SUGGESTED SOLUTION

MAF 635
JANUARY 2013

QUESTION 1

a) Benefits of transfer pricing within a decentralized company:

1. It can lead to goal congruence by motivating divisional managers

to make decision, which improve divisional profit and improve
profit of the organization as a whole

2. It prevent dysfunctional decision making so that decision taken by

a divisional manager are in the best interest of his own part of the
business, other division and the organization as a whole

3. Transfer pricing can be set at any level that enables divisional

performance to be measured commercially. A transfer pricing
system should therefore report a level of divisional profit that is a
measurable measure of managerial performance of the division

4. It should ensure that divisional autonomy is not undermined. A

well run transfer pricing system help to ensure that a balance is
kept between divisional autonomy to provide incentive and
motivation, and centralized authority to ensure that the division are
all working towards the same target, the benefit of the
organization as a whole.
(any 3 x 3 marks= 9 marks)

b) Features of effective performance measurement system:

1. Performance measures should link to strategy and goals of

organization to promote goal congruence
2. Measures are understandable and easy to communicate to
employees
3. Measures relate to activities and processes that are under their
control
4. Performance measures should be expressed in positive rather
than negative terms
5. Performance measurement should be reported as close as
possible to the period they relate
6. Performance measures are benchmarked to high external
standards
7. Embrace employees’ participation and empowerment in their
formulation and operation.
8. Include only a few performance measures
9. Performance measurement should be linked to the rewards
system
(any 3 x 2 marks = 6 marks)

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c) Ways to measure customers’ satisfaction

1. Market research information on customer’s

preferences and customer’s satisfaction with specific product
features
2. Number of defective units supplied to customers as
a percentage of total units supplied
3. Number of customer complaint as a percentage of
total sales volume
4. Repeat business from existing customers
5. Percentage of products which fail early or
excessively
6. On-time delivery rate
7. Average time to deal with customer’s queries

(any 5 x 1 mark= 5 marks)

d) Selling Division

Total number of washing machines sold

= 800/0.4
=2000 units

Sales revenue= RM13,000,000

Selling price for a washing machine

=RM13,000,000/2000 units
=RM6,500 (including RM400 service fees for first year)

Variable cost = VC
Sales revenue 13,000,000

= 52%

VC = 52% x13,000,000
VC = 6,760,000

Service Division

Fixed overhead costs per unit

= RM78,000/1300 units
= RM600/unit

The calculation of the transfer service at market price is as follows:

RM per maintenance
Part 600 /
Labour (RM300 x 3 hrs) 900 /
Variable overhead (RM150 x 3 hrs) 450 /
Variable Cost 1950
Fixed Overhead 600/
Total Cost 2550/
Mark-up (25%) 637.5
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 Transfer service 3187.50/
(6 x 0.5 marks= 3 marks)
i) Profit if transfers at 25% mark-up
Selling Service Cosplant
Division Division
(‘000) (‘000) (‘000)
Sales 13,000/ Service revenue 2550/ 13,000
External customers Internal customers
(2,000 x 6500) (800 x 3187.50)
external customers 1593.75/ 1593.75
(500 x 3187.50)
Less: Less:
-Variable cost of sales (6,760)/ (6,760)
-Transfer Service Cost (2550)/ -variable service (2,535)/ (2,535)
(800 x3187.50) cost
(1300 xRM1950)
-Fixed costs (2,340)/ -fixed cost (780)/ (3120)
Profit 1,350 828.75 2178.75

ii) Profit if transfers at variable cost

Selling Service Cosplant
Division Division
(‘000) (‘000) (‘000)
Sales 13,000 Service revenue 1560 13,000
External customers Internal customers
(2,000 x 6500) (800 x 1950)
external customers 1593.75 1593.75
(500 x3187.50)
Less: Less:
-Variable cost of sales (6,760) (6,760)
-Transfer Service Cost (1560)/ -variable service cost (2,535) (2,535)
(800 x 1950) (1300 xRM1950)
-Fixed costs (2,340) -fixed cost (780) (3120)
Profit 2,340 (161.25)/ 2178.75/
Analysis:

The Selling Division will agree to get the warranty work from the Service Division
if the transfers are made at variable costs. This allows the division to get the
profit of RM2,340,000. If the transfers are made at full costs (or at market price)
the division will get lower profit of RM1,350,000. /

The Service Division will agree to provide service to the Selling Division if the
transfers are made at full cost plus mark up or at market price. This allows the
division to get profit of RM828,750. If the transfers are made at variable cost the
division will loss of RM161,250. /

