MAS-08: RESPONSIBILITY ACCOUNTING & TRANSFER PRICING

RESPONSIBILITY ACCOUNTING
 RESPONSIBILITY ACCOUNTING is a performance measurement tool where managers are held responsible
for their performance, actions of subordinates and all activities within their area of authority and control.
 Responsibility accounting is consistent with MANAGEMENT BY OBJECTIVES (MBO) -- the management
process in which managers and subordinates agree on goals as well as the methods to achieve them and
subordinates are subsequently evaluated with reference to the agreed plan.
 Responsibility accounting system functions best under a decentralized form of organization as
DECENTRALIZATION allows the separation of an entity into manageable units wherein each unit is managed
by an individual who is given decision authority and is held accountable for his/her decisions.
 Decentralized organizations must avoid SUB-OPTIMIZATION, which happens when managers decide in favor
of their own unit even at the expense of the entire organization as a whole.
 Most decentralized organizations are divided into responsibility centers (also called STRATEGIC BUSINESS
UNITs) to facilitate improved decision making through the use of more information at the local level.
 A RESPONSIBILITY CENTER is a component of an entity (e.g., product line, department, and division)
whose manager has authority over, and is responsible and accountable for, a particular set of activities.
 The four common types of responsibility centers are:
A) COST CENTER – managers are responsible mainly for the costs incurred by the unit
B) REVENUE CENTER – managers are responsible mainly for the revenues generated by the unit
C) PROFIT CENTER – managers are responsible for both revenues and costs of the unit
D) INVESTMENT CENTER - managers are responsible for revenues, costs and investment of capital.
 The PERFORMANCE REPORT, which is often considered as the end-product of the responsibility accounting,
shows and compares actual results with the intended (budgets or standards) results of a responsibility
center, thereby highlighting material deviations that need corrective actions. The contents would normally
depend on type of responsibility center presenting the performance report:
RESPONSIBILITY CENTER KEY PERFORMANCE MEASURES
Cost Center Variance Analysis: Actual vs. Budgeted/Standard Costs
Revenue Center Variance Analysis: Actual vs. Budgeted/Target Sales
Variance Analysis: Actual vs. Budgeted/Target Profit
Profit Center
Segmented Income Statement
Variance analysis: Actual vs. Budgeted/Target Profit
Investment Center Segmented Income Statement
ROI, Residual Income, EVA
NOTE: Variance analysis is covered under MAS-07 (Standard Costing with GP Variance Analysis).
 The SEGMENTED INCOME STATEMENT is a detailed version of the contribution format of income statement.
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:
Sales  Direct costs are separable costs that are attributable or traceable to
Less: VARIABLE Manufacturing Costs the segment or business unit.
Manufacturing Contribution Margin  CONTROLLABILITY is based on degree of influence a manager can
exercise over an amount with reference to assigned responsibilities.
Less: VARIABLE Non-Manufacturing Costs
 Most controllable costs are discretionary costs by nature.
Contribution Margin  Non-controllable costs are either committed costs or costs that are
Less: Controllable Direct FIXED Costs controllable by others or higher authority.
Controllable or Performance Margin  CONTROLLABLE or PERFORMANCE MARGIN is usually used to
Less: Non-Controllable Direct FIXED Costs evaluate the performance of the manager.
Segment Margin  SEGMENT MARGIN is usually used to evaluate the performance of
Less: Allocated Common Costs the segment or business unit (i.e., continue vs. shutdown).
Profit  Common costs allocated to a segment are usually not controllable
by the manager of the same segment.
 RETURN ON INVESTMENT (ROI):
 ROI broken down into margin and turnover is
ROI = Margin x Turnover based on the Du Pont Technique.
 ROI is also known as return on assets.
 MARGIN - net profit margin, return on sales.
Operating Income Operating Income Sales  TURNOVER - assets turnover, investment
Operating Assets = Sales
x
Operating Assets turnover, capital turnover.

