Chapter022 Solutions Manual

CHAPTER 22
RESPONSIBILITY CENTER ACCOUNTING

AND TRANSFER PRICING
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Brief
Exercises
B. Ex. 22.1
B. Ex. 22.2
B. Ex. 22.3
B. Ex. 22.4
B. Ex. 22.5
B. Ex. 22.6
B. Ex. 22.7
B. Ex. 22.8
B. Ex. 22.9
B. Ex. 22.10
Topic
Contribution margin effects
Contribution margin vs. responsibility margin
Responsibility center design
Transfer Prices
Contribution margin ratios
Identifying transfer prices
Tracing common costs
Common or traceable costs
Responsibility accounting system
Evaluating responsibility center managers
Exercises
22.1
Topic
Accounting terminology
22.2
22.3
Types of responsibility centers

Classification of costs in an income statement
22.4
22.5
22.6
22.7
22.8
22.9
Real World: Home Depots segments

Preparing a responsibility income statement
Evaluation of responsibility centers and center
managers
Closing an unprofitable business unit
Cost-volume-profit analysis
Transfer pricing
22.10
Types of responsibility centers
22.11
22.12
22.13
22.14
22.15
Corporate costs; traceable or common

Transfer prices and responsibility margins
Transfer price and international taxes
Responsibility centers in a golf resort
Real World: Home Depots responsibility
centers
Learning
Objectives
22-5
22-2, 22-3
22-1, 22-2
22-6
22-2, 22-3
22-6
22-4
22-1, 22-4
22-2
22-4, 22-5
Skills
Analysis
Analysis, judgment
Analysis, judgment
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis, judgment
Analysis
Learning
Objectives
Skills
22-1, 22-4, Analysis
22-6
22-1
Analysis, judgment
22-4
Analysis
22-1, 22-2
22-122-5
22-1, 22-2
Analysis, research
Analysis
Analysis, judgment
22-122-3,
22-122-4
22-1, 22-2,
22-6
22-122-3
Analysis
Analysis
Analysis, judgment
22-2, 22-4
22-3, 22-5,
22-6
22-1, 22-2
22-122-3
Analysis,
communication,
judgment
Analysis, judgment
Analysis
Analysis
Analysis, judgment
Analysis,
communication,
research
Copyright 2015 by McGraw-Hill Education All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Problems
Sets A, B
22.1 A,B
Learning
Objectives
Skills
22-322-5 Analysis, communication
22.5 A,B
22.6 A,B
Topic
Preparing and using responsibility income
statements
statements
statements
Preparing responsibility income statements
in a Responsibility accounting system
Analysis of responsibility income statements
Evaluating an unprofitable business center
22.7 A,B
Transfer pricing decisions
22-1, 22-6
Analysis, communication,
judgment
22.8 A,B
Transfer pricing with external market prices
22-1, 22-6
judgment
22-1, 22-2,
22-4
22-1, 22-3,
22-6
22-1, 22-2,
22-5
22-122-3
judgment
judgment
judgment
judgment, research,
technology
judgment
22.2 A,B
22.3 A,B
22.4 A,B
Critical Thinking Cases

22.1
Allocating fixed costs to responsibility
centers
22.2
An ethical dilemma
22.3
Hospital profit centers
22.4
Real World: General Mills & Kirby

(Internet) Comparing responsibility centers
22. 5
Real World: University of Minnesota

(Ethics, fraud & corporate governance)
22-322-5
Analysis, communication
22-322-5
Analysis
22-322-5
judgment
Analysis
judgment
22-322-5
22-322-5
22-1, 22-2
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES

Below are brief descriptions of each problem and case. These descriptions are accompanied by the
estimated time (in minutes) required for completion and by a difficulty rating. The time estimates
assume use of the partially filled-in working papers.
Problems (Sets A and B)
Chocolatiers Company/Fasteners, Inc.
22.1 A,B
Students prepare responsibility income statements and determine the
product line in which it would be most advantageous to invest
advertising dollars.
20 Easy
22.2 A,B
Regal Flair Enterprises/Brown Enterprises

Prepare a responsibility income statement and identify the business units
that will provide the most benefit from short-run product promotion and
from long-run expansion. Requires an understanding of the different
roles of contribution margin and responsibility margin in managerial
decisions.
30 Medium
22.3 A,B
Giant Chef Equipment Company/Glassware Company

Prepare a responsibility income statement and use the data to perform
cost-volume-profit analysis.
30 Medium
22.4 A,B
Muscle Bound Company/Freeze, Inc.

Prepare income statements at two successive levels of responsibility.
Also, compute the return on assets for two investment centers and use
data in several managerial decisions.
60 Strong
22.5 A,B
Butterfield, Inc./Sotheby, Inc.

Given income statements at two levels of responsibility, students are
asked to make several decisions based upon the data and to explain the
disappearance of the common costs as the responsibility centers are
redefined. Also calls for a revised version of one responsibility
statement reflecting different sales levels.
45 Strong
22.6 A,B
Flywiz, Inc./Footware, Inc.

Students are asked to evaluate a decision to close a seemingly
unprofitable unit of a business. However, upon closer examination, they
may discover that seasonality is distorting the data and that products of
the unprofitable unit support sales in the more profitable unit.
15 Easy
22.7 A,B
Tots-To-Go/Eastrise Corporation
Students are asked to evaluate a transfer price used by two responsibility
centers of a business. The manager of one center wants the transfer price
reduced. Students are to recognize that, regardless of the transfer price
used, the profit of the entire company remains the same. Students must
also consider opportunity costs and the way in which center managers
are evaluated.
20 Easy
22.8 A,B
Sparta and Associates/Westminster, Inc.

Students investigate market-based transfer prices versus less than market
transfer prices. Students will see the loss in profits to the entire company
when divisions purchase from outside the company rather than
transferring within the company.
40 Medium
Critical Thinking Cases

Lands End Hotel
22.1
A conceptual (nonnumerical) case focusing upon the problems that often
arise from efforts to allocate common fixed costs among profit centers. A
practical problem, in that many businesses make such
allocationsperhaps without recognizing the pitfalls.
35 Medium
22.2
Osborn Diversified Products, Inc.

A computer error results in the overstatement of a division managers
bonus. He needs the money because he has large medical bills and a
daughter in college. The only other person who may be aware of the
problem is another division manager who is angry with the company.
This is a good problem to assign to small groups or teams of students.
40 Medium
22.3
Hospital Profit Centers

Students identify cost and profit centers for hospitals. Students consider
the ethical implications of having a type of surgery as a profit center.
30 Medium
22.4
General Mills and the Kirby Company

Internet
Students are asked to visit the web pages of two companies and decide
how responsibility centers could be assigned within each. They are also
asked to think of examples of investment centers, profit centers, and cost
centers within each firm. Finally, they are asked what characteristics lead
to the differences in the responsibility center systems.
30 Medium
22.5
University Ethics
Ethics, Fraud & Corporate Governance
Students evaluate the ethical implications when a university views
students as a profit center.
20 Medium
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