The company as a whole will be indifference of the choice of the methods used
to transfer the service. This is because for both methods, the net profit for the
company is the same ,i.e RM2,178,750./
(14 x 0.5= 7 marks)
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 Total 10 marks

e)
Selling Service Cosplant
Division Division
(‘000) (‘000) (‘000)
Sales 13,000 Service charge 0/ 13,000
External customers (internal customers)
(2,000 x 6500)
external customers 1593.75 1593.75
(500 x x3187.50)
Less: Less:
-Variable cost of sales (6,760) (6,760)
-outside Service Cost (1680) -variable service cost (975) (2655)
(800 x 2100) (500 xRM1950)
-Fixed costs (2,340) -fixed cost (780) (3120)
Profit 2,220 (161.25)/ 2,058.25/
3 x 0.5 = 1.5

The Selling Division will agree to get the service from the Smart Service Sdn Bhd
where the division will get profit of RM2,220,000 which is higher than the profit it
will get the service from Service Division which is only RM1,350,000.This higher
profit is due to the lower service cost offered by the external service provider
which is RM2,100 compared to RM3187.50 which is at the full cost plus 25%
mark up. /

The Service Division will not agree if Selling Division get the external service.
This division’s profit will decrease dramatically from RM828,750 to loss of
RM161,250.This is because the division’s revenue will depend on the service to
external customers only./

Comparing the results from internal transfer and external service from Smart,
Costplant would prefer the internal transfer./ Both options of internal transfer will
give the same profit to the company of RM2,178,250 regardless of the methods
used. /The external service will give lower profit to the company as a whole i.e
RM2,058,250. This lower profit is probably due to the capacity of Service Division
is underutilized or not properly utilized./

However, the internal service will raise question to at what price should be
charge that will benefit both division. Basing the transfer price on the variable
cost will raise conflict between both divisions since the Service division will get
loss while the Selling Division enjoys huge profits. Bearing in mind, Cosplant has
restructured its division into profit centers, the full cost plus mark up would best
serve both divisions. /However, allowing too high profit for Service Division would
not encourage Selling Division to obtain its warranty work from Service Division./

Thus, for the best interest of the company as a whole it is advisable for Selling
Division not to outsource the service from outside company but to acquire the
service internally. Selling Division and Service Division may negotiate of the best
transfer price between RM2100 (same as external service charge offered by
Smart Services Sdn Bhd) to RM3187.50 (same as the charge that Service
Division charged to external customers) to benefit both divisions/
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 (8 ½ marks)
Total 40 marks

QUESTION 2

a) Target costing process

i. Estimate the selling price

Target costing begins by specifying a product an organization wishes to
sell. This will involve extensive customer analysis, considering which
features customer’s value and which do not. Ideally, only those features
valued by customers will be included in the product design.

The price at which the product can be sold at is then considered. This will
take into account the competitor products and the market conditions
expected at the time that the product will be launched. Hence, a heavy
emphasis is placed on external analysis before any consideration is made
on the internal cost of the product. For example the company target to sell
a new design of compact camera at RM380 per unit after considers the
customer’s preferences and customer’s products.

ii. Deduct required profit

From the above price, a desired margin is deducted. This can be a gross
or a net margin. This leaves the cost target. An organization will need to
meet this target if their desired margin is to be met. For example the
company wants the profit margin at 25% of the target selling price. Here,
the target profit is 25% x 380= RM95 per unit.

iii. Calculate the target costs

The target is calculated by deducting the profit margin from the target
price. In this example, the target cost is 380-95= RM285. The costs for
the product are then calculated (material costs, direct labour costs and
production overhead costs) and compared to the cost target mentioned
above. Let say the estimated production costs is RM310.The difference
between the estimated costs and the target cost is called the cost gap.
The cost gap here is 310-285=RM25.

iv. Close gap

This gap of RM25 would have to be closed, by some form of cost
reduction, if the desired margin is to be achieved. This is often called
value engineering. There are various ways to close the gap for example
to use substitute materials which will give the same quality of product.