 ‘Operating income’ for most investment centers is based on earnings before interests & taxes (EBIT).
 ‘Operating assets’ are preferably based on the average balance for the reporting period and composed
of productive assets used to earn the operating income (i.e., idle assets are excluded).
 The term ‘invested capital’ is sometimes used as the denominator of ROI. While the term means
operating assets for most investment centers, invested capital may also mean total assets, owners’
equity or total assets less current liabilities, depending on the situation and application.
 RESIDUAL INCOME (RI):
RI = Operating Income – Required Income  Minimum ROI is also known as desired rate of return,
business quota or minimum required rate of return.
where: Required Income = Operating Assets x Minimum ROI
 The ‘Minimum ROI’ under RI is usually based on the imputed interest rate, which is imposed and set by a
higher authority like a head office (for branches) or a holding company (for subsidiaries).
 ECONOMIC-VALUE ADDED (EVA):
 WACC is also called hurdle rate, cutoff
EVA = Operating Income after Tax – Required Income rate, target rate, standard rate or
minimum acceptable rate of return.
where: Required Income = (Total Assets – Current Liabilities) x WACC
 EVA is a specific form of RI that measures a segment’s economic profit based on residual wealth after
accounting for the costs of capital; EVA is often used for incentive compensation & investor relations.
 Unlike RI, EVA uses the Weighted Average Costs of Capital (WACC) as the minimum required rate of
return to determine the amount of required income.
 WACC is computed based on the long-term sources of financing -- debt and equity -- hence, the
computation: (total assets – current liabilities) being equal to (long-term liabilities and equity).
[WACC shall be exhaustively discussed in MAS-13 (Capital Structure & Costs of Capital) during Week 15]
 Under EVA, ‘operating income after tax’ is based on the formula: EBIT (100% - tax rate)
 ROI vs. RI:
 Under ROI method, division managers tend to accept only the investments whose returns exceed the
division’s ROI; otherwise, the division’s overall ROI would decrease.
 Under RI method, division managers would accept an investment as long as it earns a rate in excess of
the minimum required rate of return. This action will increase the division’s overall RI.
 RI is regarded as a better measure of performance than ROI because it encourages investment in
projects that would otherwise be rejected under ROI.
 A major disadvantage of RI is that it cannot be used to compare divisions of different sizes or asset
base -- RI tends to favor larger divisions because of larger peso amount involved.
 Consider the following relationship between ROI vs. RI and their corresponding implications:
ROI = Minimum ROI Residual Income = 0 (nil) Indifference point
ROI > Minimum ROI Residual Income > 0 (positive) Performance is generally satisfactory
ROI < Minimum ROI Residual Income < 0 (negative) Performance is generally unsatisfactory
TRANSFER PRICING
 When one division of a manufacturing company supplies components or materials to another division, the
price charged by the selling (producing) division to the buying division is known as the TRANSFER PRICE.
 Transfer prices are usually determined by one of the following methods:
A) MARKET price – regarded as the best transfer price that maximizes the over-all company profit,
provided that: (1) a competitive market price exists, and (2) divisions are independent of each other.
B) COST-BASED price – easy to understand and convenient to use but inefficiencies of the selling division
may be passed on to the buying division with little incentive to control costs. Cost-based price can be
based on selling division’s variable cost, full (absorption) cost or cost-plus.
C) NEGOTIATED price – widely used when market prices are subject to rapid fluctuation or no intermediate
market price exists. In negotiating a transfer price, the usual range shall be based on the following:
 Maximum price (buying division): market price
 Minimum price (selling division): outlay cost + opportunity cost
D) ARBITRARY price – normally imposed by the corporate headquarters to promote over-all company goals
with neither the selling division nor the buying division having a control over the price.
 When managers of both selling and buying divisions act in their individual best interests, the entire
organization may suffer from sub-optimization. Management hence establishes the methodology for setting
transfer prices in such a way to promote GOAL CONGRUENCE, which occurs when division managers make
decisions that are consistent with the goals and objectives of the organization as a whole.
 Aside from goal congruence, other important factors considered in setting the transfer price include cost
structure, capacity constraints, segmental performance, negotiation flexibility and tax implications.
 The following transfer pricing rule helps to ensure goal congruence among divisions and managers:
Transfer price per unit = outlay cost per unit + opportunity cost per unit
 OUTLAY COST includes selling division’s variable production costs (e.g., materials, labor and variable
overhead) plus any additional costs incurred (e.g., storage, transportation, administrative).
 OPPORTUNITY COST refers to the margin or profit sacrificed by transferring units internally rather than
selling them to external customers. Depending on sales demand and production capacity of the selling
division, there may or may not be an opportunity cost associated with the internal transfer:
 Selling division is operating at capacity (FULL Capacity):
 Opportunity cost = contribution margin (given up for sacrificing external sales)
 Selling division is operating at less than full capacity (EXCESS/IDLE Capacity):
 Opportunity cost = zero (nothing to sacrifice when there is no need to give up external sales)
 When selling division is operating at capacity, market price is the ‘theoretically correct’ transfer price.
 When selling division has an excess capacity, transfer price must be based on the variable costs
incurred to produce each unit. In practice, this price usually serves as the MININUM (floor) or lower
threshold in a transfer price negotiation or as the basis for cost-based pricing.
 DUAL PRICING is an attempt to eliminate the internal conflicts associated with transfer prices by giving both
the buying and selling divisions the price that works best for them:
 Selling division: uses market price as its transfer-out price to prevent decrease in divisional income
 Buying division: uses variable cost as its transfer-in price to minimize divisional costs and avoid ‘profit
sharing’ with selling division by agreeing to a transfer price above cost.
Dual pricing is rarely used nowadays because of the little incentive to control costs -- neither manager from
both buying divisions (assured of a low price) and selling divisions (assured of high price) must exert much
effort to show a profit on segmental performance reports.
 EXERCISES: RESPONSIBILITY ACCOUNTING & TRANSFER PRICING
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)
A. The accounting department of Reza ZPA Review Zenter.
B. The Ezem Mall car park ticket outlets.
C. The Magnolia product division of Zan Miguel Corporation.
D. The College of Accountanzy of the Ezpaña University.
E. The repairs and maintenance department of Zebu Pazipic.
F. The Zampaloc branch of KFZ (Kinatay na Fried Zicken).
G. The parts department of Izuzu Motorz Corporation.
H. The convenience store (Zeven-Eleven) that is owned by a chain organization; the head office
supplies all the goods to be sold and determines the selling prices.