1. Management makes use of accounting information about individual responsibility centers of the
business in many ways, including (1) planning and allocating resources, (2) evaluating the
performance of responsibility centers, (3) controlling costs, and (4) evaluating the performance
of center managers.
2. A cost center is a part of the business that incurs cost but that does not directly generate
revenue. Examples include service departments such as the accounting, janitorial, laundry, or
other departments that render services to other parts of the business.
A profit center generates revenue as well as incurring costs. Examples include the emergency
room, outpatient surgieries, CT or MRI scans, etc.
An investment center is a profit center for which management can readily identify the assets
invested (without resorting to arbitrary allocations). This characteristic allows the use of return
on investment techniques in evaluating performance. Examples of investment centers include
hospitals or clinics.
3. Three types of transfer prices are market-based, cost-based, and negotiated. Market-based
transfer prices are more likely to be used when a competitive external market exists for the
product and the transferring division is a profit center. Cost-based transfer prices are used when
there is no comparable external market and the transferring division is most likely to be a cost
center. Finally, negotiated transfer prices are used when an external market exists for the
product, but there are some internal savings or synergies that can reduce the internal transfer
price.
4. In a responsibility accounting system, the recording of revenue and costs should begin with the
smallest areas of responsibility. This enables the preparation of income statements for even the
smallest profit centers. The income statements for larger responsibility centers are then prepared
largely by combining the income statements of the centers subunits.
5. Traceable fixed costs are fixed costs that arise because of the existence of a particular business
unit and that would be eliminated if that unit were closed. Common fixed costs are fixed costs
that jointly benefit two or more business units. Often, the level of these common costs would not
change even if one of the units were discontinued.
In an automobile dealership divided into a sales department and a service department, the salary
of the service manager and depreciation on garage equipment are examples of fixed costs
traceable to the service department. The property taxes on the dealerships location is an
example of a common fixed cost.
6. Unless the costs of operating the service center can be traced directly to one or more of the
responsibility centers appearing in the responsibility income statement, these costs are shown as
common fixed costs.
7. No. Although the salary of the sales territory manager is a common fixed cost when the sales
territory is divided by the product line, this cost is directly traceable to the activities of the
territory. Thus, if an income statement were divided by sales territory, the territory managers
salary would be classified as a traceable fixed cost.
8. The transfer price for a product will divide that products profits between different divisions.
When those divisions are located in different tax jurisdictions or can be subject to tariffs, then
the transfer price can affect the taxes paid on the profits for that product. Locating profits in the
lowest tax jurisdiction is important for reducing international income tax expense.
9. This statement is not a logical criterion for closing departments. First, a business unit that has
any responsibility margin is contributing to the common fixed costs and profitability of the
business. Unless the resources relating to the unit can be put to better use, there generally is no
reason to close any unit with a positive responsibility margin.
Second, the responsibility margin ratio (15%) states responsibility margin as a percentage of
sales, not a percentage of assets employed by the unit. A unit with high inventory turnover, such
as a supermarket, may show a very low responsibility margin ratio, yet provide a very high
return on the assets utilized in the units operations.
Finally, the statement ignores the possibility that the existence of one business unit may
contribute substantially to sales of other units. In summary, the decision of whether or not to
close a department involves far more analysis than using a cutoff responsibility margin ratio.
10. Contribution margin is a measurement of performance that takes into consideration only
revenue and variable costs. Therefore, this measurement is useful in evaluating the probable
outcomes of decisions that affect primarily revenue and variable costs. These would include
pricing decisions and other marketing strategies.
Responsibility margin is a measure of performance that takes into consideration not only
revenue and variable costs but also fixed costs traceable to the responsibility center . Therefore,
responsibility margin is useful in evaluating decisions that involve significant changes in
traceable fixed costs, such as expanding or contracting plant capacity.
11. All the elements of responsibility marginrevenue, variable costs, and traceable fixed
costswill be eliminated if a center is closed. Without considering other issues, this information
implies that closing the department will eliminate the negative responsibility margin, thus
increasing the operating income of the business by this amount.
In addition to the negative responsibility margin, several questions to be considered in the
decision of whether or not to close a center are:
(1) To what extent might closing the center affect the sales of other centers?
(2) What are the alternative uses of the facilities now used by the center?
(3) What is the likelihood that center performance can be improved?
12 Controllable fixed costs and committed fixed costs are subclassifications of fixed costs
traceable to a responsibility center. The controllable fixed costs are those that are readily
controllable by the center manager. Committed fixed costs, on the other hand, are those that the
center manager cannot readily change.
Performance margin is revenue, less variable costs, and less controllable fixed costs. This
subtotal often is used to evaluate the performance of center managers, because it represents the
subtotal of those revenue and cost flows under the managers direct control. Thus, this subtotal
does not penalize the manager with committed costs which he or she is unable to change in the
short run.
13. No. The costs relating to operations of the corporate headquarters cannot be traced to the revenue
of specific restaurants on a basis of cause and effect. With respect to the individual restaurants,
the costs of operating the corporate headquarters should be viewed as common fixed costs.
Reasons for not allocating these costs include:
(1) Any allocation would be arbitrary, not necessarily corresponding to benefit derived or
factors causing the cost to be incurred.
(2) As these costs would not be eliminated even if a specific restaurant were closed, including
these costs in the restaurants income statements obscures the contribution that each
restaurant makes toward the profitability of the business.
(3) These costs are not controllable by the individual restaurant managers. This decreases the
usefulness of the departmental income statements for evaluating managerial performance
and also causes managers to lose confidence in the significance and fairness of the
performance evaluation system.
14. A profit center is evaluated based upon its ability to generate profits. If cost is used as a transfer
price, the center has no opportunity to earn a profit on the products that it produces and transfers
to other parts of the business. In essence, profit ultimately reported on these products is
transferred from the profit center that produced them to the profit center that sells them to an
outside customer.
15.
Managers of responsibility centers are typically held accountable for costs or profits. In a cost
center the manager is held accountable for the costs incurred to meet the obligations of the center.
If those costs are too high, perhaps because of transfer prices that are high, then the manager is
going to try to reduce those costs even if it means looking for another supplier outside of the firm.
A profit center manager transferring a product will try to set as high a transfer price as possible to
earn more profits. The manager of a profit center receiving the transferred product will want the
price to be as low as possible to reduce the cost of the profit center.
SOLUTIONS TO BRIEF EXERCISES

B. Ex. 22.1
Department B. Short-run product promotion affects revenue and variable costs but
generally does not affect long-run fixed costs. Thus, the $10,000 advertising cost
should be compared to the additional contribution margin expected to result from a
$50,000 increase in departmental sales. The department with the highest
contribution margin ratio will generate the highest dollar amount of contribution
margin from a sales increase of a given size.
B. Ex. 22.2
The contribution margin for the combo is $1.75 - ($0.89 + $0.37 + $0.42) = $0.07.
The small contribution margin for the combo likely implies a negative
responsibility margin. However, it is not worrisome because the bakery is a small
component of the store and likely to be treated as a cost center. It is not intended to
earn a large profit but rather to render service (attracting customers) to the store.
In evaluating the bakery as a cost center the question becomes, is the cost (the
negative responsibility margin of the bakery) justified by the services rendered to
the other parts of the store?
B. Ex. 22.3
Divisions Two and Three make investment decisions and should be designated as
investment centers. Divisions One, Four, and Five sell their products in external
competitive markets and should be designated as profit centers. Divisions Six and
Seven should be designated as cost centers since the overwhelming portion of their
output is internally consumed. Although some students may argue that if 20
percent of Division Sixs output is sold externally, then it could be designated as a
profit center with appropriate market-based internal transfer prices.
B. Ex. 22.4
The transfer price with an available competitive market should be $48. However, if
there is no external competitive market then a cost-based transfer price might
work. Whether that cost should be the variable cost of $26 or some cost-based price
that allows the Wheel & Frame division to make a profit is not clear. If the Wheel
& Frame division has been designated as a profit center, then it will want to earn a
profit on the internal transfer. If it cannot earn a profit on #606, it will use
productive capacity to make a part on which it can earn a profit. If the cost-based
transfer price was variable cost plus 20 percent it would be: $26 + (.2 $26) =
$31.20 per part.
B. Ex. 22.5
$300,000 sales .75 contribution margin = $225,000

($225,000 - $188,000 traceable costs) = $37,000 responsibility margin.
B. Ex. 22.6
a.
b.
c.
d.
Negotiated transfer price.

Cost-based transfer price.
Market-based transfer price.
Market-based transfer price
B. Ex. 22.7
Upkeep:
$450,000 15,000 square feet = $30/squ. Ft. 1,800 square feet = $54,000.
Human Resources:
$118,000 220 employees = $536.36/ employee 6 = $3,218.16
B. Ex. 22.8
a.
b.
c.
d.
e.
f.
B. Ex. 22.9
Traceable to each store.