(6 marks)

b) Benefits of adopting target costing

 The organization will have an early external focus to its product development.
Businesses have to compete with others (competitors) and an early
consideration of this will tend to make them more successful. Traditional
approaches (by calculating the cost and then adding a margin to get a selling
price) are often far too internally driven.
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 Only those features that are of value to customers will be included in the product
design. Target costing at an early stage considers carefully the product that is
intended. Features that are unlikely to be valued by the customer will be
excluded. This is often insufficiently considered in the traditional cost plus
method.
 Cost control will begin much earlier in the process. If it is clear at the design
stage that a cost gap exists then more can be done to close it by the design
team. Traditionally, cost control takes place at the ‘cost incurring’ stage, which is
often far too late to make a significant impact on a product that is too expensive
to make.
 Costs per unit are often lower under a target costing environment. This
enhances profitability. Target costing has been shown to reduce product cost by
between 20% and 40% depending on the product and market conditions. In
traditional cost plus systems an organization may not be fully aware of the
constraints in the external environment until after the production has started.
Cost reduction at this point is much more difficult as many of the costs are
‘designed in’ to the product.
 It is often argued that target costing reduces the time taken to get a product to
market. Under traditional methodologies there are often lengthy delays whilst a
team goes ‘back to the drawing board’. Target costing has an early external
focus and hence tends to help get things right first time and this reduces the time
to market.
Any 3 x 3 marks= 9 marks
(Total 15 marks)

QUESTION 3

a) Divisional performance

ROI:
Real Estate Division
Net profit = $446,000 x 28% = RM124,880 √√
ROI = RM124,880/RM828,000 = 15·08% √√

Construction Division
Net profit = $218,000 x 33% = RM71,940 √√
ROI = RM71,940/RM406,000 = 17·72% √√
Economic Value Added:
Real Estate Division
Divisional profit after tax = $124,880 x .7 = RM87416
Capital employed = $828,000
EVA = RM87416-(10%x 828,000) = RM4616 √√

Construction Division
Divisional profit after tax= $71,940 x .7 = RM50358
Capital employed = $406,000
EVA = RM50358 – (10% x 406,000) = RM9758 √√

Comments
If a decision about whether to proceed with the investments is made based on ROI,
it is possible that the manager of Real Estate Division will reject the proposal
whereas the manager of Construction Division will accept the proposal. This is
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 because each division currently has a ROI of 16% and since the Real Estate
Division investment only has a ROI of 15·08%, it would bring the division’s
overall ROI down to less than it’s current level. On the other hand, since the
Construction Division investment is higher than its current 16%, the investment
would bring the division’s overall ROI up. √√√√

When you consider what would actually be best for the company as a whole, you
come to the conclusion that, since both investments have a healthy return, they
should both be accepted. Hence, the fact that ROI had been used as a decision-
making tool has led to a lack of goal congruence between Real Estate Division and
the company as whole. This backs up what the new manager of Real Estate
Division is saying. If they used EVA in order to aid the decision-making process,
both proposals would be accepted by the divisions since both have a healthy EVA.
√√√

In this case, EVA helps the divisions to make decisions that are in line with the best
interests of the company. Once again, this backs up the new manager’s viewpoint.
It is important to note, however, that each of the methods has numerous
advantages and disadvantages that have not been considered here. √

(√20 x 0.5 = 10 marks)

b) The critical successes factors are the limited number of areas in which
satisfactory results will ensure successful competitive for the individual,
department or organization. Identifying the CSF allows the firm to focus their
capability to build the requirements necessary to meet CSF.
(3 marks)
Two critical factors to be monitored by Daya Global Builders
 Quality of service
 Service Delivery
 Innovation
 Resources/ cost utilization
(2 marks)
Total 15 marks

QUESTION 4

a) Herzberg’s theory suggests that there are two factors that affect the employee
behavior; the motivation factors and hygiene factors. Motivation factors are
factors that relate to job content or to outcomes of the job that encourage
motivation. This factor is consistent with job satisfaction, cause happy feelings
or a good attitude within the worker. Examples are achievement, recognition, the
work itself, responsibility, advancement and growth. These factors can give
satisfaction to employees in an organization. The instilling of satisfaction is
crucial for management towards the employees as it creates confidence, loyalty
and ultimately improves the quality of output.

The hygiene factors are those factors that provide the necessary setting for
motivation but do not themselves motivate employees. It is associated with
job dissatisfaction and happened when there are feelings of unhappiness or bad
attitudes present. These factors are not directly related to the job itself but the
conditions surrounded in doing that job. Examples include working condition,
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 wage levels, rules and regulations, relationship with colleagues and job security.
When these factors are adequate, employees will not be dissatisfied, but also,
they will not be satisfied.

The expectancy theory explains the behavioural process of why individuals

choose one behavioural option over another. This theory states that employee
motivation is a function of the strength of expectancy, instrumentality and
valence. These 3 elements are important behind choosing one element over
another because they are clearly defined effort-performance expectancy,
performance- outcome and also outcome- personal goal.

