MS-07: RESPONSIBILITY ACCOUNTING & TRANSFER PRICING RESPONSIBILITY ACCOUNTING - a system of accounting wherein performance, based on costs/revenues, are recorded and evaluated by Jevels of responsiblity. within an organization, t Nae Sa Responsibility Accounting COST Center NUE Center VESTMENT Center F Controllable Controllable Controllable #— Controllable Non-controltable Non-controtiable Non-controllable Non-controllable “Ror” ~ PERFORMANCE REPORT Nature of Expenses ‘Maintenance Expense / <——— wEVA" ~ ‘Supplies Expense Direct Labor “Residual Income”. ‘STEPS IN IMPLEMENTING RESPONSIBILITY ACCOUNTING 1) Responsibility accounting requires that costs and/or revenues be classified according to responsibility centers. RESPONSIBILITY CENTER - is a segment of an entity engaged in performing a single function or a group of related functions and is usually governed by a manager, ‘who is accountable and responsible for the activities of the segment. ‘Types of Responsibility Centers: 1. COST center - managers are held responsible for the costs incurred by the segment. 2. REVENUE center - managers are held responsible primarily for revenues of the segment. 3. PROFIT center ~ managers are held responsible for both revenues and costs of the segment. 4. INVESTMENT center - managers are held responsible for revenues, costs and investments. ‘The central performance is measured in terms of the use of the assets as well as revenues earned and the costs incurred. The following may be used as basis of evaluating performance of investment centers: fp bales Sek ates + Return on Investment (RoI) = Operating. + Operating Assets = Margin x Turnover Where: Margin = Operating Income + Sales Turnover = Sales + Operating Assets a Guten » msn. por fol computation is based on the DuPont formula: Return on Assets = Asset Turnover x Return on Sales rok ane Net income”! "Sales _Net Income Sales: ba | psaldual tneomne « OperatiG HRSa Aste income Where: Required Income = Operating Assets x Minimum Rol + Economic value added (EVA) > more specific version of residual income Sean a2 a a ns emer capital (WAC) to compute the reauired income, : coh dakerred ap. already declucteal is. d vA = Operating ame Re 1S Reged cand. Mel beck Where: Required Income = (Total Assets ~ Current Liabiliti ies) x WACC Soogich Page 1 of 6 pages (wee Yone) Aye a wean,STEPS IN IMPLEMENTING RESPONSIBILITY ACCOUNTING (CONTINUED) 2) with each responsi Y center, costs are classified as either controflable or non-controllable. Ganoraly, all costs are controllable. The Key difference ties in the level of management who can control the costs, * CONTROLLABLE COSTS are costs that may be directly regulated at lower levels of management + NON-CONTROLLABLE COSTS are costs that cannot be regulated at @ particular management : level other than the top level Gusts may also be classitied into DIRECT (attributable to a particular segment) or INDIRECT ‘ {cemmon to a number of seaments), the latter being subject to arbitrary allocation. 3) With the controllable classification, costs are classified according to the nature of expense. 4) A performance report 1s furnished by each center and reported to the appropriate level of management. The PERFORMANCE REPORT 1s the end product of responsibility accounting process. It 1s a report hat shows and compares actual results with the intended (budgets or standards) results of a uw ronsibiity Center, thereby highlighting deviations that need corrective actions. “WP The ‘contribution’ format to computing results of operations (1.e., profit) 1s emphasized in responsibility accounting. This income statement presentation highlights. controllability of costs by behavioral classification. In addition to the usual variable costs and fixed costs, a more detailed Classification of costs may be made. Consider the following illustrative example (all amounts are assumed): Sales P 500,000 Variable manufacturing costs (150,000) ‘Manufacturing contribution margin P 350,000 Variable selling and adininistrative cots (59,900) Contribution margin 300,000 * Controllable direct fixéd costs: Manufacturing P 100,000 Selling and administrative 75,000. (175,000) Short-run performance margin P 125,000 = Non-controllable direct fixed costs: 7 Depreciation P 40,000 Rent and leases, insurance 10,000 (50,000) Segment margin P75,000 Allocated common costs _. (30,000) Income P 45,000 DECENTRALIZATION DECENTRALIZATION - refers to the separation or division of the organization into more manageable units wherein each unit is managed by an individual who 1s given decision authority and is held accountable for his or her decisions. DECENTRALIZATION-RELATED CONCEPTS ‘GOAL CONGRUENCE All units of organization have incentives to perform for a common interest The purpose of a responsibility system is to motivate management Berformance that adheres to company overall objectives, SUB-OPTIMIZATION This happens when one segment of a company takes action that is in its own best interests but is detrimental to the firm asa whole. NOTE: Aside from its contro! function, responsibility account ing 1s designed to achieve goal congruence and to discourage sub-optimization within an organization. om oe # ORGANIZATIONAL CHART A chart that shows the responsibility relationship among managers in an : organization. It sets forth each principal management position and helps define authority, responsibility, and accountability. A well-designed organizational chart helps a decentralized organization’in carrying out duties with clear lines of responsibiitie : nities. del each of the segment of an organization legated to each of the seqTRANSFER PRICING TRANSFER PRICE - the amount charged by one segment of a firm for products or services that are supplied to another segment of the same firm. It is also known as intersegment price. Primary objective To evaluate performance by virtually transforming cost centers into profit centers so that performance of the manager of mainly cost centers can be measured reliably in terms of both revenues and expenses. Secondary objective To save on costs involved in producing or buying a product by in-sourcing rather than outsourcing. vison, BN iq Basis of Transfer Price ‘+ COST-BASED TRANSFER PRICE Variable cost ¥ Full cost (Variable and fixed manufacturing and non-manufacturing costs) ¥ Full absorption cost (Variable and fixed manufacturing costs) ¥_Cost-plus (Vanable costs / Full costs / Full absorption costs plus mark-up) * MARKET-BASED TRANSFER PRICE v Market price (Regular selling price) ¥_ Modified market (Selling price adjusted for any allowance for discounts, etc.) | NEGOTIATED PRICE © ARBITRARY PRICE Maximum vs. minimum transfer prices For transfer pricing not to defeat its purpose, organization normally sets a limitation as to the transfer price being charged by one segment to another segment. To minimize the effect of sub- optimization, a range for transfer price must be set based on the following limits > UPPER LIMIT i Maximum transfer price = Cost of buying from outside suppliers ** > LOWER LIMIT Minimum transfer price = Variable cost per unit + Lost CM per unit on outside sales ** Strictly speaking, upper limit shall be the higher amount of: 11) Cost of buying from outside suppliers, OR 2) Selling price to outside customers. When a company segment is operating at full capacity, the lost CM per unit on outside sales is the ‘opportunity cost of transferring products to another company segment. bual pricing concept The ‘selling’ center could transfer to andther segment at the usual market price that would be paid by an outsider. The ‘buying’ center, however, would record a purchase at the variable coxt of production. This practice 's now rarely applied because neither manager from both the buying and selling center must exert much effort to show a profit on a segmental performance reports, Transfer pricing considerations ‘ «Goal congruence factors © Will the transfer price promote the goals of company as whole? «Segmental performance factors = ne fae price promote the interest of the segment under the manager's + Capacity factors ‘Does the seller have excess capacity to accomm: = Cost structure factors What portions of production costs are variable or fixed, direct or indirect? jodate further inter-segment transfer?4. ll RESPONSIBILITY ACCOUNTING & TRANSFER PRICING EXERCISES: RESPONSIBILITY ACCOUNTING & TRANSFER PRIGING 1. RESPONSIBILITY CENTERS Indicate how each of the business situations below is most likely to be organized: cost center (CC), revenue center (RC), profit center (PC), or investment center (IC) . The accounting