Responsibility Accounting and Transfer Pricing

Decentralized Organizations
● refers to the separation or division of the organization into more manageable
units wherein each unit is managed by an individual who is given decision
authority and held accountable for his decisions.

Segment Reporting
● A method of reporting a segment/division/department by a manager on that
particular segment. It aims to measure and control its performance by way of
costs and revenue allocation to the department.

Responsibility Accounting (Activity or Profitability Accounting)

● system of accounting wherein costs and revenues are accumulated and reported
by levels of responsibility or by responsibility centers within the organization.
● It aims to identify responsibility centers with their objectives as well as the
strategies in achieving such.

Responsibility Center
● A segment within the organization that is assigned with a specific function that is
headed by a manager or a delegated officer.

Types of Responsibility Centers

I. Cost Center (Expense Center)

● a responsibility center where a manager has control over the incurrence of

costs but not over revenues or investments such as an accounting
department and a maintenance department and it aims to reduce or
minimize costs.
● Pro-forma responsibility cost report

VALUATIONS – Responsibility Accounting and Transfer Pricing

 II. Profit Center
● a responsibility center where a manager has control over both costs
and revenues such as a marketing department or a branch. The
objective of this center is not only to minimize costs but more
practically, to maximize profit.
⮚ Pro-forma responsibility cost report

III. Investment Center

⮚ a responsibility center where a manager has control both over costs
and revenues as well as significant control over the use of assets or
the investments in assets such as a commuter airline division of an
airline company. The objective of this segment is also to maximize
profit but is viewed as the assets employed.

⮚ Return on Investment (ROI)

𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
𝑅𝑂𝐼 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐴𝑠𝑠𝑒𝑡𝑠

𝑜𝑟
𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠
𝑅𝑂𝐼 = 𝑆𝑎𝑙𝑒𝑠
𝑥 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐴𝑠𝑠𝑒𝑡

VALUATIONS – Responsibility Accounting and Transfer Pricing

 𝑜𝑟
𝑅𝑂𝐼 = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 𝑥 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

⮚ Residual Income (RI)

𝑅𝐼 = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛
𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝑥 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛

⮚ Economic Value Added (EVA)

▪ Like the concept of Residual Income, it is just that it uses the cost
of capital (weighted average of the cost of the firm’s two sources of
funds: Borrowing and selling stocks) instead of the minimum rate of
return.

IV. Revenue Center

● a responsibility center where a manager has control over revenues but
not over costs such as a sales department. It aims to maximize
revenues.

1. Sales Price Variance

(𝐴𝑐𝑡𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 𝑃𝑟𝑖𝑒 − 𝑀𝑎𝑠𝑡𝑒𝑟 𝐵𝑢𝑑𝑔𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 𝑃𝑟𝑖𝑐𝑒)𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝑈𝑛𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
2. Sales Volume Variance
(𝐴𝑐𝑡𝑢𝑎𝑙 𝑈𝑛𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 − 𝑀𝑎𝑠𝑡𝑒𝑟 𝐵𝑢𝑑𝑔𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 𝑃𝑟𝑖𝑐𝑒)
𝑥 𝑀𝑎𝑠𝑡𝑒𝑟 𝐵𝑢𝑑𝑔𝑒𝑡 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑀 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡
3. Sales Mix Variance
(𝐹𝑙𝑒𝑥𝑖𝑏𝑙𝑒 𝐵𝑢𝑑𝑔𝑒𝑡 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑀 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
− 𝑀𝑎𝑠𝑡𝑒𝑟 𝐵𝑢𝑑𝑔𝑒𝑡 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑀 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡)
𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝑈𝑛𝑖𝑡 𝑆𝑎𝑙𝑒𝑠

Summary:

Financial Performance Accounting Analysis

Responsibility Center
Measure Tool
Cost Cost incurrence and costs Cost variance analysis
savings
Revenue Revenue generation and Sales variance analysis
meeting of revenue targets

VALUATIONS – Responsibility Accounting and Transfer Pricing

 Profit Profit generation Gross profit variation
concerning profit targets analysis, profitability ratios,
and segment margin
analysis
Investment Profit generation Return on assets, residual
concerning assets invested income, economic
value-added, equity
spread, market
value-added, and total
shareholders’ return

Cost Classification under Responsibility Accounting

1. Controllable Cost
● costs that can be regulated at a given level of managerial authority
2. Non-controllable Cost
● Costs that are beyond the authority of a manager or officer
3. Direct Cost
● costs that can be specifically identified to a certain responsibility center.
4. Indirect Cost
● These are non-controllable costs that cannot be specifically identified to a
certain responsibility center
5. Traceable Fixed Cost
● fixed costs that are incurred because of the existence of the segment or
activity. The inexistence of a segment will affect the existence of such
costs.
6. Common Fixed Cost
● Costs that are shared by different segments simultaneously.