Traceable to each store.
Traceable to stores department (Repair & Sales).
Traceable to company.
The three characteristics are: 1) preparing budgets prior to operations; 2)

Measuring performance using actual results; and 3) Preparing timely and
frequent performance reports comparing actual results with the budget.
No, Cold Moo Ice Cream does not appear to follow the characteristics of
successful responsibility centers. First, it does not appear that budgets are
prepared. Second, the performance reports are not frequent or timely and the
performance reports do not compare actual with budget. Cold Moo should start
with implementing a budget process that involves each store reporting to
headquarters the store plans for the coming period. This would include planned
pricing amounts so that management could know what the expected profits were
going to be. Then, Cold Moo should provide frequent comparisons of budgeted
and actual results, probably monthly.
These steps should go a long way toward fixing some of the current problems.
B. Ex. 22.10
Disadvantages of allocating common costs are: 1) Because common fixed costs

do not change when a business center is eliminated, inclusion in the business
center responsibility margin could distort decision making; 2) Common fixed
costs are not under the control of responsibility managers; and 3) Allocation of
common fixed costs results in changes to profits that are not related to the
operation of the responsibility center.
SOLUTIONS TO EXERCISES
Ex. 22.1
a.
b.
c.
d.
e.
f.
g.
Traceable fixed costs

Cost-plus transfer price
None (The statement describes controllable fixed costs.)
Performance margin
Contribution margin
Responsibility margin
Transfer price
Ex. 22.2
a.
An individual video arcade within a chain of video arcades will be

evaluated as an investment center because each arcade will generate a
profit and will have an identifiable asset base.
A snack bar within one of the companys arcades will most likely be
evaluated as a profit center. It is unlikely that a snack bar will be
evaluated as an investment center because it will share common assets
with other profit centers in each arcade.
A particular game within one of the companys arcades will most likely
be evaluated as a profit center. However, if the companys investment in
each game is viewed as its asset base (and the common assets it shares
with other games within the arcade are ignored), the company could
consider each game an investment center.
The security for each arcade will most likely be evaluated as a cost center
because security officers contribute no profit to the company.
b.
c.
d.
Ex. 22.3
a.
b.
c.
d.
e.
f.
g.
Common fixed costs

Traceable fixed costscontrollable
None (Sales taxes are a liability, not an expense.)
Traceable fixed costscommitted
Traceable fixed costscontrollable
Common fixed costs
Variable costs
Ex. 22.4
Student responses will differ. Below are some suggested measures:

--Country level investment center measures:
Capital budgeting (activities/growth in the investment center)
Return on invested capital (standard measure for an investment center)
--Store level profit center measures:
Earnings before provision of taxes (allows profitability comparisons between
states and countries without consideration of variation in taxes)
Comparable store sales increase (decrease) (a direct comparison with competitors
salesthe most important indicator of profitability)
Weighted average sales per square foot (another measure of profitability)
--Inventory cost center measures:
Inventory turnover (clearly related to efficiency, but also related to overall store
performance)
Average ticket ($) (combine with inventory
Weighted average sales per square foot ($)
--Janitorial cost center measures:
Average square footage per store (to calculate janitorial cost per square foot)
Number of customer transactions (indicator of store attractiveness)
Ex. 22.5
Geminis responsibility income statement is shown below:

HEPRAS INCORPORATED
Responsibility Income Statement
For the Current Month
Entire Company
Dollars
Percent of
Sales
Sales
Variable costs
Contribution
margin
Fixed costs
traceable
to product
lines
Product
responsibility
margin
Common fixed
costs
Income from
operations
$ 1,400,000
590,000
Routers Line
Dollars
Percent of
Sales
100
42
800,000
320,000
100
40
600,000
270,000
100
45
480,000
60
330,000
55
250,000
31.25
125,000
20.8
230,000
28.8
205,000
34.2
810,000
58
375,000
27
435,000
31
220,000
15.7
215,000
15.30%
Ethernet
Switches Line
Dollars
Percent of
Sales
Ex. 22.6
Store 3. The effect of an advertising campaign upon operating income is determined by
comparing the cost of the advertising ($15,000 per month) with the additional contribution
margin that will be generated by the increase in sales. Given that the increase in monthly sales is
expected to be $60,000 per month regardless of which store is advertised ($600,000 10%), the
company will derive the most benefit by increasing the sales of the store with the highest
contribution margin ratio (45% for Store 3). A $60,000 increase in sales will produce $27,000 in
contribution margin at Store 3 ($60,000 x 45%); $22,800 at Store 1 ($60,000 38%); and $22,200
at Store 2 ($60,000 37%).
Store 1. The contribution that each store makes toward common costs and toward the
profitability of Drexel-Hall is measured by responsibility marginthat is, revenue less all costs
directly traceable to the store. Store 1 has the highest responsibility marginsurpassing Store 2
by $6,000 per month, and Store 3 by $66,000 per month. Store 1 surpasses Store 3 in profitability,
despite Store 3s higher contribution margin, because of Store 3s excessive level of controllable
fixed costs. Store 1s small advantage over Store 2 is in the area of committed fixed costs, which
probably stems from the lower depreciation charges on Store 1s building.
Store 2. The effectiveness of the store managers strategies are best evaluated by looking at the
relationship of revenue to expenses under the managers direct control. This relationship is
measured by the subtotal performance margin ratio. Store 2 has the highest performance margin
and performance margin ratio. The only reason that Store 2 is not more profitable than Store 1 is
that Store 2 is saddled with higher depreciation charges due to higher costs at the time the store
was built. These depreciation charges, however, are not controllable by the store manager and
should not enter into an evaluation of his or her effectiveness. The managers of Stores 1 and 3
should both consider the marketing strategies in use at Store 2.
Ex. 22.7
a.
Decrease in monthly sales from closing Store 3

Less: Increases in sales expected at Stores 1 and 2
($60,000 + $120,000)
Net decrease expected in total monthly sales
600,000
180,000
420,000
Store 1
b.
c.
Expected increase in monthly contribution margin:

Store 1: ($60,000 additional sales 38%)
Store 2: ($120,000 additional sales 37%)
Less: Additional traceable fixed costs
Expected increases in monthly responsibility margin
Increase in income from operations from elimination of
the negative responsibility margin of Store 3
Expected increase in income from operations resulting
from increase in responsibility margin of Stores 1 and 2
($22,800 + $44,400, per part b)
Expected increase in monthly operating income from
closure of Store 3
22,800
0
22,800
Store 2
$
$
44,400
0
44,400
6,000
67,200
$
73,200
Ex. 22.8
Strategy 1: Advertise the name Drexel-Hall:

Expected increase (decrease) in monthly contribution margin:
Store 1: ($228,000 5% increase)
Total expected increase in monthly contribution margin*
Monthly cost of advertising campaign
Expected increase in monthly income from operations
$
$
11,400
11,100
13,500
36,000
15,000
21,000
*As the contribution margin of all stores is expected to increase at the same
5% rate, we could shorten our computation by applying the 5% increase
to the companywide contribution margin of $720,000.
Strategy 2: Advertise low prices at Store 2:
Expected increase (decrease) in contribution margin:
Store 1: ($30,000 decrease in sales 38% contribution margin ratio)
Store 2: ($150,000 increase in sales 37% contribution margin ratio)
Store 3: ($30,000 decrease in sales 45% contribution margin ratio)
Total expected increase in monthly contribution margin
Monthly cost of advertising campaign
Expected increase in monthly income from operations
$
$
(11,400)
55,500
(13,500)
30,600
15,000
15,600
Ex. 22.9
The higher each divisions responsibility margin, the higher each divisions
profitability will be. Thus, since the managers are paid a bonus based on the
profitability of their respective divisions, each will favor a transfer price that
maximizes his divisions responsibility margin. For the Processed Meat Division, a
market value approach would most likely result in the highest responsibility
margin. For the Frozen Pizza Division (the buying division), a cost approach or a
negotiated approach would probably be most beneficial.
Ex. 22.10
(1)
(2)
(3)
(4)
(5)
(6)
Profit center
Cost center
Investment center
Profit center
Profit center
Cost center
Responsibility centers assist managers in evaluating the overall performance of

subunits of a business, and also help in creating future budgets and setting future
performance goals. A responsibility income statement shows the revenues and
expenses of each segment of the business, as well as for the business as a whole.
Revenue is first assigned to the profit center that is responsible for generating that
revenue. Then, expenses are classified into fixed and variable before assigning
traceable costs to the applicable business segment.
Ex. 22.11
Although these division managers' arguments have been frequently repeated, that
does not make them wrong. The point is that Harrys response is not appropriate.
The common costs should not be allocated to the division for performance
evaluation. At a minimum, the divisions should not be evaluated based on
responsibility margins that include uncontrollable common costs.
Ex. 22.12
The total variable costs incurred in Repairs is $8,000. Twenty-five percent of