2. Controllable vs. Non-Controllable Costs, Direct vs. Indirect Costs

The supervisor of the ASSEMBLY DEPARTMENT of Tuyuta Cars is in-charge of (1) purchasing supplies, (2)
authorizing repairs, and (3) hiring labor for the department. Various costs are given:
1 2 3
A) Sales, salaries and commission A P 10,000 ×
B) Salary, supervisor of Assembly department B 8,000 ×
C) Factory heat and light C 6,000 ×
D) General office salaries D 4,000 ×
E) Depreciation, factory E 2,000 ×
F) Supplies, Assembly department F 4,000 
G) Repairs and maintenance, Assembly department G 6,000 
H) Factory insurance H 8,000 ×
I) Labor costs, Assembly department I 10,000 
J) Salary of factory supervisor J 12,000 ×
TOTAL COSTS
REQUIRED: Determine the following:
1. Total costs controllable by the supervisor of the Assembly department.
2. Total costs directly identified with the Assembly department.
3. Total costs allocated to the factory departments.
4. On the basis of the answers above, which is a FALSE statement?
a. All controllable costs by the supervisor are direct costs of the Assembly department.
b. All direct costs of the Assembly department are controllable costs by its supervisor.
c. Assembly department costs not controllable by its supervisor may be controlled by others.
d. Common costs allocated to the Assembly department are not controllable by its supervisor.

