Responsibility Acctg. (OK Na!)

UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014

Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!
CHAPTER 10:
Responsibility Accounting and Transfer Pricing
☛RESPONSIBILITY ACCOUNTING
 a system of accounting in which costs are in designing and managing autonomous
assigned to various managerial levels responsibility centers.
according to where control of the costs is ☛PERFORMANCE EVALUATION
deemed rest, with managers being held  is done within the concept of controllability
responsible for the difference between (or authority).
actual and budgeted results. ☛CONTROLLABILITY
 refers to the power of the manager to
☛Responsibility center decide or influence the incurrence or non-
 a clearly identified part or segment of an incurrence of an item. The span of authority
organization that is for a specified function given to a manager defines the items that
or set of activities. he has control with. The concept of
 any part of the organization whose controllability is extremely important in
manager has control over cost, revenue, or measuring manager’s performance.
investment funds.
Responsibility center managers are evaluated as
TYPES OF RESPONSIBILITY CENTERS follows:
1. Cost Center(or expense center) Center managers Evaluation models

 A segment of an organization in which Cost center manager Costs variance analysis
managers are held responsible for the costs Revenue center Revenue variance analysis
or expenses incurred in the segment. manager
2. Revenue Center Profit center manager Segment margin analysis
 Where management is responsible Investment center Return on
primarily for revenues. manager investment(ROI), Residual
3. Profit Center income model, Economic
 A segment of the organization in which the value added, Equity
manager is held responsible for both spread, Total shareholders
revenues and costs, return, and the Market
4. Investment Center value added.
 A segment of the organization where the
manager controls revenues, costs, and ☛Segment margin is determined as follows:
investments. The center’s performance is
measured in terms of the use of the assets Contribution margin Pxx
as well as the revenues earned and the Less: Avoidable fixed costs and expenses xx
costs incurred. Segment margin xx
Less: Unavoidable fixed costs and expenses xx
☛CENTRALIZATION Profit xx
 happens when decisions rests exclusively to Segment margin is the same as segment income
top management. or segment profit
☛DECENTRALIZATION a. Return on Investment (ROI) model
 the power to make decision is entrusted to  it is sometimes refer to as return on
operating managers; this is the model used assets(ROA). It is computed as follows:
Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
55 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
-
ROI= Segment income/ Investment
 measures the marginal benefit obtained by
Three advantages of using ROI to evaluate the using resources in relation to the business
performance of investment centers: of increasing shareholder value.
1. It encourages managers to pay careful attention
to the relationship among sales, expenses, and Operating profit after tax P xx (PBIT x ATR)
investment, as should be the case for a manager of Less: MRLTE*
an investment center. (TACL*) x WACOC xx
2. It encourages cost efficiency. Economic Value Added xx
3. It discourages excessive
Two disadvantage of using ROI are: *TACL= Total assets – Current Liability
1. It discourages managers from investing in projects *MRLTE = Minimum return on long-term equity
that would decrease the divisional ROI but would (Where: PBIT = profit before interest and tax and
increase the profitability of the company as a whole. WACOC = weighted average cost of capital)
(Generally, projects with an ROI less than a division’s
current ROI would be rejected.) d. Equity Spread
2. It can encourage myopic behavior, in that  it measures managerial performance
managers may focus on the short run at the expense regarding creation of shareholder value. It is
of the long run. computed as follows:
☛ROI Du Pont Analysis Shareholders’ equity-beginning P xx

X (Return on equity** – Cost of equity rate) xx%
ROI= (Segment income/ Sales) x (Sales/ investment) Equity spread xx
or Return on Sales x Assets turnover **Return on equity= profit/ average shareholders’
ROI is expressed on percentage and has an equity
inherent limitation of disregarding the peso value
performance of a business segment and its manager. e. Total shareholders’ return
= change in the Stock Price + dividend per share
b. Residual Income Model Initial stock price
Residual income is computed as follows: f. Market Value Added

Segment income P xx
Less: Minimum income** xx Market value of equity
Residual income xx (shares outstanding x market price) xx
** Minimum income= investment x imputed income Less: equity supplied by shareholders xx
rate Market Value Added xx
Sometimes, the imputed rate is the cost of
capital
If the residual income is positive, the
performance is above standard and, is therefore,
favorable.
Residual income is considered superior than the
ROI because it is determined in peso, not in rate.
c. Economic Value added (EVA)

