0)
(0)
(2,700)U
(600)U
(900)U

(1,500)F
$(10,401)U

Byfar,giventhatrevenuesexceededthebudget,thetwobiggestcontributors
to the seminars decreased profitability were the failure to include the
speakersairfareintheoriginalbudgetandthefailuretoincludethegratuity
onthemeals.Alsocontributingtothereducedprofitabilitywerehigherthan
expectedfixedcostsforrentandadvertising.However,theflexiblebudget
shows that variable costswerebudgetedcorrectlyperparticipant, withthe
exceptionofthegratuity.
47. a. CRM is typically defined as the process of finding, getting, and retaining
customers. CRM is also defined as tracking customer behavior to develop
marketingandrelationshipbuildingprogramsthatbondconsumerstoabrand
often by development of software systems to provide oneonone contact
betweenthemarketingbusinessandtheircustomer.CRMisthecoreofany
customerfocusedbusinessstrategyandincludes thepeople,processes,and
technologyassociatedwithsales,marketing,andservice.
b. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.
c. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.However,
contact centers that are engaged in answering customer questions and
providinghelpserviceswilltypicallybecostcenters;thosethathavebeen
designedtoengageinproductsaleswilltypicallybeprofitcenters.
d. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.However,
contactcentercostscouldbeallocatedtorevenueproducingareasbasedon
number of people, time spent on services related to a particular product,
dollarsofrevenues,etc.
e. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.However,
thefollowingmeasurementsmaybeuseful:

Averagetimetoanswercalls
Percentofcallsabandoned

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Chapter 13

127

Percentofcallsthatneededtobereferredtoanotherrepresentative
Averagenumberofissueshandledpercall
Averagecallhandlingtime
Employeeturnover
Number of caller complaints; number of caller complaints per
employee
Numberofinstancesofreportedidentitytheft

48. a. Viewing childcare facilities as a cost center could create a negative

perspectiveofsuchoperationsfromthecompanysstandpoint.Assuch,the
companymighttrytocontrolorreducethecostsofthechildcarefacilitiesby
engaginginoneormoreofthefollowingactions:

Hiringlessqualified,lowerpaidstaffpersonnel
Reducingjanitorialand/ormaintenanceactivities
Limitingthenumberofstafftolessthannecessary
Purchasing lowquality equipment, toys, etc. that could be potentially
harmfultothechildren
Settingheating/airconditioningthermostatstoohighortoolow to save on
electrical/gas costs

Providingunhealthyorlowqualityfoodandsnacks

b. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.However,
itshouldbepointedoutthatdesiringaparticularrateofreturnonthefacilities
canalsocreatesomeproblemsbecausethefacilitiesmaynolongerbeseenas
anemployeebenefitbut,instead,awayforthecompanytoincreaseitsbottom
line.Suchaperspectivecouldalsoleadtosomeofthesameactionsdiscussed
in(a)oremployeescouldcontinuallyfindtheirchargesincreasingbecausethe
companydidnotseektocontrolcostssincetheywouldbepassedalonginthe
form of increased charges. It would probably be most beneficial to the
employeesforthecompanytoattempttobreakevenonthechildcarefacility
ratherthanviewitasaprofitenhancer.
Anotherpossibilityisforthecompanytoallocatethecostofthefacilityto
revenueproducingdepartments.Suchanaction,however,mightbedifficult
becauseofthedifficultyinfindingareasonableallocationbase.Forexample,
numberofemployeesisnotappropriatebecauseallemployeesdonothave
childrennorwouldallthosehavingchildrenchoosetheusethechildcare
facilities.
c. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.
49. a. Footballs:$1,200,000$60=20,000units
Shoulderpads:$1,800,000$45=40,000units
b. Salesvolumevariance=$60(21,00020,000)=$60,000F
c. Actualvolume=40,000($360,000$45)=40,0008,000=32,000
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Actualprice=$1,680,00032,000=$52.50
Salespricevariance=32,000($52.50$45)=32,000$7.50=$240,000F
d. Totalsalespricevariance($63,000U+$240,000F)
$177,000F
Totalsalesvolumevariance($60,000F+$360,000U)
300,000U

Totalsalesvariance
$123,000U
Budgetedrevenueexceededactualrevenueby$123,000fortworeasons.First,
footballs were sold at a lower price than budgeted, and second, too few
shoulderpadsweresold.Thesenegativeeffectswerepartiallyoffsetby(1)a
higherpriceforshoulderpadsand(2)ahigherthanplannedsalesvolumeof
footballs.
50. a. Actualsalesvolumes
HDradiotuners:
Satelliteradios:
MP3cardecks:

$195,500$115=1,700units
$141,400$70=2,020units
$228,250$55=4,150units

Salespricevariances
HDradiotuners:1,700($120$115)
Satelliteradios: 2,020($68$70)
MP3cardecks: 4,150($60$55)
Total
b. Salesvolumevariances
HDradiotuners:$120(1,6001,700)
Satelliteradios: $68(2,1002,020)
MP3cardecks: $60(1,0504,150)
Total