Illustrations:

VALUATIONS – Responsibility Accounting and Transfer Pricing

 1. Return on Investment
Problem 1: The following selected data pertain to the belt division of Watah Corp. for
last year:
Sales Php 500,000
Average operating assets Php 200,000
Net operating income Php 80,000
Turnover 2.5
Minimum required return 20%
How much is the return on investment? 40%
Solution: 80,000/200,000=40%

Problem 2: Joy Corporation has provided the following data:

Sales Php 625,000
Gross margin Php 70,000
Net operating income Php 50,000
Stockholders' equity Php 90,000
Average operating assets Php 250,000
Residual income Php 20,000

The return on investment for the past year was: 20%

Solution: 50,000/250,000=20%

Problem 3: The Mouse Division of TechTok Company makes and sells only one
product. Annual data on the Mouse Division's single product follow:

Unit selling price Php 50

Unit variable cost Php 30
Total fixed costs Php 200,000
Average operating assets Php 750,000
Minimum required rate of return 12%

What is the return on investment if 16,000 units were sold? 16%

Solution: [(50-30) (16,000) – 200,000] / 750,000 = 16%
What is the residual income if 16,000 units were sold? 30,000
Solution: [(50-30) (16,000) – 200,000] – (12%) (750,000) = 30,000 or;
(750,000) (16%-12%) = 30,000
What is the residual income if 15,000 units were sold? 10,000
Solution: [(50-30) (15,000) – 200,000] – (12%) (750,000) = 10,000

Problem 4: The Bottle Department of SMP Brewery, is evaluated based on residual

income generated. For 2021, the Division generated a residual income of Php2,000,000
and a net income of Php 5,000,000. The target rate of return for all divisions of SMP
Brewery is 20%. For 2021, what was the ROI for Bottle Department? 33%
Solution: Total Asset = (5M - 2M) / 20% = 15 M
ROI= 5M / 15M = 33.33%

VALUATIONS – Responsibility Accounting and Transfer Pricing

 Transfer Pricing
⮚ A form of responsibility accounting
⮚ decentralized organizations use transfer prices when a department transfers
goods to another department under a similar company.
Factors to Consider in Choosing the Transfer Price
a) Goal Congruence – a transfer price must enable a segment to perform as an
independent entity and be able to achieve its goals while taking into
consideration the overall goal of the company.
b) Segmental Performance – a transfer price must be profitable regardless of the
sale was made within the same organization
c) Negotiation – the transfer price should be agreed upon between the buying and
selling segments. If the transfer price is costly than the price from outside
providers, it will not be optimal for the buying entity to purchase within the
company.
d) Capacity – the capacity determines the ability of the segment to supply products
to another segment. If there is excess capacity, it would be better to produce
goods for other segments. However, deficiency in capacity will result in losses
which will be difficult for the selling segment to sustain.
e) Cost Structure – cost must be classified into a variable or fixed.

Methods of Setting the Transfer Price

I. Minimum Transfer Pricing
⮚ 𝑇𝑟𝑎𝑛𝑠𝑓𝑒𝑟 𝑃𝑟𝑖𝑐𝑒
= 𝐼𝑛𝑐𝑟𝑒𝑚𝑒𝑛𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 + 𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝐶𝑜𝑠𝑡 𝑃𝑒𝑟 𝑈𝑛𝑖𝑡
● Where,
o Incremental Cost is equal to the variable cost per unit
o Opportunity cost is equal to loss contribution margin
per unit to outside sales
● Take note, opportunity cost exists if there is no excess capacity.
II. Market-Based Transfer Pricing (Maximum Transfer Price)
● 𝑇𝑟𝑎𝑛𝑠𝑓𝑒𝑟 𝑃𝑟𝑖𝑐𝑒 = 𝑃𝑟𝑒𝑣𝑎𝑖𝑙𝑖𝑛𝑔 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒
● This is for a situation where goods are services are available at their
present form to outside market and is the perfect choice for selling
department which has no idle capacity
● This method can be used only if a market for the goods or services
exists.
● Transfer price must not exceed the prevailing market price.
III. Cost-Based Transfer Price
a. Variable Cost
▪ Transfer price is equal to variable cost. However, a change in fixed
cost must be considered in deciding on the transfer price.
b. Full Cost
▪ Transfer price is based on actual manufacturing that is both fixed
and variable plus a fraction of marketing and administrative costs