Expectancy is the individual’s perception or belief that effort will result in

attainment of desired performance goal. Expectancy is influenced by factors such
as possession of appropriate skills for performing the job, availability of right
resources, and also the degree of goal difficulty. In order for the expectancy to be
high, individuals must believe that they have some degree of control over
outcomes. Employees have different expectations and level of confidence about
they are capable of doing.

Instrumentality is the likelihood that achieving the outcome will lead to a reward.
It means the belief that a person will receive a reward if the performance
expectation is met. Reward may come in a form of pay increase, promotion,
recognition etc. Instrumentality is low when the reward given is for all
performance given. Factors influence instrumentalities are trust, control and
policies. If the individuals trust their superiors, they are more likely to believe in
their leaders promises. When there is a lack of trust on leadership, people often
attempt to control the reward system. When individuals believe that they have
some kind of control over how, when, and why rewards are distributed,
instrumentality tends to increases.

Valence is the preference that an employee has for the particular reward. It
means the value the individuals place on rewards based on their needs, goals
and value. It is an expected and not the actual satisfaction that an employee
expects to receive after achieving the goals. It is a value that the individual
attaches to its first and second order outcomes. First order outcomes define as
the behavior that result directly from the effort an employee expect on job for
example, performance, creativity, tardiness and reliability. The second outcomes
define as anything good or bad that results from the first order outcomes, for
example, praises from boss, salary increase, job security and acceptance by co-
worker.

.
( 9 marks)

b) Expectancy theory suggests that the individuals will be motivated to perform

when they perceive a close linkage between their effort and achieving the
performance measure (high level of expectancy; when they have confidence that
the reward will be provided (high instrumentality); and when they value that
particular reward that is offered (high valence) .Thus the effectiveness of a
reward system in motivating employees may depend whether employees
perceive that the performance target is achievable and will lead to a reward
that is valued. Some employees may value monetary rewards, while others may
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 value the sense of achievement that comes with meeting a challenging goal. The
theory suggests that employees will be motivated only if they value certain
rewards

Herzberg’s theory suggests that it is not hygiene factors but factors such as
achievement, recognition and responsibility that are strong motivators.
Thus the organization should cultivate the culture of appreciation of intrinsic
reward for them to be valued and considered motivational by employees.
Herzberg also suggests that extrinsic rewards are not motivators but provide the
only setting for these intrinsic rewards

QUESTION 5

a) The concept of EMA:

EMA consists of environmentally related management accounting system
and practices. These system and practices can include life cycle costing,
environmental cost accounting, environmental performance measures,
assessment of environmental benefits and the strategic planning for
environmental management. It, however, do not take into consideration the
external cost to society or the environment for which the organization is not
elgally accountable.

EMA provides both financial and physical information which enables the
organization to measure the environmental impact of their activities as well as
supporting the management in making tactical decisions and capital
investment decisions.

The relationship Environmental Management Accounting has with

Sustainability
EMA provide useful information for an organization committed to
sustainability. However, EMA focuses on environmental impacts whereas
sustainability is concerned with the economics, environmental and social
impact of an organization’s activities.
Also, EMA focuses on narrowly defined and measurable impacts within the
organization whereas sustainability is also concerned about external impact
on the economy, the environment and society.

The current management practice such as performance measurement and

capital expenditure investment appraisal is extended to include the
sustainability perspective so as to generate information required to support
sustainability analysis.
( 9 marks)

b) How can a company benefit from EMA

a. By identifying and controlling environmental cost, EMA systems can help
environmental managers justify cleaner production projects and

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 identifying ways of saving money and improving environmental
performance at the same time. This is because wastages in production
cost creates environmentally related cost which causes production costs
to be much higher than anticipated.

b. The systematic use of the EMA principles will assists managers in

identifying environmental cost often hidden in a general accounting.
When cost are hidden, it is impossible to know what share of the cost is
related to any particular product or process or is actually environmental.
Without the ability to isolate and separate this portion of the overall cost
from that of production, product pricing will not reflect the true cost of its
production. Polluting products will appear more profitable than they
actually are because some of their production cost is hidden, and they
may be sold underpriced.

c. Implementing EMA will multiply the benefits gained from other

environmental management tools. Besides the cleaner production
assessment, EMA is useful in evaluating the significance of
environmental aspects and impacts and prioritizing potential action plans
during the implementation and operation of an environmental
management system.

( 3 x 2 marks = 6 marks)
(Total marks= 15 marks)

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