=$8,500U
=4,040F
=20,750U
$25,210U
=$12,000F
=5,440U
=186,000F
$192,560F

c. Overall,thesalespricevariancewas$25,210unfavorableand,approximately
82percentofthiswascausedbynegativepricevarianceoftheMPScardecks.
Theseresultscouldbeattributedtoshorttermeconomicpressuresormarketing
tacticsusedbyTaub.Assumingtheresultsreflectarationalstrategy,Taubmay
haveacceptedlowerpricestoincreasetheoverallvolumeofsaleswhichis
indicatedbythehighvolumeofMP3cardecksales.Theresultscouldalso
indicateatrendthatmorecustomersareoptingtopurchaseMP3cardecks
because they prefer to listen to the music they have selected rather than
someoneelseschoicesaswouldbethecasewitheitheroftheothermusic
options.
d. By telling Taub that her performance would only be evaluated on three
specificproducts,shewouldtendtoignoreotherproductsinherarea,which
couldhavebeenmoreappropriatetocustomersneeds.Taubmightalsonot
haveunderstoodwhethershewasbeingevaluatedonthebasisofvolumeor
revenue.Ifshebelievedthatthecompanywasconcernedaboutthevolumeof
productsales,Taubcanpointtothefactthatvolumesfortwoofthethree
products were higher than budgeted, which could have been forced by
reducingsellingprices.
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Chapter 13

129

51. a. Actualsalesprice=$235,0005,000=$47
Budgetedsalesprice=$300,0006,000=$50
ASPASV
$475,000
$235,000

BSPASV
$505,000
$250,000

$15,000U
SalesPriceVariance

BSPBSV
$506,000
$300,000

$50,000U
SalesVolumeVariance

b. The budgeted contribution margin was $120,000 6,000 or $20 per unit.
Sincethecompanyssalesvolumewas1,000unitslessthanbudgeted,the
totalimpactonthecompanyscontributionmarginwouldbeareductionof
$20,000fromwhatwasbudgeted.
c. Toisolatetheeffectonoperatingincomeofanincreaseordecreaseinmarket
share, the company must know its budgeted andactual market shares,the
actual size of the market share for November 2013, and the budgeted
weighted average unit contribution margin. These computations may help
Folsomsmanagersdeterminewhetherthedeclineinsaleswasduetoalossof
competitivenessorashrinkageoftheoverallmarket.
d. Performance evaluation would be limited, because in most instances,
managersarealsoresponsibleformanagingsomecostsintheircenters.In
Folsomscase,evaluationofthecontrolovervariableandfixedcostsgoes
beyondthesalespriceandsalesvolumevariances.

52.
Surgery
Inpatient
Outpatient

Assets
Employed
$3,948,500
2,458,500
1,043,000

$7,450,000

%
53
33
14

#of
Employees
20
36
44

100

%
20
36
44

Hoursof
Operation
24,850
28,400
17,750
71,000

%
35
40
25

Administrationcosts:
Surgery:$5,400,0000.53=$2,862,000
Inpatient:$5,400,0000.33=$1,782,000
Outpatient:$5,400,0000.14=$756,000
Publicrelationscost:
Surgery:$1,100,0000.20=$220,000
Inpatient:$1,100,0000.36=$396,000
Outpatient:$1,100,0000.44=$484,000
Maintenanceandjanitorialcost:
Surgery:$1,700,0000.35=$595,000
Inpatient:$1,700,0000.40=$680,000
Outpatient:$1,700,0000.25=$425,000
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Chapter 13

Administration
PublicRelations
Maintenance
Total

Surgery
$2,862,000
220,000
595,000
$3,677,000

InPatient
$1,782,000
396,000
680,000
$2,858,000

OutPatient
$756,000
484,000
425,000
$1,665,000

53. a. Administration:45+210+18=273
Commercial=45273=16%;0.16$1,500,000=$240,000
Residential=210273=77%;0.77$1,500,000=$1,155,000
PropertyMgmt.=18273=7%;0.07$1,500,000=$105,000

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Chapter 13

131

Accounting=$900,000+$1,440,000+$540,000=$2,880,000
Commercial=$900,000$2,880,000=31%;0.31$990,000=$306,900
Residential=$1,440,000$2,880,000=50%;0.50$990,000=$495,000
PropertyMgmt.=$540,000$2,880,000=19%;0.19$990,000= $188,100
Promotion:$10,000,000+$18,000,000+$2,000,000=$30,000,000
Commercial=$10,000,000$30,000,000=33%;0.33$720,000=$237,600
Residential=$18,000,000$30,000,000=60%;0.60$720,000=$432,000
PropertyMgmt.=$2,000,000$30,000,000=7%;0.07$720,000=$50,400
b.