department of Banco De Oro Bank. ¢¢/ °1 4 bum wh a bunvnres SM Arena car park ticket outlets, RC The Magnolia product division of San Miguel Corporation The repairs and maintenance department of Philippine Airlines, CC: The Morayta branch of Starbox Coffee, 1 The College of Nursing of UP-Manila. Po The parts department of Honda Cars Corporation. PC The convenience store that is owned by a chain organization; the head office supplies ail the goods t0 be sold and determines the selling prices. fo, Za7moneP CONTROLLABLE /NON-CONTROLLABLE COSTS, DIRECT/INDIRECT COSTS The supervisor of the Painting department of Toyota Motors 1s in-charge of (1) purchasing supplies, (2) ‘authorizing repairs, and (3) hiring labor for the department. Various costs are given rt! ag Q)_ 2) A | Sales, salaries and commission ~P 16,200 ims B | Salary, supervisor of Painting department ~ 2,500 C | Factory heat and tight ~ 3/900 D | General office salaries "41,000 E | Depreciation, factory ~ 11800 F | Supplies, Painting department 4500 G | Repairs and maintenance, Painting department [1,400 H | Factory insurance 2,100 1 | Labor costs, Painting department 15,600 ae 3. | Salary of factory supervisor 2,700 | iecsry | Bee | Total \Bsoo gow tose’ jy.200 REQUIRED: 'L. How much is the total costs controllable by the supervisor of the Painting department? 2. “How much is the total costs directly identified with the Painting department? 3. How much is the total costs that will have to be allocated to the factory departments? 4. How much is the total costs that do not pertain to factory operations? 3. SEGMENTED INCOME STATEMENT The following data pertain to Zest-O Airlines operations for the year 2014: TOTAL TONG _—___ YANG “Amount % ‘Amount % “Amount Sales P 1,000,000 (100%) _r,-cu (100%) Ure ig Less: Variable Expenses C eo (404) c.) P 360,000 (60%) ¢ (P 150,000) ( —) ~(P 260,000) ¢ —) ELD. ( —YB120,000 (30% ) Contribution margin Less: Traceable fixed expenses Division segment margin Less: Common fixed expenses Income REQUIRED: Fill-in the missing data. (Adepted: Managerial Accounting by Garrison & Noreen) 4. RETURN ON INVESTMENT vs. RESIDUAL INCOME > bucrh — For each of the following independent cases, the um desired Return on Investment (Rol) is 20%.) Division Al Division B2~ Division C3 — Sales 400,000 (5)42p 700,000 . Operating Income (1) Gove (6) ys p.42,000 a Operating Assets (2) tec.cee P 300,00 (9) | fe Margin 15% 8% (10) Res gh 43% a Turnover G) x 3 times (1) meds a , “@A) Return on Investments 30% 2 aa aa Residual Income (4) % (8) ay » 22,000 ey, Opirebnsp len REQUIRED: tp Best's ‘Compute for each division’s missing items. en (Adapted: Managerial Accounting by Louderback, et.al.) Peete Fee 35S. SERVICE Cost ALLOCATION The Fatness First has two service departments (A and 1) and two producing departments (X and Y). Service Departments Operating Departments a 8 x Y Direct costs P150 P.300 Services performed by Dept, A 40% 40% 20% Services performed by Dept. B 20% 70% 10% REQUIRED: Compute allocated cost to departments X and ¥ using the following metho 1) Direct method 2) Step-down method (cost of department A 1s allocated first) 3) Step-down method (cost of department B is allocated first) 4) Reciprocal method SOLUTION. GUIDE to Item No. § FATNESS FIRST Service Cost Allocation (1) Direct Method (2) Step Down Method - A A B x z A B P 150 40% (aco) ” 20% (ayo) P150 40% | (P.150) ; Ts" (P 150) [0 P 300 | 70% ¢rey90) 10% ¢s0yn0), P 300 (300) | a" (ary Allocated Costs: aS ae Miocated Costs: (3) Step Down Method _ (4) Reciprocal B A x A B | P300 20% | 70% 10%) Pp 150 40% L¢p 300) | zs pd | ¢ te | P50 [40% ea) 20% cays) 20 580 bgt) a a Mee eel Alfocated Costs. = . ba ft Allocated Costs: Reciprocal/Alaebraic/Simultaneous. method First Equation: A= 150 + 0.28 Second Equation: B = 300 + 0.4A Substitute First Equation to Second Equation: . B = 300 + 0.4 (150 + 0.2 8) B = 360/0.92 = 391.30* (rounded) Substitute Value of B to First Equation: A= 150 + 0.2 (391.30) = 228.26 ‘TRANSFER PRICING Tamansky Company's Division ‘A’ (Aldayag) produces a small too} used by other companies as a key part in their products. Cost and sales data relating to the small tool are given below: Selling price per unit P50 Variable costs per ut P30 Fixed costs per unit* P12 * - Based on Aldayag division's capacity of 40,000 tools per year, ‘The company's Division ‘8’ (Bonarita) is introducing 9 new product that will use the same tool such as the ‘one produced by Division A. An outside supplier has quoted the Division a price of P 48 per tool. Division B would like to purchase the tools from Division A, if an acceptable transfer price can be worked out. REQUIRED: 1. Determine the lower limit of the transfer price assuming that: {A) Division A has ample idle capacity to handle all the Division B’s néeds? 