$8,000 = $2,000 is revenue from the Sales Department. This $2,000 is included in
both revenues and variable costs for the Repairs department and does not generate
any contribution margin. As a result, the total sales revenue for the Repairs
Department is $2,000 revenue from Sales and $18,000 revenue from external
customers. This means .75 $8,000 = $6,000 of variable costs generates revenue of
$20,000 - $2,000 = $18,000. Thus, each dollar of variable cost from outside
customers ($6,000) generates $3.00 ($18,000 $6,000) of sales dollars (the mark-up
is 300% of variable costs). Thus, the total revenue that the Sales Department must
pay to equal market rates would be $2,000 300% = $6,000 dollars. This would
increase revenues in Repairs by $6,000 - $2,000 = $4,000 and variable costs in Sales
by the same amount.
Sales
Department
Sales
Variable Costs
Contribution Margin
Fixed Traceable Costs
Responsibility Margin
$
$
180,000
94,000
86,000
18,000
68,000
Repairs
Department
24,000
8,000
16,000
14,000
2,000
$
$
Ex. 22.13
a. Using a transfer price of 650,000 pounds, the tax liability for each division and for the
company as a whole:
Entire
Company
Sales
Operating Expense
Cost of goods transferred
Taxable Income
Tax Rate
Tax Liability
UK
Division
1,500,000
550,000
950,000
235,000
1,500,000
350,000
650,000
500,000
20%
100,000
Mexican
Division
650,000
200,000
450,000
30%
135,000
Ex. 22.13 (continued): Using a transfer price of 750,000, the tax liability for each division
and for the company as a whole:
Entire
Company
Sales
Operating Expense
Cost of goods transferred
Taxable Income
Tax Rate
Tax Liability
UK
Division
1,500,000
550,000
950,000
245,000
Mexican
Division
1,500,000
350,000
750,000
400,000
20%
80,000
750,000
200,000
550,000
30%
165,000
b. The transfer price of 650,000 will be most useful to the company as a whole in minimizing
the total tax liability.
Ex. 22.14
Student responses will vary, but here is one organizational design:
Jasper Golf Resort*
Hotel**
Housekeeping***
Restaurants**
Golf Courses**
Weddings &
Meetings**
Grounds***
&
Maintenance
Carts**
ProShops**
Key: * = investment center, **= profit center, ***= cost center.
Ex. 22.15
Home Depots Note 1 in Appendix A outlines a couple of different scenarios for

responsibility center organization. First, responsibility centers could be organized
around customer groups. The note mentions do-it-yourself, do-it-for me, and
professional customers. Alternatively, responsibility centers could be organized
around geographic areas, where geographic area might be an investment center and
each store withing a geographic area a profit center. A responsibility center designs
will vary.
SOLUTIONS TO PROBLEMS SET A

20 Minutes, Easy
a.
Sales
Variable costs
Contribution margin
Fixed costs traceable to product lines
Product responsibility margin
Common fixed costs
Income from operations
PROBLEM 22.1A
CHOCOLATIERS COMPANY
CHOCOLATIERS COMPANY
Entire Company
Solid Chocolate
Dollars
Percent
Dollars
Percent
$ 1,720,000
100 $ 850,000
100
859,000
50
467,500
55
$ 861,000
50 $ 382,500
45
425,000
25
175,000
21
$ 436,000
25 $ 207,500
24%
125,000
7
$ 311,000
18%
Powdered Chocolate
Dollars
Percent
$ 870,000
100
391,500
45
$ 478,500
55
250,000
29
$ 228,500
26%
b. According to the analysis in part a , the Powdered Chocolate product line is more profitable.
When determining the profitability of any product line, common fixed costs should not be
considered. Only the costs that are directly traceable to the product line should be considered.
Common fixed costs are not directly traceable to any product, as they are only arbitrarily allocated
in proportion to a chosen factor, such as machine hours or square feet of space occupied.
c. Due to the short term nature of such an advertising campaign, fixed production costs will most likely
not be affected. The effects of this campaign will be in both sales and variable costs, and therefore
the company should select the product line based on which product has the highest contribution
margin ratio, Powdered Chocolate.
30 Minutes, Medium
a. Responsibility income statement:
Sales
Variable costs
Contribution margin
Common fixed costs
PROBLEM 22.2A
REGAL FLAIR ENTERPRISES
REGAL FLAIR ENTERPRISES
Entire Company
Jewelry Line
Apparel Line
Dollars
Percent
Dollars
Percent
Dollars
Percent
$ 1,250,000
100.0 $ 800,000
100.0 $ 450,000
100.0
566,000
45.3
440,000
55.0
126,000
28.0
$ 684,000
54.7 $ 360,000
45.0 $ 324,000
72.0
450,000
36.0
200,000
25.0
250,000
55.6
$ 234,000
18.7 $ 160,000
20.0% $ 74,000
16.4%
100,000
8.0
$ 134,000
10.7%
PROBLEM 22.2A
REGAL FLAIR ENTERPRISES (concluded)
b. Recommendations on increased advertising:
It appears that increasing advertising expenditures on apparel will increase the profitability
of the business, but spending the proposed amount to advertise jewelry would reduce
profitability.
Short-run decisions that are not likely to affect fixed costs may be evaluated based upon the
expected change in contribution margin. Thus, the expected effect of the proposed
advertising campaign upon income from operations may be summarized as follows:
Jewelry
Expected increase in contribution margin:
Jewelry ($150,000 45%)
Apparel ($150,000 72%)
Less: Increase in advertising expenditures
Expected increase (decrease) in operating income
67,500
$
75,000
(7,500) $
Apparel
108,000
75,000
33,000
Because of the relatively high contribution margin in the apparel segment, spending $75,000
per month to achieve a monthly sales increase of $150,000 will increase overall profitability.
Jewelry, however, provides a lower contribution margin. After variable costs, a $150,000
increase in jewelry sales leaves only $67,500 in contribution margin, which does not cover
the cost of the proposed advertising campaign.
c.
Results of investment in each product line:

Jewelry

Jewelry ($300,000 45%)
Apparel ($300,000 72%)
Less: Increase in traceable fixed costs (75%)
135,000
$
150,000
(15,000) $
Apparel
216,000
187,500
28,500
Thus, it would appear that an investment in the Apparel line would produce the most
profitable results. The contribution margin ratio of the Jewelry line is considerably less
than that of the Apparel line (45% compared to 72%). Thus, an expected increase of
$300,000 in sales will only contribute $135,000 toward covering the expected increase in the
lines traceable fixed costs of $150,000 ($200,000 75%). On sales of $300,000, the relatively
high contribution margin of the Apparel line will enable it to contribute $216,000 to cover
its $187,500 increase in fixed costs ($250,000 75%).
PROBLEM 22.3A
GIANT CHEF EQUIPMENT COMPANY
30 Minutes, Medium
a. Responsibility income statemen
Sales
Variable costs
Contribution margin
Fixed costs traceable to product
divisions
Division responsibility margin
Common fixed costs
Operating Income
GIANT CHEF EQUIPMENT COMPANY

For June
Entire Company
Commercial Sales Division
Home Products Division
Dollars
Percent
Dollars
Percent
Dollars
Percent
$ 2,400,000
900,000
100.0 $ 1,500,000
100.0 $
100.0
1,440,000
60.0
990,000
66.0
450,000
50.0
$
960,000
40.0 $
510,000
34.0 $
450,000
50.0
$
$
360,000
600,000
120,000
480,000
15.0
25.0 $
5.0
20.0%
180,000
330,000
12.0
22.0% $
180,000
270,000
20.0
30.0%
PROBLEM 22.3A
GIANT CHEF EQUIPMENT COMPANY (concluded)
b. Sales volume required for a $500,000 monthly responsibility margin in the Home
Products Division may be computed as follows:
Division Sales = [Division Fixed Costs + Responsibility Margin] Contribution
Margin Ratio
= [$180,000 + $500,000] 50% = $1,360,000
c. The decision to increase monthly advertising expenditures is supported by the
following calculations:
Incremental revenue ($900,000 5%)