Revenue
Directcosts
Allocatedcosts:
Administration
Accounting
Promotion
Operatingincome

Comm.
Res.
$10,000,000 $18,000,000
(10,490,000) (9,179,000)

Prop.Mgmt.
$2,000,000
(398,400)

(240,000) (1,155,000)
(306,900)
(495,000)
(237,600)(432,000)
$(1,274,500)$6,739,000

(105,000)
(188,100)
(50,400)
$1,258,100

54.a. Administrationcosts($1,500,000)
Base
Accounting
15300
Promotion
12300
Commercial
45300
Residential
210300
PropertyMgmt.
18300
Total(rounded)

Allocation
$75,000
60,000
225,000
1,050,000
90,000
$1,500,000

Accountingcosts($990,000+$75,000=$1,065,000)
Base
Allocation
Promotion
$720,000$3,600,000
$213,000
Commercial
$900,000$3,600,000
266,250
Residential
$1,440,000$3,600,000
426,000
PropertyMgmt.
$540,000$3,600,000

159,750
Total(rounded)
$1,065,000
Promotion($720,000+$60,000+$213,000=$993,000)
Base
Allocation
Commercial
$10,000,000$30,000,000
$331,000
Residential
$18,000,000$30,000,000
595,800
PropertyMgmt.
$2,000,000$30,000,000
66,200
$993,000
Summaryofallocations:
Commercial:$225,000+$266,250+$331,000=$822,250
Residential:$1,050,000+$426,000+$595,800=$2,071,800
PropertyMgmt.:$90,000+$159,750+$66,200=$315,950
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accessible website, in whole or in part.

Chapter 13

b.

133

Commercial Residential
PropertyMgmt.
Revenues
$10,000,000
$18,000,000
$2,000,000
Directcosts
(10,490,000) (9,179,000) (398,400)
Indirectcosts

(822,250)
(2,071,800)
(315,950)
Income
$(1,312,250)
$6,749,200
$1,285,650
ThePropertyManagementDepartmentisthemostprofitablewithareturnon
revenuesof64.3percent.

55. a. Personnel:72+48=120
Residential=72120=60%;0.60$140,000=$84,000
Commercial=48120=40%;0.40$140,000=$56,000
Administration:$480,000+$800,000=$1,280,000
Residential=$480,000$1,280,000=37.5%;0.375$180,000=$67,500
Commercial=$800,000$1,280,000=62.5%;0.625$180,000=$112,500
TotalsupportcostsallocatedtoResidential=$84,000+$67,500=$151,500
TotalsupportcostsallocatedtoCommercial=$56,000+$112,500=$168,500
b.
Administration
Residential
Commercial

#ofEmpl.
30
72
48

%
20%
48%
32%

DirectCosts

$480,000
800,000

37.5%
62.5%

150
Personnel=$140,000ofcosts
Administration=0.20$140,000=$28,000
Residential=0.48$140,000=$67,200
Commercial=0.32$140,000=$44,800
Administration=$180,000+$28,000=$208,000ofcosts
Residential=0.375$208,000=$78,000
Commercial=0.625$208,000=$130,000
TotalsupportcostsallocatedtoResidential=$67,200+$78,000=$145,200
TotalsupportcostsallocatedtoCommercial=$44,800+$130,000=$174,800
c. (1)DirectMethod
Residential=$480,000+$151,500=$631,500;$631,50060,000=$10.53
Commercial=$800,000+$168,500=$968,500;$968,500570,000=
$1.70
(2)StepMethod
Residential=$480,000+$145,200=$625,200;$625,20060,000=$10.42
Commercial=$800,000+$174,800=$974,800;$974,800570,000=
$1.71
56.
Department

ADMINISTRATION
Base
%

EDITORIAL
Base
%

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134

Chapter 13

Admin.(A)
Editorial(E)
CollegeTexts
Prof.Pubs.
Total

N/A
$75,000
600,000
525,000
$1,200,000

N/A
6.25
50.00
43.75

100.00

5
11.11
N/A
N/A
25
55.56
15 33.33

45 100.00rounded

A=$225,000+0.1111E
E=$175,000+0.0625A
A=$225,000+0.1111($175,000+0.0625A)
A=$225,000+$19,443+0.0069A
0.9931A=$244,443
A=$246,141
E=$175,000+0.0625($246,141)
E=$175,000+$15,384
E=$190,384
Dept.
Directcosts
Admin.
Edit.
Total

Admin.
Edit.
$225,000
$175,000
(246,141)
15,384
21,152 (190,384)
$0
$0

College
Texts
Prof.Pubs.
$2,250,000 $950,000
123,071
107,687
105,777 63,455
$2,478,848 $1,121,142

Note:TheAdministrationcolumndoesnotsumtozerobecauseofrounding.
57.a.
Adv.
Cir.

AssetsEmployed
%
$381,200
29
935,150
71
$1,316,350 100%

Admin. (0.29 $390,750; 0.71 $390,750)

H.Res. (0.32 $246,350; 0.68 $246,350)
b. Adv.:$478,900+$192,150=
Cir.:$676,300+$444,951=
c.

#ofEmployees
%
6
32
13

68
19 100%
Adv.
Cir.
$113,318 $277,433

78,832 167,518

$192,150 $444,951

$671,050
1,121,251

$1,792,301(offduetorounding)

Admin.($390,750):
Base
H.Res.
$145,850$1,462,200
Adv.
$381,200$1,462,200
Cir.
$935,150$1,462,200

Allocation
$38,976
101,870

249,904
$390,750

H.Res.($246,350+$38,976)=$285,326:
Base
Allocation
Adv.
619
$90,103
Cir.
1319
195,223

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Chapter 13

135

$285,326
d. Adv.:$478,900+$101,870+$90,103=
Cir.:$676,300+$249,904+$195,223=

e.
Department
Admin.(A)
H.Res.(H)
Adv.
Cir.

