Responsibility Accounting & Transfer Pricing

RESPONSIBILITY ACCOUNTING – a system of accounting wherein performance, based on

cost/revenues, are recorded and evaluated by levels of responsibility within an organization. It
involves:
1. Identifying responsibility centers with their corresponding objectives
2. Developing measures of achievement of such objectives
3. Preparing reports of such measures by the responsibility centers
Responsibility Accounting

Cost Center Revenue Profit Center Investment

Center Center

These centers can have a controllable and non-controllable parts. Usually the controllable parts
here are the expenses which are:
Maintenance Expense
Supplies Expense
Direct Labor
Steps in implementing Responsibility Accounting:
1. Responsibility accounting requires that costs and/or revenues be classified according to
responsibility centers.
Responsibility centers is a segment of an entity engaged in performing 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.

Type of Responsibility Centers

a. Cost Center
b. Revenue Center
c. Profit Center
d. Investment Center – managers are held responsible for revenues, cost 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:
1. Return on Investment (RoI) = Operating Income / Operating Assets
alternative formula: RoI = Margin * Turnover
where:
Margin = Operating Income / Sales
Turnover = Sales / Operating Assets
 or Simply:
RoI = (Operating Income / Sales) * (Sales/Operating Assets)

2. Residual Income = Operating Income – Required Income

Where: Required income is usually the desired Income
Required Income = Operating Assets * Minimum RoI

3. Economic Value Added (EVA) – more specific version of residual income that
measures the investment centers real economic gains. It uses the weighted
average cost of capital (WACC) to compute the required income.
EVA = Operating Income after Tax – Required Income
Where: Requried Income = (total assets – current liabilities ) * WACC

2. Within each responsibility center, costs are classified as either controllable and non-
controllable.
Generally, all costs are controllable. The key difference lies 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 a particular
management level other than the top level.

Costs may also be classified into DIRECT (attributable to a particular segment ) or

INDIRECT (common to a number of segments), the latter being subject to arbitrary
allocation.

3. Within the controllable classification, costs are classified according to the nature of
expense.

4. A performance report is furnished by each center and reported to the appropriate level of
management

The PERFORMANCE REPORT is the end product of responsibility accounting process.

It is a report that shows and compares actual results with the intended (budgets or
standards) results of a responsibility center, thereby highlighting deviations that need
corrective actions.
 SALES P500,000
Variable manufacturing costs (150,000)
Manufacturing contribution margin 350,000
Variable selling and administrative costs (50,000)
Contribution Margin 300,000
Controllable Direct Fixed costs:
Manufacturing P100,000
Selling and administrative 75,000 (175,000)
Short-run performance margin 125,000
Non-controllable direct fixed costs
Depreciation 40,000
Rent and Leases, insurance 10,000 (50,000)
Segment Margin 75,000
Allocated Common Costs (30,000)
Income P45,000

TRANSFER PRICING – the amount charged by one segment of a firm for products or services
that are supplied to another segment of the same firm. It also known as intersegment price.
Primary Objective
To evaluate the performance by virtually transforming costs centers into profit
centers so that performance 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

Basis of Transfer Price

1. Cost-Based transfer price
- Variable costs
- Full costs (manufacturing and non-manufacturing costs)
- Full absorption costing (variable costs and Fixed manufacturing costs)
- Cost-plus (either of the three plus mark-up)
2. Market Based Transfer Price
- Market Price (Regular Selling Price)
- Modified Market (selling price adjusted for any allowance for discount and
etc.)
3. Negotiated Price
 Note: There are limits in transfer pricing:
a. Upper Limit (maximum transfer price should not be higher than cost from buying outside)
b. Lower Limit (variable cost per unit + lost CM per unit on outside sales**)
**when a segment is operating at full capacity lost CM per unit on outside sales is considered as
opportunity costs of transferring products to another segment