Less: Incremental variable costs ($45,000 50%)
Increase in contribution margin
Less: Incremental increase in fixed costs
Incremental increase in responsibility margin
$
$
$
45,000
22,500
22,500
15,000
7,500
PROBLEM 22.4A
MUSCLE BOUND CO.
60 Minutes, Strong
a.
Responsibility income statement of

the Eastern Territory:
Sales
Variable costs
Contribution margin
Common fixed costs
Operating income
b.
$
$
$
$
Responsibility income statement of

the entire company:
Sales
Variable costs
Contribution margin
Fixed costs traceable to territories
Common fixed costs
Operating income
$
$
$
$
MUSCLE BOUND COMPANY

Eastern Territory
For January
Eastern Territory
FasTrak
RowMaster
Dollars
Percent
Dollars
Percent
Dollars
Percent
1,350,000
600,000
750,000
100.0 $
100.0 $
100.0
720,000
53.0
270,000
45.0
450,000
60.0
630,000
47.0 $
330,000
55.0 $
300,000
40.0
230,000
17.0
80,000
13.0
150,000
20.0
400,000
30.0 $
250,000
42.0% $
150,000
20.0%
120,000
9*
280,000
21.0%
MUSCLE BOUND COMPANY

For January
Entire Company
Eastern Territory
Western Territory
Dollars
Percent
Dollars
Percent
Dollars
Percent
1,950,000
600,000
100.0 $ 1,350,000
100.0 $
100.0
990,000
50.8
720,000
53.0
270,000
45.0
960,000
49.2 $
630,000
47.0 $
330,000
55.0
480,000
24.6
350,000**
26.0
130,000
21.7
480,000
24.6 $
280,000
21.0% $
200,000
33.3%
180,000
9.2
300,000
15.4%
* Minor rounding difference

** $350,000 = $120,000 common fixed costs of Eastern Territory + $230,000 traceable fixed costs.
PROBLEM 22.4A
MUSCLE BOUND CO. (concluded)
c.
Each territorys return on assets:

Eastern
Territory
Average assets
Return on assets
Western
Territory
280,000 $
200,000
14,000,000
12,000,000
2.0%
1.7%
d. All costs are traceable at some level of the organization. While the $120,000 in common
fixed costs was not traceable to product lines within the Eastern Territory, these costs are
traceable to the territory itself. Therefore, in the income statement divided by territories,
this $120,000 is combined with the other fixed costs of the Eastern Territory and is shown as
Fixed costs traceable to territories.
e. The manager should focus the campaign on the product line that will generate the greatest
contribution margin in relation to the additional fixed advertising cost. Thus, the manager
should support advertising of FasTrak, as shown below:
FasTrak
Incremental revenue
Less: Incremental variable costs (45%, 60%)
Incremental increase in contribution margin (55%, 40%)
Less: Incremental fixed costs
Increase (decrease) in responsibility margin
$
$
$
120,000
54,000
66,000
50,000
16,000
RowMaster
$
120,000
72,000
$
48,000
50,000
$
(2,000)
f. In the type of long-run investment described, top management must be aware of the ability
of the investment to cover fixed costs as well as variable costs. Thus, management should
look to such measures as responsibility margin and return on assets. As management knows
the cost of assets currently invested in each sales territory, return on investment techniques
may be used to evaluate the relative profitability of each territory. In part c, we determined
that the return on assets of the Eastern Territory was approximately 2% per month, or 24%
per year. The Western Territory offers an even higher return of 1.7% per month, or 20.4%
per year. Thus, the Eastern Territory appears to offer the higher potential return on
investment.
45 Minutes, Strong
PROBLEM 22.5A
BUTTERFIELD, INC.
a. Computation of expected change in responsibility margin:
Expected increase in sales

Product contribution margin ratio
Expected increase in contribution margin
Expected change in fixed costs (advertising)
Expected change in responsibility margin
(1) Product A
$
30,000
48%
$
14,400
10,000
$
4,400
(2) Product B
$
30,000
36%
$
10,800
10,000
$
800
b. When an increase in revenue requires new manufacturing facilities, the revenue must be
sufficient to cover the increase in fixed costs as well as the variable costs of production. The
ability to cover fixed costs is indicated by the responsibility margin ratio. Product B has the
higher responsibility margin ratio, with 28% of total revenue currently adding directly to
the operating income of the business. Therefore, Product B appears to be the logical choice
for expansion.
c. In the Division 1 responsibility income statement, this $21,000 in costs was classified as
common because the costs could not be traced to the subunits within the division.
However, the costs are traceable to the division itself. Therefore, when the segments are
defined as entire divisions, these costs are combined with the other fixed costs relating to
Division 1 and are identified as traceable to the division. Notice that the fixed costs
traceable to Division 1 total $63,000; this represents the $42,000 traceable to the subunits
within the division, and this $21,000.
d. An increase in the monthly sales of Division 2 to $200,000 represents a $50,000 increase over
the current level of sales. As Division 2 has a contribution margin ratio of 70%, a $50,000
increase in sales should add $35,000 in contribution margin to the division. As there should
be no change in fixed costs, this entire $35,000 should also increase the operating income of
the company.
PROBLEM 22.5A
BUTTERFIELD, INC. (concluded)
BUTTERFIELD, INC.
Income Statement by Divisions
For the Month Ended April 30
e.
Sales
Variable costs
Contribution margin
Fixed costs traceable to divisions
Common costs
$
$
$
$
Butterfield, Inc.
Dollars
Percent
500,000
100
240,000
48
260,000
52
135,000
27
125,000
25
45,000
9
80,000
16
Divisions
Division 1
Division 2
Dollars
Percent
Dollars
Percent
$
300,000
200,000
100 $
100
180,000
60,000
60
30
$
120,000
140,000
40 $
70
63,000
72,000
21
36
$
57,000
68,000
19 $
34
15 Minutes, Easy
PROBLEM 22.6A
FLYWIZ, INC.
a. Based solely on the financial data given, closure of the Rod Division would have increased
the companys operating income to $9,000 (a $4,000 increase resulting from the elimination
of the negative responsibility margin generated by that division).
b. It is very possible that the Rod Division contributes to the sales volume of the Reel Division.
Indeed, these products seem extremely complementary in nature (i.e., if you buy a fishing
rod, youll need a fishing reel, and if you buy a fishing reel, youll need a fishing rod). The
other issue to consider is the seasonality of the fishing equipment industry. January is
typically a very slow month for sales of fishing equipment. Thus, to close the Rod Division
based on a single month of activity in the slow season may be premature.
c. The Rod Division has a contribution margin ratio of 50% ($13,000 $26,000). Thus, for
each dollar of sales, the divisions responsibility margin is increased by $0.50. In order for
the Rod Division to generate a positive responsibility margin of $4,000, it would have to
increase its current responsibility margin (a $4,000 loss) by $8,000. Thus, it would have to
increase monthly sales by $16,000, calculated as follows:
Sales Increase Required 50% Contribution Margin Ratio = $8,000
Sales Increase Required = $8,000 50% = $16,000
20 Minutes, Easy
a.
PROBLEM 22.7A
TOTS-TO-GO COMPANY
Using the market price, the contribution margins for each division and for the company as a
whole:
Sales (1)
Variable Costs (2)
Contribution Margin
Entire
Company
Seat
Division
Stroller
Division
$4,200,000
2,650,000
$1,550,000
$2,400,000
1,900,000
$500,000
$3,000,000
1,950,000
$1,050,000
(1) Seat Division Sales = 20,000 units $120 = $2,400,000

Stroller Division Sales = 10,000 units $300 = $3,000,000
Entire Company Sales = (10,000 units $120) + (10,000 $300) = $4,200,000
b.
(2) Seat Division Variable Costs = 20,000 units $95 = $1,900,000