$670,873
1,121,427

$1,792,300

ADMIN.
Base
%
N/A
N/A
$145,850
10
381,200
26
935,150
64
$1,462,200

H.RES.
Base
%
5
21
N/A
N/A
6
25
13
54
24

A=$390,750+0.21H
H=$246,350+0.10A
A=$390,750+0.21($246,350+0.10A)
=$390,750+$51,733.50+0.021A
0.979A=$442,483.50
A=$451,975
H=$246,350+0.10($451,975)
=$246,350+$45,197.50
=$291,548
Directcosts
Admin.
H.Res.

Admin.
H.Res.
$390,750
$246,350
(451,975)
45,198

61,225 (291,548)
$0
$0

Advertising
$478,900
117,514
72,887
$669,301

Circulation
$676,300
289,264
157,436
$1,123,000

58. a. AdministrativeCosts($2,130):(000somitted)
Base
Allocation
Legal/Acctg.
40800
$106.50
Maint./Eng.
60800
159.75
Proc.
400
1,065.00
800
Finish.
300
798.75
800
$2,130.00
Legal/Acctg.($1,680+$106.50=$1,786.50):
Base
Allocation
Maint./Eng.
4004,000
$178.65
Proc.
1,6004,000
714.60
Finish.
2,0004,000
893.25
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136

Chapter 13

$1,786.50
Maint./Eng.($2,370+$159.75+$178.65=$2,708.40):
Base
Allocation
Proc.
136340
$1,083.36
Finish.
204340

1,625.04
$2,708.40
Summaryofallocation:
Proc.:$1,065+$714.60+$1,083.36+$7,520=$10,382.96
Finish.:$798.75+$893.25+$1,625.04+$7,200=$10,517.04

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Chapter 13

137

Factoryoverheadrates:
Proc.:$10,382.96400=$25.96perdirectlaborhour
Finish.:$10,517.04300=$35.06perdirectlaborhour
b.
Proc.
Finish.

FloorSpace
1,600
2,000
3,600

Admin.
Legal/Acctg.
Maint./Eng.
Total

% #ofEmployees
44
400
56
300
700
Proc.
$1,214
739
948
$2,901

% #ofHours
57
136
43
204
340

%
40
60

Finish.
$916
941
1,422

$3,279

Factoryoverheadrates:
Proc.:($7,520+$2,901)400=$26.05perdirectlaborhour
Finish.:($7,200+$3,279)300=$34.93perdirectlaborhour
c.

Department
Admin.(A)
Legal/Acctg.(L)
Maint./Eng.(M)
Proc.
Finish.

ADMIN.
Base
%
N/A
N/A
40
5.00
60
7.50
400
50.00
300
37.50
800

LEGAL/ACCTG.
Base
%
800
16.67
N/A
N/A
400
8.33
1,600
33.33
2,000
41.67
4,800

MAINT./ENG.
Base %
7.32
30
9.76
40
N/A
N/A
33.17
136
49.76
204
410

A=$2,130+0.17L+0.07M
L=$1,680+0.05A+0.10M
M=$2,370+0.075A+0.08L
A=$2,130+0.17($1,680+0.05A+0.10M)+0.07M
A=$2,130+$285.60+0.0085A+0.087M
0.9915A=$2,415.60+0.087M
A=$2,436+0.088M
M=$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+0.079A
M=$2,525+0.0796A
SubstitutingM:
A=$2,436+0.088($2,525+0.0796A)
A=$2,436+$222.20+0.007A
0.993A=$2,658.20
A=$2,677
M=$2,525+0.0796($2,677)
=$2,525+$213.09
=$2,738
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Chapter 13

L=$1,680+0.05($2,677)+0.10($2,738)
=$1,680+$133.85+$273.80
=$2,088
Admin.
L/A
M/E
Proc.
Directcosts
$2,130
$1,680
$2,370
$7,520
Admin.
(2,677)
134
201
1,339
Legal/Acctg.
355 (2,088)
167
689
Maint./Eng.
192
274
(2,738) 904
$0
$0
$0
$10,452