VALUATIONS – Responsibility Accounting and Transfer Pricing

 c. Alternative Cost
1. Full Absorption Cost-based Transfer
▪ The difficulty of determining opportunity cost is the reason why
companies use this approach.
▪ The transfer price is based on the full manufacturing costs alone,
which include fixed and variable.
2. Cost-Plus Transfer
▪ In cases where the market price is not available, companies apply a
normal mark-up on their interdepartmental transfer.
▪ Mark up is applied on either variable or full absorption costs.
IV. Negotiated Transfer Price
● the transfer price is based on agreed prices between the selling and
buying divisions within the firm.
● It reflects the best bargain price acceptable to the selling and buying
divisions who acted in good faith.
Multi-National Transfer Pricing
● Applies when the transacting divisions are not situated in a similar
country of operations.
● International companies practice transfer prices to try to lessen
worldwide income taxes, import duties, and tariffs.
● Management should be aware of relevant laws and regulations in
setting international transfer prices.

Illustrations

VALUATIONS – Responsibility Accounting and Transfer Pricing

 Problem 1: PERMAN Corporation produces various products used in the computer
industry. Segment 1 produces 100,000 motherboards each month. Relevant information
for last month follows

Total sales (all external) Php 250,000.00

Expenses (Per unit)
Variable manufacturing Php 0.50
Fixed manufacturing Php 0.25
Variable selling Php 0.30
Fixed selling Php 0.40
Variable G&A Php 0.15
Fixed G&A Php 0.50
Total Php 2.10

Executives are finding the best transfer price when 10,000 motherboards go from
Segment 1 to Segment 2.
1. What is the transfer price based on variable cost? Php 0.95
Solution: 0.50 + 0.30 + 0.15 = 0.95
2. What is the transfer price based on full production cost? Php 0.75
Solution: 0.50 + 0.25 = 0.75
3. What is the minimum transfer price if Segment 1 sells 100,000 units to outside
customers? Php 2.50 (Selling Price)
Solution: 0.95 + 1.55
Problem 2: Oisac Company has a Department Alpha which produces products that can
be transferred to Department Omega to be processed further or they can be sold to
outsiders. The following are data regarding Department Alpha:
Annual Production Capacity 80,000 Units
Selling Price to Outside Customers Php 35.00
Variable cost per Unit Php 23.00
Fixed cost per Unit Php 5.00
Department Omega uses 15,000 units per year of the product produced by Alpha.
However, Omega pays an outside supplier at Php 33 per unit.

VALUATIONS – Responsibility Accounting and Transfer Pricing

 With the aforementioned information, consider the following independent situation.
1. Determine the lowest possible transfer price that can be charged by Alpha if the
demand from outside customer is only 50,000. Php 23
Solution: VC=Transfer Price if there is excess capacity=Php 23
2. Determine the lowest possible transfer price that can be charged by Alpha if the
demand from outside customer is only 80,000 units. Php 35
Solution: 23 + 12 = 35
3. Assuming that a Php 4.00 variable selling expense can be saved if Omega
purchased materials from Alpha, determine the lowest possible transfer price that
can be charged by Alpha if the demand from outside customer is only 80,000
units. Php 31
Solution: (23 – 4) + 12 = 31
4. Determine the lowest possible transfer price that can be charged by Alpha if the
demand from outside customer is only 70,000 units. Php 27
Solution: (10/15)23 + (5/15)35 = 26.99999 = 27

VALUATIONS – Responsibility Accounting and Transfer Pricing

 Theories:
1. Which item is usually not relevant to a decision by a divisional manager to reduce
a transfer price to meet a price offered to another division by an outside supplier?
A. Opportunity cost
B. Variable manufacturing costs
C. Fixed divisional overhead
D. The price offered by the outside supplier
2. The general rule in establishing transfer prices consistent with economic decision
making is the:
A. Differential cost plus opportunity cost if goods are transferred
internally.
B. Actual cost plus opportunity cost if goods are transferred internally.
C. Standard cost plus opportunity cost if goods are transferred internally.
D. all of the above.
3. S1: Decentralization is a transfer of authority from the bottom to the top of an
organization
S2: Decentralization can result in a lack of goal congruence among departments.
A. S1 is False
B. S2 is False
C. Both are True
D. Both are False
4. Costs of decentralization include all of the following except
A. more elaborate accounting control systems.
B. potential costs of poor decisions.
C. additional training costs.
D. slow response time to changes in local conditions
5. Transfer pricing is primarily incurred in
A. foreign corporations exporting their products.
B. decentralized organizations.
C. multinational corporations headquartered in the U.S.
D. closely held corporations.
6. Which of the following is a consistently desirable characteristic in a transfer
pricing system?
A. system is very complex to be the most fair to the buying and selling units
B. effect on subunit performance measures is not easily determined
C. system should reflect organizational goals
D. transfer price remains constant for a period of at least two years
7. Corporate taxes and tariffs are particular transfer-pricing concerns of
A. investment centers.
B. multinational corporations.