 aftertax version of the residual income
model.
COMPREHENSIVE PROBLEM:
Max Corporation has two divisions, Green Enterprises and White Merchandisers. Green Enterprises produces
product Tiner with the following data:
Unit sales price P125
Production cost per unit:
Materials 8
Direct Labor 13
Variable Overhead 25
Fixed Overhead (based on normal capacity of 40,000 units) 12
Marketing and General expenses:
Variable 8
Fixed 6
Maximum capacity 50, 000 units
Units sold to outside customers 40, 000 units
White Merchandisers, a newly established division, needs 5,000 units of product Tiner. An outside supplier which
produces Tiner with comparable quality as that of Green Enterprise has quoted White to supply the 5,000 units for
P75. White would sell product Tiner to its customer for P140 after incurring marketing and packaging costs of P25
per unit. Green Enterprises would not incur any variable marketing expense if 5,000 units are sold to White
Merchandisers.
White Merchandisers would use P250,000 incremental average assets for the production and sale of 5,000 units of
product Tiner.
Green Enterprises uses an average of P2,000,000 in assets to produce Tiner.
Additional information for Max Corporation:

EBIT 6, 000, 000
Interest Expense (950, 000 x 8%) 76, 000
Average Total Assets 22, 500, 000
Average Current Liabilities 6, 000, 000
Average Bonds Payable 950, 000
Stockholder’s Equity, beginning 650, 000
Market Value per share of stock:
January 1 64
December 31 72
Dividend per Share 16
Weighted Average Cost of Capital 15%
Cost of Common Equity 24%
Tax Rate 30%
Common stock outstanding 40, 000 shares
Required:
a. For the 5,000 units to be ordered by White Merchandisers, determine the return on investment (ROI) for
Green Enterprise, White Merchandisers, and Max Corporation if inter-divisional transfer price is P70.
b. What would be the minimum transfer price between Green Enterprises and White Merchandisers?
c. What would be the minimum transfer price assuming Green Enterprises is already operating at maximum
capacity?
d. Residual income
e. Economic value added(EVA)

f. Total shareholders’ return
g. Market value added
SOLUTION:
a.
Green Enterprises White Merchandisers Max Corporation
Sales (5,000 x P70) P 350, 000
(5,000 x P140) P 700, 000 P 700, 000
Variable costs(5,000 x P46) (230, 000) (230, 000) (230, 000)
Variable expenses(5,000 x P25) - (125, 000) (125, 000)
Divisional/ Total Income 120, 000 345, 000 345, 000
Average Investments 2, 000, 000 200, 000 2, 200, 000
Return on Investment 6% 137.50% 12.50%
b.
Minimum Transfer Price = Incremental Costs + Opportunity Costs
= ( 8 + 13 + 25)
= P46
There is no opportunity cost since Green Enterprises has an excess capacity of 10, 000 units (i.e., 50, 000 units – 40,
000 units), which is more than enough to accommodate the possible sales to White Merchandisers. There is also
expressed alternative use of the excess capacity, hence, no opportunity costs to be considered.
c.
Incremental Costs P 46.00
+ Opportunity Costs (125 – 46 – 8) 71.00
Minimum transfer price with no excess capacity P 117.00
or
Unit Sales Price P 125.00
- Avoidable variable marketing costs 8.00
Minimum transfer price with no excess capacity P117.00
d. Earnings before interest but after tax {[P 6, 000, 000 – (P6, 000, 000 – P76, 000) 30%]} P4, 222, 800
- Minimum return on long-term financing [(P22, 500, 000 – 6, 000, 0000) x 15%] 2, 475, 000
Economic Value Added 1, 747, 800
e. Shareholder’s Equity, Beginning P650, 000

x Spread Rate 26.67%
Equity Spread 173, 335
IBIT (P6, 000, 000 – P76, 000) P5, 924, 000

- Tax (30%) 1, 777, 200
Net Income 4, 146, 800
Average Stockholder’s equity (P22, 500, 000 - 6, 000, 000 - 950, 000) 15, 550, 000
Return on Equity 26.67%
f. Total Shareholder’s return = [(P72 – 64) + P16] / P64 = 37.50%

g. Market Value Added = (72 – 64) x 40, 000 shares = P320, 000

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UNIVERSITY OF SAINT LOUIS-TUGUEGARAO

School of Business Administration and Accountancy, 2013-2014

1. Cost Center(or expense center) Center managers Evaluation models

☛ROI Du Pont Analysis Shareholders’ equity-beginning P xx

Residual income is computed as follows: f. Market Value Added

c. Economic Value added (EVA)

Additional information for Max Corporation:

e. Economic value added(EVA)

e. Shareholder’s Equity, Beginning P650, 000

IBIT (P6, 000, 000 – P76, 000) P5, 924, 000

f. Total Shareholder’s return = [(P72 – 64) + P16] / P64 = 37.50%

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