Fin.
$7,200
1,004
877
1,369
$10,450

Factoryoverheadrates:
Proc:$10,452400=$26.13perdirectlaborhour
Finish:$10,450300=$34.83perdirectlaborhour
59. Allocationofcomputerservicescostsshouldbemadeonanhoursusedbasisto
permit a more efficient use of company resources. The charging basis should
encourage users to take advantage of the Computer Systems Departments
services but not permit the Computer Systems Department to pass on its
inefficiencies. For instance, a standard hourly usage rate should be developed
basedonpastexperience,adjustedforefficiencyconsiderations.Divisionswould
bechargedthestandardrateforthehoursofrecordedusage.
(CMAadapted)
60. a. Case1upperlimit=$70
Case1lowerlimit=[$32+$12+$4+($6$1)]+(LostCMof$26)=$79
LostCM=$80($32+$12+$4+$6)=$26
Case2upperlimit=$57
Case2lowerlimit=[$22+$10+$3+($3$1)]+(LostCMof$27)=$64
LostCM=$65($22+$10+$3+$3)=$27
Interpretation:When,asinbothcasesinthisproblem,thelowerlimitexceeds
theupperlimit,theintracompanytransfersshouldnotbemadebecausethe
companywillbeworseoff.
b. Sellingprice=Variablecost+$12
Case1sellingprice=[$32+$12+$4+($6$1)]+$12=$65
Case2sellingprice=[$22+$10+$3+($3$1)]+$12=$49
c. DualtransferpricesforCase1:Speakerssellingprice[from(b)]=$65Sound
Systemspurchaseprice=($70$12)=$58
SpeakersDivisionmanagershoulddemonstratethatthewholecompanywill
beworseoffifthisisdonebasedontheanswerto(a):
ContributionmarginlostbySpeakerDivision
$26
SavingstoSoundSystembypurchasing
belowtheexternalpurchaseprice($70$58)
(12)
Losstocompanyperunittransferred
$14
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Chapter 13

139

61. a. Currentexternalsellingprice,$10,464
SellingDivisionfairvaluesincemostareproducedandsoldatthisprice
externally.
BuyingDivisionpriceishigherthanoutsidevendorpricesothiswouldmake
itsperformancereportappearworsethanbybuyingexternally.
Totalvariableproductioncost($4,200)+20%=$5,040
Selling Divisioncontributes minimally to covering fixed costs, and
therefore,noprofitisshownfromthesesalesasopposedtoexternalsales.
Thereislittleincentivetosellinternallyifthesellingdivisioncansellallits
outputexternally.
Buying Divisionless than external purchase price, therefore it is more
beneficialtothebottomlineofLudmillaCompany.
Totalproduct($6,000)cost+20%=$7,200
Selling Divisioncovers some but not all costs for this division, therefore
incentive to sell internally isnt there if Engine Division can sell its output
externally.
BuyingDivisionpurchasepricebelowexternalsobetterformargininthis
division.
Bidpricefromexternalsupplier($9,280)
Selling Divisionallows for some profit which is an incentive to sell
internallyunlessitcansellallitsoutputexternally.
BuyingDivisionnoincentivetobuyinternallysinceitcoststhesameasto
buyfromanexternalsupplier.
b. Upperlimit=$9,280
Lowerlimit=costsof$4,800+Contributionmarginof$5,664=$10,464
Sincethelowerlimitexceedstheupperlimit,thecompanywouldbebetteroff
notmakingtheinternaltransfers.
62.a. RollEmOn
A/R(SWDiv.)
640,000
Intraco.Sales

SkyWheels
Inventory
640,000
640,000
A/P(REODiv.)

640,000

WorldlyTravelers
Intraco.CGS 368,000
FinishedGoods 368,000
[4,000($40+$12+$16+$24)=4,000$92]

b. Variablecost=$40+$12+$16+$8=$76;$76+(0.15)($92)=$89.80
Totaltransfercost=4,000$89.80=$359,200
RollEmOn
A/R(SWDiv.)
359,200
Intraco.Sales

359,200

WorldlyTravelers
Intraco.CGS
368,000
FinishedGoods

368,000

SkyWheels
Inventory
359,200
A/P(REODiv.)
359,200

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Chapter 13

[4,000($40+$12+$16+$24)=4,000$92]

c. RollEmOn
A/R(SWDiv.)
Intraco.Salesin
Excessof
AssignedCost
Intraco.Sales

SkyWheels
Inventory
272,000
A/P(REODiv.)
272,000

272,000
368,000
640,000

WorldlyTravelers
Intraco.CGS
368,000
FinishedGoods
368,000
d. RollEmOn
A/R(SWDiv.)
368,000
Intraco.Sales

SkyWheels
Inventory
368,000
368,000 A/P(REODiv.)
368,000

WorldlyTravelers.
Intraco.CGS
368,000
FinishedGoods
368,000
PlainCookies DecoratedCookies

63.a.
Sales
Tooutsiders
Tootherdivision
Variablecosts:
Cookies
Othercosts
Contributionmargin
Fixedcosts
Segmentmargin
Bonus(10%)
Operatingincome

$6,000
0

$3,200

(1,500) (1,600)

(600)
$4,500
$1,000

(300)
(500)
$4,200
$500

(420)
(50)
$3,780
$450

CompanyTotal
$9,200
0

(3,100)

(600)
$5,500

(800)
$4,700

(470)
$4,230

b. SincethePlain Cookies Divisioncurrentlyhasexcesscapacity, thelowest

transferpriceshouldbeitsvariablecostplustheopportunitycost.Withexcess
capacity,opportunitycostis$0.Thelowesttransferpriceis$0.50percookie.
SincethemanageroftheDecoratedCookiesDivisionwouldbuyfromoutside
vendorsatapriceinexcessofthemarketpriceof$2percookie,thehighest
transferpricewouldbe$2.
c. Transferpriceof$0.50percookie
PlainCookies DecoratedCookies CompanyTotal
Sales
Tooutsiders
$6,000
$3,200
$9,200
Tootherdivision
400
0
Variablecosts:
Cookies
(1,500) (400) (1,500)
Othercosts