Stroller Division Variable Costs = 10,000 units ($75 + $120) = $1,950,000
Entire Company Variable Costs = (20,000 units $95) + (10,000 units $75) =
$2,650,000
Using the discount price, the contribution margins for each division and for the company as
a whole:
Sales (1)
Variable Costs (2)
Contribution Margin
Entire
Company
Seat
Division
Stroller
Division
$4,200,000
2,650,000
$1,550,000
$2,300,000
1,900,000
$400,000
$3,000,000
1,850,000
$1,150,000
(1) Seat Division Sales = (10,000 units $120) + (10,000 units $110) = $2,300,000
Stroller Division Sales = 10,000 units $300 = $3,000,000
(2) Seat Division Variable Costs = 20,000 units $95 = $1,900,000
Stroller Division Variable Costs = 10,000 units ($75 + $110) = $1,850,000
Entire Company Variable Costs = (20,000 units $95) + (10,000 $75) = $2,650,000
c.
If division managers are evaluated and rewarded based on their divisions contribution
margin, the transfer price becomes an important issue of concern. However, it is important
to note that regardless of the transfer price used, the contribution margin for the company
as a whole remains the same ($1,550,000). Only if the Stroller division could buy less
expensive seats of equal quality from an outside vendor would the contribution margin of
the company as a whole increase. Of course, the cost savings to the Stroller Division would
also have to offset the increase in shipping costs that would be experienced by the Seat
Division.
40 Minutes, Medium
PROBLEM 22.8A
SPARTA AND ASSOCIATES
a. Using the market price, the pre-tax operating profit for each division and for the company as
a whole:
Sales (1)
Variable Costs (2)
Contribution Margin
Fixed Costs
Operating Profit
Entire
Company
$
525,000
242,500
$
282,500
157,500
$
125,000
Green
Division
$
300,000
130,000
$
170,000
100,000
$
70,000
White
Division
$
450,000
337,500
$
112,500
57,500
$
55,000
(1) Green Division Sales = 2,000 units $150 = $300,000

White Division Sales = 1,500 units $300 = $450,000
Entire Company Sales = (2,000 1,500) $150 + (1,500 $300) = $525,000
(2) Green Division Variable Costs = 2,000 units $65 = $130,000
White Division Variable Costs = 1,500 units ($150 + $75) = $337,500
Entire Company Variable Costs = (2,000 $65) + (1,500 $75) = $242,500
b. Using the discount price, the pre-tax operating profit for each division and for the company
as a whole:
Sales (1)
Variable Costs (2)
Contribution Margin
Fixed Costs
Operating Profit
Entire
Company
$
525,000
242,500
$
282,500
157,500
$
125,000
Green
Division
$
277,500
130,000
$
147,500
100,000
$
47,500
White
Division
$
450,000
315,000
$
135,000
57,500
$
77,500
(1) Green Division Sales = (1,500 units $135) + (500 units $150) = $277,500
PROBLEM 22.8A
SPARTA AND ASSOCIATES (concluded)
c.
Transfer prices generate accounting entries that show the flow of goods between
departments. One department records the transfer price as revenue, while the other
department records the transfer price as an expense. Internal transfer prices do not have
a direct effect on the companys net income because these revenue and expense entries
are cancelled out for the entire company.
d.
Using the external sale price and purchase price for the trophy base, the pre-tax
operating profit for each division and for the company as a whole:
Sales (1)
Variable Costs (2)
Contribution Margin
Fixed Costs
Operating Profit
Entire
Company
$
750,000
482,500
$
267,500
157,500
$
110,000
Green
Division
$
300,000
130,000
$
170,000
100,000
$
70,000
White
Division
$
450,000
352,500
$
97,500
57,500
$
40,000
(1) Green Division Sales = 2,000 units $150 = $300,000

It is more beneficial to the company as a whole if the White Division purchases the trophy
base from the Green Division, as the company earns $15,000 more in operating profit.
SOLUTIONS TO PROBLEMS SET B

PROBLEM 22.1B
FASTENERS INC.
20 Minutes, Easy
a.
Sales
Variable costs
Contribution margin
Common fixed costs
$
$
$
$
FASTENERS INC.
Entire Company
Zippers Line
Buckles Line
Dollars
Percent
Dollars
Percent
Dollars
Percent
355,000
135,000
220,000
100 $
100 $
100
126,000
27,000
99,000
35
20
45
229,000
108,000
121,000
65 $
80 $
55
156,000
90,000
66,000
44
67
30
73,000
18,000
55,000
21 $
13% $
25%
35,000
10
38,000
11%
b. According to the analysis in part a, the Buckles product line is more profitable.
When determining the profitability of any product line, common fixed costs should not be considered. Only the costs that are
directly traceable to the product line should be considered. Common fixed costs are not directly traceable to any product, as they
are only arbitrarily allocated in proportion to a chosen factor, such as machine hours or square feet of space occupied.
c. Due to the short term nature of such an advertising campaign, fixed production costs will most likely not be affected. The effects
of this campaign will be in both sales and variable costs, and therefore the company should select the product line based on which
product has the highest contribution margin ratio. The contribution margin ratio for Zippers is .8 and would generate $40,000
.8 = $32,000 in contribution. However, Buckles would generate $40,000 .55 = $22,000 in contribution. So the advertising should
be spent on Zippers.
PROBLEM 22.2B
BROWN ENTERPRISES
30 Minutes, Medium
a. Responsibility income statement:
Sales
Variable costs
Contribution margin
Common fixed costs
$
$
$
$
BROWN ENTERPRISES
Entire Company
Bag Line
Shoe Line
Dollars
Percent
Dollars
Percent
Dollars
Percent
1,500,000
500,000
100 $ 1,000,000
100 $
100
750,000
600,000
150,000
50
60
30
750,000
400,000
350,000
50 $
40 $
70
525,000
250,000
275,000
35
25
55
225,000
150,000
75,000
15 $
15% $
15%
75,000
5
150,000
10%
PROBLEM 22.2B
BROWN ENTERPRISES (concluded)
b. Recommendations on increased advertising:.
It appears that increasing advertising expenditures on shoes will increase the profitability of
the business, but spending the proposed amount to advertise bags would reduce
profitability.
Short-run decisions that are not likely to affect fixed costs may be evaluated based upon the
expected change in contribution margin. Thus, the expected effect of the proposed
advertising campaign upon income from operations may be summarized as follows:
Bags
Bags ($100,000 40%)
Shoes ($100,000 70%)
Less: Increase in advertising expenditures
$
$
Shoes
40,000
$
50,000
(10,000) $
70,000
50,000
20,000
Because of the relatively high contribution margin ratio in the shoe segment, spending
$50,000 per month to achieve a monthly sales increase of $100,000 will increase overall
profitability. Bags, however, provides a lower contribution margin ratio. After variable
costs, a $100,000 increase in bag sales leaves only $40,000 in contribution margin, which
does not cover the cost of the proposed advertising campaign.
c.
Results of investment in each product line:

Bags

Bags ($250,000 40%)
Shoes ($250,000 70%)
Less: Increase in traceable fixed costs (60%)
100,000
$
150,000
(50,000) $
Shoes
175,000
165,000
10,000
Thus, it would appear that an investment in the Shoe line would produce the most
profitable results. The contribution margin ratio of the Bag line is considerably less than
that of the Shoe line (40% compared to 70%). Thus, an expected increase of $250,000 in
sales for the Bag line will only contribute $100,000 toward covering the expected increase in
the lines traceable fixed costs of $150,000 ($250,000 60%). On the other hand, a $250,000
increase in sales of shoes will produce a contribution margin that is greater than the
expected increase in traceable fixed costs. This indicates that the company should expand
its operations for the Shoe line.
PROBLEM 22.3B
GLASSWARE COMPANY
30 Minutes, Medium
GLASSWARE COMPANY
For August
Entire Company
Etched Glass Division
Clear Glass Division
Dollars
Percent
Dollars
Percent
Dollars
Percent
$ 13,500,000
100.0 $ 7,500,000
100.0 $ 6,000,000
100.0
7,950,000
59.0
4,650,000
62.0 $ 3,300,000
55.0
$ 5,550,000
41.0
2,850,000
38.0 $ 2,700,000
45.0
a. Responsibility income statement for August:
Sales
Variable costs
Contribution margin
Fixed costs traceable to product
divisions
Common fixed costs
Operating income
$
$
2,400,000
3,150,000
100,000
3,050,000
18.0
23.0 $
1.0
22.6%
1,200,000
1,650,000
16.0
22.0% $
1,200,000
1,500,000
20.0
25.0%
PROBLEM 22.3B
GLASSWARE COMPANY (concluded)
b. Sales volume required for a $1,600,000 monthly responsibility margin in the Clear Glass
Division may be computed as follows:
Division Sales = [Division Fixed Costs + Responsibility Margin]
Contribution Margin Ratio
= [$1,200,000 + $1,600,000] 45% = $6,222,222
c. The decision to increase monthly advertising expenditures is supported by the following
calculations:
Incremental revenue ($6,000,000 4%)