3. Segmented Income Statement

Mr. Z, the QC branch manager of ABZ Corporation, recently reported annual sales of P 1,000,000 and
presented the following cost information:
Variable manufacturing costs 430,000
Allocated corporate overhead costs 170,000
Variable selling & administrative expenses 220,000
Controllable fixed costs traceable to QC branch 200,000
Uncontrollable fixed costs traceable to QC branch 180,000
REQUIRED:
1. Determine the following:
A) Manufacturing contribution margin
B) Controllable or performance margin
C) Segment margin
2. Identify the appropriate margin that shall be used to evaluate the performance of:
A) Manager (Mr. Z)
B) Business unit (QC Branch of ABZ Corp)
4. Return on Investment & Residual Income
For each of the following independent cases, the minimum desired Return on Investment (RoI) is 20%.
Division US Division UK
Sales P 400,000 P 700,000 Division US
Operating Income (1) _____ P 42,000  Unit selling price: P 20
Operating Assets (2) _____ (5) _____  Total fixed costs: P 100,000
Margin 15% (6) _____
Turnover (3) _____ (7) _____ Division UK
Return on Investments 30% (8) _____  Unit selling price: P 700
Residual Income (4) _____ P 22,000  Total fixed costs: P 258,000

REQUIRED:
1. Compute for each division’s missing items (1) to (8).
2. How many more units shall be sold by US to achieve a 40% ROI?
3. How much increase in selling price will allow UK to reach 50% ROI from its current unit sales?
5. Economic Value Added (EVA)
Vaccine Company presents the following year-end data:
Book Value Fair Value
Current assets P 800,000
Non-current assets 3,200,000
Current liabilities 400,000
Non-current liabilities (10% interest rate) 1,000,000 P 1,000,000
Stockholders’ equity 2,600,000 3,000,000
Additional data:
 Income before interests and taxes: P 800,000.
 Income tax rate: 20%.
 Cost of equity capital: 12%.

REQUIRED:
1. Weighted Average Costs of Capital (WACC)
2. Economic Value-Added (EVA)

6. Transfer Price Computation

Kaycee Company is operating with two divisions. Division S is producing a product line that is required as a
component part of the product being manufactured by Division B.

For Division S, the costs of producing the component part per unit are:
Direct materials P 10
Direct labor P8
Variable factory overhead P5
Fixed factory overhead P2
The product of Division S is being sold in a highly competitive market for P 30 per unit.

Division B is currently buying 80% of the production output of Division S at a negotiated price of P 28 per
unit. It is expected that 25,000 units of product will be produced by Division S.

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 S to Division B.

The unit selling price of the product of Division B is P 45 while the additional unit processing cost is P 8.

REQUIRED:
Determine Division B’s gross profit per unit under each of the following independent assumptions:
A) Transfer price is full-cost based.
B) Transfer price is cost-based plus mark-up.
C) Transfer price is based on a negotiated price.
D) Transfer price is market-based.

7. Transfer Pricing
SB-17 Company’s Division ‘S’ (selling division) produces a small tool used by other companies as a key part
in their products. Cost and sales data related to the small tool are given below:

Selling price per unit P 50

Variable costs per unit P 30
Fixed costs per unit* P 12
* based on capacity of 40,000 tools per year.

The company’s Division ‘B’ (buying division) is introducing a new product that will use the same tool such as
the one produced by Division S. An outside supplier has quoted the Division B a price of P 48 per tool.
Division B would like to purchase the tools from Division S, only if an acceptable transfer price can be
worked out.

REQUIRED: Consider the following independent cases:

1. Division S has ample idle capacity to handle all the Division B’s needs:
A) What is the minimum transfer price for Division S?
B) What is the maximum transfer price for Division B?
2. Division S is presently selling all the tools it can produce to outside customers:
A) What is the minimum transfer price?
B) Shall the Division B purchase the tools from Division or from the outside supplier? Why?
3. Division S is presently selling 36,000 tools per year to outside customers and that Division B
requires 10,000 tools per year and:
A) What is the minimum transfer price for Division S?
B) Shall the company make-and-transfer 10,000 tools or buy the tools from the outside
supplier? Why?