(400)
(600) (1,000)
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Chapter 13

141

Contributionmargin
$4,500
$2,200
$6,700
Fixedcosts

(300)
(500)
(800)
Segmentmargin
$4,200
$1,700
$5,900
Bonus(10%)

(420)
(170)
(590)
Operatingincome
$3,780
$1,530
$5,310
Note:Theintracompanyrevenueof$400andintracompanycostof$400have
beeneliminatedinthecompanytotalincomestatement.

Davissbonusincreasesby$120becauseofthe$1,200costsavingsfrom
buying cookies from Plain Cookies Division rather than from outside
suppliers(savingsof$1.50percookie800decoratedcookies).
CookieDelightssegmentmarginincreasesbythesame$1,200.
Lindens bonus remains that same because the Plain Cookies Division
makesnoadditionalmoneyonthetransferofcookiestotheDecorated
CookiesDivision.

Transferpriceof$2.00percookie
PlainCookies DecoratedCookies CompanyTotal
Sales
Tooutsiders
$6,000
$3,200
$9,200
Tootherdivision
1,600
0
Variablecosts:
Cookies
(1,500) (1,600) (1,500)
Othercosts

(400)
(600) (1,000)
Contributionmargin
$5,700
$1,000
$6,700
Fixedcosts

(300)
(500)
(800)
Segmentmargin
$5,400
$500
$5,900
Bonus(10%)

(540)
(50)
(590)
Operatingincome
$4,860
$450
$5,310
Note:Theintracompanyrevenueof$1,600andintracompanycostof$1,600
havebeeneliminatedinthecompanytotalincomestatement.

d.

Davissbonusremainsat$50becausethereisnocostsavingsfrombuying
cookiesfromPlainCookiesDivisionratherthanfromoutsidesuppliers.
CookieDelights segment marginstill increases by$1,200becausethe
companyscostpercookieis$0.50ratherthan$2.00.
Lindensbonusincreasesby$120,whichis10percentofthe$1,200profit
hisdivisionmakesonsellingplaincookiestoDecoratedCookiesDivision
for$1,200morethantheycosttomake.

ThecomputationsshowthatCookieDelightCompanyisbetteroffatanyvalue
betweenthelowesttransferpriceof$0.50andthehighesttransferpriceof$2
because of the companys cost savings from making the cookies that the
DecoratedCookiesDivisionusesratherthanbuyingthemfromtheoutside.
However,becauseofthebonusstructure,Lindenwouldpreferthe$2transfer
pricewhileDaviswouldpreferthe$0.50transferprice.Theoptimumsolution
istoencouragethedivisionmanagerstonegotiateanacceptabletransferprice.

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Chapter 13

Anegotiatedtransferpriceof$1.25wouldencouragebothdivisionmanagers
totransferinternallyandcreategoalcongruenceinthecompany.
64. a. To maximize shortrun contribution margin, the Alberton Division should
acceptthecontractfromNewLondonCompany.Thisconclusionissupported
bythefollowingcalculations.
(1) AlbertontransfertoSummerside:
Transferprice(1,500$1,500)
Variablecost
Purch.fromOLeary(1,500$600)
ProcessbyAlberton(1,500$500)
ContributionMargin

(2) AlbertonacceptsNewLondoncontract:
Sellingprice(1,750$1,250)
Variablecost
Purch.fromOLeary(1,750$500)
ProcessbyAlberton(1,750$400)
ContributionMargin

$2,250,000
$900,000
750,000

$2,187,500
$875,000
700,000

Conclusion:
ContributionmarginfromNewLondoncontract
ContributionmarginfromSummersidesale
DifferenceinfavorofNewLondoncontract
b.

(1,650,000)
$600,000

(1,575,000)
$612,500
$612,500

(600,000)
$12,500

AlbertonDivisionsdecisiontoacceptthecontractfromNewLondonCompany
isinthecompanysbestinterestbecausethedecisionincreasesthecompanys
overall contribution margin. This conclusion is supported by the following
calculations.
RevenuesandcostsavingstoCharlottetownInc:
Sale:AlbertontoNewLondon(1,750$1,250)
Sale:OLearytoMontague(1,500$400)
Costsavings(variablecostsavoidedbynot
notacceptingtheSummersideorder)
OLearyssavings(1,500$300)
Albertonssavings(1,500$500)
ExpendituresincurredbyCharlottetownInc.
VariablecostsincurredforNewLondonorder
Alberton(1,750$400)
OLeary(1,750$250)
Variablecostincurredforpurchase
SummersidefromMontague(1,500$1,500)
MontaguefromOLeary(1,500$200)
Positivecontributionmargin

$2,187,500
600,000
450,000
750,000

$3,987,500

$700,000
437,500
2,250,000

300,000 (3,687,500)
$300,000
(CMAadapted)

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accessible website, in whole or in part.