Less: Incremental variable costs ($240,000 55%)
Increase in contribution margin
Less: Incremental increase in advertising costs
Incremental increase in responsibility margin
$
$
$
240,000
132,000
108,000
12,000
96,000
Increasing the advertising expenditures for the Clear Glass Division would increase the
responsibility margin by $96,000 per month. Therefore, the company should increase
advertising expenditures.
PROBLEM 22.4B
FREEZE, INC.
60 Minutes, Strong
a.
Sales
Variable costs
Contribution margin
Common fixed costs
Operating income
$
$
$
$
b.
Sales
Variable costs
Contribution margin
Fixed costs traceable to territories
Common fixed costs
Operating income
$
$
$
$
FREEZE, INC.
Northern Territory
For January
Northern Territory
Economy
Efficiency
Dollars
Percent
Dollars
Percent
Dollars
Percent
1,500,000
500,000
100.0 $
100.0 $ 1,000,000
100.0
850,000
150,000
700,000
56.7
30.0
70.0
650,000
350,000
300,000
43.3 $
70.0 $
30.0
290,000
90,000
200,000
19.3
18.0
20.0
360,000
260,000
100,000
24.0 $
52.0% $
10.0%
125,000
8.3
235,000
15.7%
FREEZE, INC.
For January
Entire Company
Northern Territory
Southern Territory
Dollars
Percent
Dollars
Percent
Dollars
Percent
2,300,000
800,000
100.0 $ 1,500,000
100.0 $
100.0
1,202,000
850,000
352,000
52.3
56.7
44.0
1,098,000
$
650,000
$
448,000
47.7
43.3
56.0
705,000
415,000
290,000
30.7 *
27.6
36.0
393,000
235,000
158,000
17.1 $
15.7% $
20.0%
140,000
6.1
253,000
11.0%
*$415,000 = $125,000 common fixed costs of Northern territory + $290,000 traceable fixed costs
PROBLEM 22.4B
FREEZE, INC. (concluded)
c.
Each territorys return on assets:

Northern
Territory
Average assets
Return on assets
Southern
Territory
235,000 $
158,000
16,000,000
10,000,000
1.5%
1.6%
d. All costs are traceable at some level of the organization. While the $125,000 in common
fixed costs was not traceable to product lines within the Northern Territory, these costs
are traceable to the territory itself. Therefore, in the income statement divided by
territories, this $125,000 is combined with the other fixed costs of the Northern Territory
and is shown as Fixed costs traceable to territories.
e. The manager should focus the campaign on the product line that will generate the greatest
contribution margin in relation to the additional fixed advertising cost. Thus, the manager
should support advertising of Economy as shown below:
Economy
Incremental revenue
Less: Incremental variable costs (30%, 70%)
Incremental increase in contribution margin (70%, 30%)
Less: Incremental fixed costs
Increase (decrease) in responsibility margin
$
$
$
100,000
30,000
70,000
40,000
30,000
Efficiency
$
$
$
100,000
70,000
30,000
40,000
(10,000)
f. In the type of long-run investment described, top management must be aware of the
ability of the investment to cover fixed costs as well as variable costs. Thus, management
should look to such measures as responsibility margin and return on assets. As
management knows the cost of assets currently invested in each sales territory, return on
investment techniques may be used to evaluate the relative profitability of each territory.
In part c, we determined that the return on assets of the Northern Territory was
approximately 1.5% per month, or 18% per year. The Southern Territory offers a slightly
higher return of 1.6% per month, or 19.2% per year. Thus, the Southern Territory
appears to offer the higher potential return on investment.
PROBLEM 22.5B
SOTHEBY, INC.
45 Minutes, Strong
a. Computation of expected change in responsibility margin:

(1) Product C
Expected increase in sales
Product contribution margin ratio
Expected increase in contribution margin
Expected change in fixed costs (advertising)
Expected change in responsibility margin
$
$
$
(2) Product D
25,000 $
50%
12,500 $
8,000
4,500 $
25,000
19%
4,750
8,000
(3,250)
b. When an increase in revenue requires new manufacturing facilities, the revenue must be
sufficient to cover the increase in fixed costs as well as the variable costs of production. The
ability to cover fixed costs is indicated by the responsibility margin ratio. Product C has the
higher responsibility margin ratio, with 27% of total revenue currently adding directly to
the operating income of the business. Therefore, Product C appears to be the logical choice
for expansion.
c. In the Division 1 responsibility income statement, this $20,000 in costs was classified as
common because the costs could not be traced to the subunits within the division.
However, the costs are traceable to the division itself. Therefore, when the segments are
defined as entire divisions, these costs are combined with the other fixed costs relating to
Division 1 and are identified as traceable to the division. Notice that the fixed costs
traceable to Division 1 total $68,000; this represents the $48,000 traceable to the subunits
within the division, and this $20,000.
d. An increase in the monthly sales of Division 2 to $200,000 represents a $40,000 increase over
the current level of sales. As Division 2 has a contribution margin ratio of 60%, a $40,000
increase in sales should add $24,000 in contribution margin to the division. As there should
be no change in fixed costs, this entire $24,000 should also increase the operating income of
the company. The original operating income of $20,000 plus this increase of $24,000 equals
the revised operating income of $44,000 shown in the income statement of the following
page.
PROBLEM 22.5B
SOTHEBY, INC. (concluded)
SOTHEBY, INC.
Income Statement by Divisions
For the Month Ended November 30
Sales
Variable costs
Contribution margin
Fixed costs traceable to divisions
Common costs
$
$
$
$
Divisions
Sotheby, Inc.
Division 1
Division 2
Dollars
Percent
Dollars
Percent
Dollars
Percent
540,000
340,000
200,000
100 $
100 $
100
318,000
238,000
80,000
59
70
40
222,000
102,000
120,000
41 $
30 $
60
132,000
68,000
64,000
24
20
32
90,000
34,000
56,000
17 $
10% $
28%
46,000
9
44,000
8%
15 Minutes, Easy
PROBLEM 22.6B
FOOTWARE, INC.
a. Closure of the Sandal Division would increase the companys operating income to $9,000 (a
$2,000 increase resulting from the elimination of the negative responsibility margin
generated by the Sandal Division).
b. It is very possible that the Sandal Division contributes to the sales volume of the Moccasin
Division and vice versa. Indeed, these products could be complementary in nature (i.e., if
you buy sandals, you may also consider moccasins, and if you buy moccasins, you may
simultaneously consider sandals for summer wear). The other issue to consider is the
seasonality of the moccasin and sandal industry. October is typically a slow month for sales
of sandals and moccasins. Thus, the Sandal Division may be profitable during the busier
months of sales activity such as April and May. Finally, exploring other options to improve
the profitability of both the Sandal Division and the Moccasin Division may be fruitful. The
Sandal Division's traceable fixed costs seem extremely high ( over 53% of sales) as
compared to the Moccasin Division (30% of sales). Also, exploring new markets such as online sales or new international markets may be useful.
c. The Sandal Division has a contribution margin ratio of 50% ($30,000 $60,000). Thus, for
each dollar of sales, the divisions responsibility margin is increased by $0.50. In order for
the Sandal Division to generate a positive responsibility margin of $2,000, it would have to
increase its current responsibility margin (a $2,000 loss) by $4,000. Thus, it would have to
increase monthly sales by $8,000, calculated as follows:
Sales Increase Required 50% Contribution Margin Ratio = $4,000
Sales Increase Required = $4,000 50% = $8,000
20 Minutes, Easy
a.
PROBLEM 22.7B
EASTRISE CORPORATION
Using the market price, the contribution margins for each division and for the company as a
whole:
Sales (1)
Variable Costs (2)
Contribution Margin
Entire
Company
Motor
Division
$ 14,000,000
7,600,000
$ 6,400,000
$ 12,000,000
6,600,000
$ 5,400,000
Mower
Division
6,000,000
5,000,000
1,000,000
(1) Motor Division Sales = 30,000 units $400 = $12,000,000