VALUATIONS – Responsibility Accounting and Transfer Pricing

 C. division managers.
D. domestic corporations involved in importing foreign goods.

8. A negotiated transfer pricing system is set up where

A. A. the two sides cannot agree on a price and the difference between the
two sides is absorbed by the home office
B. a ready market price is not available and the two sides must come up
with an agreeable price
C. the buyer buys at variable cost and the seller only sells at full cost
D. the two sides agree to use a cost basis for transfer pricing
9. To minimize taxes, some multinational companies set low transfer prices when
goods are shipped from
A. low tax countries to other low tax countries
B. high tax countries to low tax countries
C. low tax countries to high tax countries
D. c or b
10. Market-based transfer prices are best for the
A. company when the selling division is operating below capacity.
B. company when the selling division is operating at capacity.
C. buying division if it is operating at capacity.
D. buying division
Problems:
1. Marsh Company that had current operating assets of one million and net income
of P200,000 had an opportunity to invest in a project that requires an additional
investment of P250,000 and increased net income by P40,000. The company's
required rate of return is 12%. After the investment, the company's residual
income will amount to:
A. 90,000 C. 85,000
B. 30,000 D. 95,000

Norbel Co transfers a product from division A to division B. Variable cost of this

product is anticipated to be P40 a unit and total fixed costs amount to P8,000. A
total of 100 units are anticipated to be produced. Actual cost, however, amounts
to P50 for variable costs. Fixed costs were same as budget. However, actual
output was twice as many.
2. Actual cost per unit amounts to
A. P90 C. P92
B. P115 D. P120
3. The transfer price based on actual variable costs plus 130% markup amounts to
A. P90 B. P115

VALUATIONS – Responsibility Accounting and Transfer Pricing

 C. P92 D. P120
4. The transfer price based on budgeted full cost plus 30% markup amounts to
A. P117 C. P140
B. P150 D. P156

Podtri Co. has the following data:

Profit P100 000
Sales P1 000 000
Asset Turnover Ratio 2 Times
Desired rate of return 12%
5. What is the ROI
A. 10% C. 5%
B. 12% D. 20%
6. What is the amount of assets?
A. P250,000
B. P1,000,000
C. P500,000
D. P2,000,000
7. Segment 1 of Colhal Mfg. makes and sells a single product which is used by
manufacturers of ring light. Presently it sells 12,000 units per year to outside
customers at P24 per unit. The annual capacity is 20,000 units and the variable
cost to make each unit is P16. Segment 2 of Colhal Mfg. would like to buy 10,000
units a year from Segment 1 to use in its products. There would be no cost
savings from transferring the units within the company rather than selling them
on the outside market. What should be the lowest acceptable transfer price from
the perspective of Segment 1?
A. P24.00
B. P21.40
C. P16.00
D. P17.60
8. Door Division of AUTOKOTO Corp. sells 80,000 units of doors to the outside
market. Doors sell for P10.00 and has a variable cost of P5.50 and a fixed cost
per unit of P2.50. Door Division has a capacity to produce 100,000 units per
period. Knob Division currently purchases 10,000 units from Door Division for
P10.00. Knob Division has been approached by an outside supplier willing to
supply the parts for P9.00. What is the effect on AUTOKOTO Corp’s overall profit
if Door Division refuses the outside price and Knob Division decides to buy
inside?
A. P35,000 decrease in AUTOKOTO Corp. profits
B. P20,000 decrease in AUTOKOTO Corp. profits
C. P10,000 increase in AUTOKOTO Corp. profits

VALUATIONS – Responsibility Accounting and Transfer Pricing

 D. no change
9. An investment center generated a contribution margin of Php 400,000, fixed
costs of Php 200,000 and sales of Php 2,000,000. The center’s average
operating assets were Php 800,000. How much is the return on investment?
A. 15% D. 25%
B. 50%
C. 40%

VALUATIONS – Responsibility Accounting and Transfer Pricing