Chapter 13

143

65. a. TotalEDPhoursused=1,220+650+190=2,060
Transferpricerevenue=2,060$80=$164,800
ActualvariableEDPcosts=
TotalEDPhoursused

$181,280
2,060

=$88transferprice

The$80transferpriceisinadequatebecausetheEDPDepartmentisleftwitha
loss(forinternalevaluationpurposes)of($181,280$164,800)or$16,480.

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accessible website, in whole or in part.

144

Chapter 13

b. andc.

Allocate administration costs of $900,000 and fixed EDP costs of

$600,000:
Lit.

Administration($900,000)
(10/18,5/18,3/18)
EDPFixed($600,000)
(80/345,240/345,
25/345)
Totalallocated
Transfercosts
Directcosts
Total

$500,000

FP

LC

Total

$250,000

$150,000

$900,000

139,130 417,392 43,478 600,000

$639,130 $667,392 $193,478 $1,500,000
97,600
52,000
15,200
164,800
400,000 510,000 680,000

1,590,000

$1,136,730 $1,229,392 $888,678 $3,254,800

66. ToachieveCarryOn!sgoals,thedivisionmanagershouldpurchasethematerials
neededatthelowestpriceavailabletoCarryOn!Divisionatthepresenttime.The
threepossiblepricesareasfollows:
Koenigsprice
$8.00
HIDEsprice
9.00
Thompsonsprice
7.00
CarryOn!DivisionshouldpurchasefromThompson.
For CarryOn! Division to achieve the overall company goals, the following
analysisisrequiredtocomparethecostsofthethreebidders:
Koenigsprice
HIDEsprice:
SalespriceProfitmargin=$9.00(0.40$9.00)
Thompsonsprice
However,theprofitmarginofBarrowsChemical
shouldbededucted=$7.00(0.30$2.00)

$8.00
$7.00
(0.60)

5.40
6.40

FromEekaydosstandpoint,therelevantcostsforthisdecisionarethevariable
costspersquarefootifthereisavailablecapacityandnoadditionalfixedcosts
would be incurred. For any division to achieve the overall company goals to
maximizeprofit,variableorganizationalcostsmustbeminimized.Inthiscase,
CarryOn! must choose the best price available to it. HIDE should consider
loweringitspricetomeetThomsonscompetition.
(CMAadapted)
67.a. Regularsellingprice
Regular selling price less variable selling anddistribution
expenses($26.00$2.40)
Standardmanufacturingcostplus15%
($12.80+$4.80)1.15
Standardvariablemanufacturingcostplus20%
($12.801.20)

$26.00
$23.60
$20.24
$15.36

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accessible website, in whole or in part.

Chapter 13

b. Currently,GondorfDivisionmanagementshouldbepositivetoeachofthese
prices in decreasing order because the division apparently has unused
capacity.Asaninvestmentcenter,themanagerofGondorfDivisionislikely
tobeevaluatedbasedonreturnoninvestment,andsinceeachoftheseprices
exceedsdivisionalvariablecosts,anyofthepriceswillincreaseGondorfs
ROI.
If,atsomepoint,allexistingcapacityofGondorfDivisionisbeingused,the
divisionsmanagerwouldwanttheintercompanytransferpricetogeneratethe
sameamountofprofitasoutsidebusinesstomaximizedivisionROI.
c. Negotiationbetweenthetwodivisionsisthebestmethodtosettleonatransfer
price.Thecompanyishighlydecentralized,andeachofthefollowingfour
conditionsnecessaryfornegotiatedtransferpricesexist:
Anoutsidemarketexiststhatprovidesbothpartieswithanalternative.
Bothpartieshaveaccesstomarketpriceinformation.
Bothpartiesarefreetobuyandselloutsidethecompany.
Top management supports the continuation of the decentralized
managementconcept.
d. No,corporatemanagementshouldnotbecomeinvolvedinthiscontroversy.
Becausethedecisionhasbeenmadetooperatethedivisionsasinvestment
centers,topmanagementmustbelievethatsuchanorganizationalstructure
will maximize longterm profits. Imposing corporate restrictions will
adversely affect the current management evaluation system because
investmentcentermanagerswouldnolongerhavecompletecontroloftheir
unitsprofits.Also,theadditionofcorporaterestrictionscouldhaveanegative
impact on division management who are accustomed to an autonomous
workingenvironment.
(CMAadapted)
68. a. ThemainadvantagethatIOWoWmighthaveisacostadvantage.Itislikely,
because the division sells mainly internally, that the division incurs lower
marketing and promotion costs than other divisions. By selling mainly
internally,thedivisionhasnorequirementtomaintainthesamemarketing
capabilityasotherdivisionsthatselltheirproductsexternally.Inaddition,the
divisionmayreapsubstantialsavingsondistributioncostsbecauseitdoesnot
havetoshipmostofitsoutputtoothercustomerlocations.
b. Becausethedivisionsellsmainlyinternally,itwouldbepossibletomakethe
IOWoW Division a cost center. Then, output of the division could be
transferredtootherinternaldivisionsatfullorvariablecost.Theotherlogical
alternative is to allow the internal buying divisions to negotiate with IO
WoWfordiscountsfromtheusualmarketpricesothatthebuyingdivisions
shareinthecostsavings.
69. Each student will have a different answer. No solution is provided. URL
is http://www.ey.com/GL/en/Services/Tax/InternationalTax/TransferPricingand
TaxEffectiveSupplyChainManagement/2011Transferpricingreferenceguide
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accessible website, in whole or in part.