20 8) Division A is presently selling all the tools it can produce to outside customers $0 2. From the standpoint of the entire company, should the Division B purchase the tools from the +” Division A (operating at capacity).or from outside suppiler? Why? 3, Assume that the Division B requires 10,000 tools per year and the Division A Ps ‘36,000 tools per year to outside customers: 4 te prorentiy eating A) Determine the lower limit of the transfer price. P42 B) What would be overall effect on company profits if all 10,000 tools were Dy oa sucnse uey fromi the eatoine suppliers? “Paccas schulred trom the é (Adapted: Managerial Accountina By Garrison ® Maree...RESPONSIBILITY ACCOUNTING & TRANSFER PRICING 7 PRICE-SETTING METHODS The Indian Spirit Company is operating with two divisions. Division H is producing a product line that is Tequired as a component part of the product being manufactured by Division W. For Division H, the costs of producing the component part per unit are: Direct materials P10 Direct labor PB Variable factory overhead PS Fixed factory overhead P2 The product of Division H is being sold in a highly competitive market for P'30 per unit. Division W is currently buying 80% of the production output of Division H at a negotiated price of P 28 per unit. It is expected that 25,000 units of product will be produced by Division H. With emphasis on divisional welfare rather than the company’s welfare, a new transfer price must be developed. It is suggested that a 40% mark-up on cost will be added when transferring the product from Division H to Division W. An additional processing cost for Division W Is P 8 per unit. The selling price of the product of Division W is P45 per unit. REQUIRED: Determine the gross profit per unit of the product from Division W under each of the following independent assumptions: ‘A) Transfer price is full-cost based. GP = 45 - (8 + 25) = P22 B) Transfer price is cost-based plus mark-up. GP = 45 - [8 + 25 (1.4)] = P2 C) Transfer price is based on a negotiated price. GP = 45 - (8 + 28)= PO D) Transfer price is market-based GP = 45 - (8 + 30) = P7 (Adapted: Cost Accounting by Barfield, et.al.) WRAP-UP EXERCISES (TRUE OR FALSE; MULTIPLE-CHOJCE) ‘The sequence that reflects increasing level of responsibility is “4a, - Cost center, investment center, profit center b. Cost center, profit center, investment center ¢. Profit center, cost center, investment center d. Investment center, cost center, profit center 7 In responsibility accounting, the most relevant classification of costs is a. Fixed and variable ¢. Discretionary and committed b. Incremental and non-incremental #8. Controllable and non-controllable Which of the following techniques would be best for evaluating the management performance of a department that is operated as a cost center? a. Return on assets ratio . Payback method b. Return on investment ratio 3d. Variance analysis ‘The segment margin of the Division ABC of XYZ Corporation should not include ‘a. Net sales of ABC b. Fixed selling expenses of ABC ¢. Variable selling expense of ABC td. ABC's share of XYZ president's salary Which of the following methods of allocating the costs of service departments provides the broadest recognition of departments served? ‘#2. Reciprocal allocation ¢. Direct allocation b. Step-down allocation d. Arbitrary allocation Which of the following describes the computation of Return on Investment (Rol)? a. Sales x Investment Turnover b. Return on Sales x Investment ¢. Income ~ (Investment x Minimum Rol) x74. Return on Sales x Investment Turnover : ihe, cos eesas Price Is considered as the ideal transfer price to use in charging co-segment within a c When @ division is operating at capacity, the transfer price to other divisions should include an element of ‘opportunity cost.