145

146

Chapter 13

(Shouldthislinknotbeaccessible,typeinErnst&Young2011TransferPricing
ReferenceGuideintosearchengine.)
70. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.
71. Eachstudentwillhaveadifferentanswer.Nosolutionisprovided.However,the
followingmaybehelpfulinthediscussion.
Excerpted from Transfer Pricing in a Recession: What Companies Should
Consider(PricewaterhouseCoopers,2009)
With rising unemployment comes reduced personal income taxes, and with
reducedcorporateprofitscomereducedcorporaterevenue.Theglobaltaxbase
has decreased and probably will continue to shrink. Even in a recession, a
discussionbyanypoliticianofincreasedtaxesisrisky.Moremoneyisneededto
keepfundingcurrentprograms,andwhiletaxesofmanyvarietiesmayincrease,a
less controversial option is for the Internal Revenue Service to collect more
revenue through increased enforcement and other means. Globally, taxing
authorities will increase their efforts to collect taxes needed to fuel their
governmentsspending.
Asubstantialincreaseintaxaudits,includingthosefocusedontransferpricing,is
expected. Inadditiontotheincreasednumberofaudits expected globally, the
difficulty and complexity of such audits are expected to increase as taxing
authoritiescontinuetobecomemoresophisticatedandopentosharingtaxpayer
information.Issuesthatmayhavebeenoverlookedbeforewillbereconsidered.
Settlement positions arrived at in the past may no longer be accepted. All
possibilitiesareonthetable.
Insuchuncertaineconomictimes,howshouldmultinationalcompaniesapproach
defendingpasttransferpricingpoliciesincludingthoseestablishedunderadvance
pricing agreements during robust economic times? How should companies
prepare to go forward regarding their transfer pricing options? In addition to
ensuringtheyhaveadequatelydocumentedtheirtransferpricingtodefendhistorical
positions,companiesalsomustconsiderwaystooptimizecurrentandfuturetransfer
pricing positions. This includes evaluating current transfer prices under current
structuresaswellasopportunitiestomodifycurrentorganizationalandtaxstructures.
Multinational companies abilities to develop and sustain taxefficient structures
(alongsiderequiredsupplychainmodifications)willhavesignificantimplicationsfor
theirabilitiestoreducecostsandremaincompetitive.
From David D. Stewart, Transfer Pricing Practitioners Find Challenges,
OpportunitiesinEconomicClimate,WorldwideTaxDaily(May22,2009):Steve
HassonwithPwCsU.K.transferpricinggroupdiscusseddifficultiesrelatedto
pricingusingcomparablesandadjustingtothecurrentenvironmentwithexisting
arrangements.Hassonnotedthatthedatabeingusedfordeterminingcomparables
arehistoricandlagged,resultinginadatasetthatdoesnotreflectthecurrent
economicenvironment.Inshort,whatitmeansisthatthedatayouarerelyingon
is drawn from boom years, and you probably dont want to benchmark your
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accessible website, in whole or in part.

Chapter 13

pricingagainstthatpositionorindeedyoumaynotbeableto,Hassonsaid.This
wholequestionofcomparabilityhasgottenawholelotharder,headded.
AccordingtoGregOssi,aprincipalwithPwCstransferpricinggroup,companies
with a current APA will face challenges in the current environment, but
companies in negotiations for APAs could find opportunities. For companies
withcurrentAPAs,Ossisaidthatwhileitisunlikelytaxauthoritieswouldbe
willingtorenegotiatetheagreementbasedonlyonadeclineinsales,itmaybe
possibletoseekanextensionofacurrentAPAwithrenegotiatedtermsforthe
remainder. For companies considering or in negotiations for an APA, Ossi
explained that the IRSs APA office is open to a range of techniques and
refinements employed in a new agreement. Among the techniques Ossi
suggestedwereusingdifferentpricingoverseveralperiodstoreflectthecurrent
downturnandexpectedrecovery,shorteningtheAPAterm,orincludingspecial
criticalassumptionsintheagreement.Iwouldcharacterizethisasaworkin
processattheAPAoffice,Andrussaid.Theyareclearlyworkingonfiguringit
out,butIdontthinkthereisafixedmenuofthingsthattheyarewillingtodoin
anycaseorineverycasethatscarvedinstoneatthispoint.
72. Each student will have a different answer. No solution is provided. However, the
following may be helpful in the discussion: New OECD Project on the Pricing of
Intangibles, A World in Transition (March 2011); http://www.kpmg.com/Global/
en/IssuesAndInsights/ArticlesPublications/Documents/world-in-transition.pdf, p. 28ff
(accessed 1/2/12).

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147