Mower Division Sales = 10,000 units $600 = $6,000,000
(2) Motor Division Variable Costs = 30,000 units $220 = $6,600,000
Mower Division Variable Costs = 10,000 units ($100 + $400) = $5,000,000
Entire Company Variable Costs = (30,000 units $220) + (10,000 units $100) =
$7,600,000
b.
Using the discount price, the contribution margins for each division and for the company as
a whole:
Sales (1)
Variable Costs (2)
Contribution Margin
Entire
Company
Motor
Division
$ 14,000,000
7,600,000
$ 6,400,000
$ 11,800,000
6,600,000
$ 5,200,000
Mower
Division
$
$
6,000,000
4,800,000
1,200,000
(1) Motor Division Sales = (20,000 units $400) + (10,000 units $380) = $11,800,000
Mower Division Sales = 10,000 units $600 = $6,000,000
(2) Motor Division Variable Costs = 30,000 units $220 = $6,600,000
Mower Division Variable Costs = 10,000 units ($100 + $380) = $4,800,000
c.
Only cost centers should use cost as a transfer price. Profit centers, such as the Motor
Division, should use market value as the transfer price of a product. This prevents the
shifting of margin from the producing department to the purchasing department.
PROBLEM 22.8B
WESTMINSTER, INC.
40 Minutes, Medium
a. Using the market price, the pre-tax operating profit for each division and for the company as
a whole:
Entire
Company
Sales (1)
Variable Costs (2)
Contribution Margin
Fixed Costs
Operating Profit
$
$
$
1,162,500
651,000
511,500
384,000
127,500
Frame
Division
742,500
396,000
346,500
280,000
66,500
$
$
Works
Division
$
$
$
825,000
660,000
165,000
104,000
61,000
(1) Frame Division Sales = 5,500 units $135 = $742,500

Works Division Sales = 3,000 units $275 = $825,000
Entire Company Sales = $825,000 + [$135 (5,500 - 3,000)] = $1,162,500
(2) Frame Division Variable Costs = 5,500 units $72 = $396,000
Works Division Variable Costs = 3,000 units ($135 + $85) = $660,000
Entire Company Variable Costs = (5,500 units $72) + (3,000 units $85) = $651,000
b. Using the discount price, the pre-tax operating profit for each division and for the company
as a whole:
Entire
Company
Sales (1)
Variable Costs (2)
Contribution Margin
Fixed Costs
Operating Profit
$
$
$
1,162,500
651,000
511,500
384,000
127,500
Frame
Division
$
$
$
727,500
396,000
331,500
280,000
51,500
Works
Division
$
$
$
825,000
645,000
180,000
104,000
76,000
(1) Frame Division Sales = (2,500 units $135) + (3000 units $130) = $727,500
Entire Company = (2,500 $135) + (3,000 $275) = $1,162,500

(2) Frame Division Variable Costs = 5,500 units $72 = $396,000
Entire Company = (5,500 $72) + (3,000 $85) = $651,000
PROBLEM 22.8B
WESTMINSTER, INC. (concluded)
c.
Transfer prices generate accounting entries to show the flow of goods between departments.
One department records the transfer price as revenue, while the other department records
the transfer price as an expense. Transfer prices do not have a direct effect on the
companys net income.
d.
Using the external sale price and purchase price for the casings, the pre-tax operating profit
for each division and for the company as a whole:
Entire
Company
Sales (1)
Variable Costs (2)
Contribution Margin
Fixed Costs
Operating Profit
$
$
$
1,567,500
1,071,000
496,500
384,000
112,500
Frame
Division
$
$
$
742,500
396,000
346,500
280,000
66,500
Works
Division
$
$
$
825,000
675,000
150,000
104,000
46,000
(1) Frame Division Sales = 5,500 units $135 = $742,500

Entire Company Sales = $742,500 + $825,000 = $1,567,500
(2) Frames Division Variable Costs = 5,500 units $72 = $396,000
Entire Company Variable Costs = $396,000 + $675,000 = $1,071,000
It is more beneficial to the company as a whole if the Works Division purchases casings from the
Frame Division, as the company earns $15,000 more in operating profit.
SOLUTIONS TO CRITICAL THINKING CASES

35 Minutes, Medium
CASE 22.1
LANDS END HOTEL
a. Evaluation of Chamberlains comments:

A basic purpose of a responsibility accounting system is to measure the performance of
specific responsibility centers. This means that the revenue and costs upon which a center
is evaluated should be traceable directly to that center and, ideally, be under the center
managers control.
Chamberlain is correct that allocating all fixed costs of the hotel (many of which are
common costs) on the basis of gross revenue penalizes a successful profit center. Not only
is the profit center charged with more costs as its revenue rises, but also it can be charged
with more costs merely because the revenue in other profit centers declines. Thus, center
performance may be obscured; the performance of strong profit centers may be
understated, and the performance of weaker centers may be overstated since these
centers are charged with less costs.
In summary, Chamberlains criticisms of the existing approach to assigning costs to
profit centers are valid. His suggestion that fixed costs should instead be allocated in
proportion to square feet of space is discussed below.
Evaluation of Mettenburgs comments:
Mettenburg is also correct in her criticism of Chamberlains suggestion that fixed costs
should be allocated on a basis of square feet of occupied space. Many fixed costs, such as
salaries, may bear little or no relationship to square feet of space. Further, space occupied
by a department may be a matter of circumstances not under the centers managers
direct control. Mettenburg, for example, does not have the option of shrinking the
Sunset Lounge.
The criticisms of the two managers point out that any allocation of common costs is
necessarily arbitrary, rewarding some profit centers, but penalizing others.
b. Note to instructor: In part b, students are asked to develop their own approach to
allocating fixed costs to departments. Thus, our answer is intended only to represent one
point of view.
We recommend that the revenue of a center should be offset only by the related variable
costs and by those fixed costs that are directly traceable to the center. Common fixed
coststhose that jointly benefit several profit centersshould not be allocated among the
centers deriving benefit. Thus, the responsibility income statement includes only those
costs directly traceable to the centers activities.
Furthermore, traceable fixed costs may be divided into the subcategories of controllable
fixed costs and committed fixed costs. This enables the responsibility income statement to
show as a subtotal (performance margin) those aspects of the centers operations that are
readily controllable by the center manager.
40 Minutes, Medium
CASE 22.2
OSBORN DIVERSIFIED PRODUCTS, INC.
a. Financially, the $40,000 error is not apt to significantly damage Osborn. However, this
does not mean that Jim should keep the money and let the error go unreported. Jim has
an ethical responsibility to make the company aware of its mistake. To do otherwise is the
same as stealing.
b. There is no easy answer to this question. One option for Sara is to inform Jim that she
knows about the error in his bonus payment. She should also let him know that he has an
ethical and legal obligation to return the money to the company. If he says that he will
return it, she may choose to trust him. If he says that he will not return it, one may argue
that she has an obligation to blow the whistle on Jim.
c. It is not ethical for Jims attorney to suggest that he keep the money. The attorneys
professional code of ethics certainly does not condone stealing. Thus, the attorney should
strongly suggest that Jim return the money. However, if Jim refuses to do so, the attorney
may not blow the whistle on him because of the legal professions legal and ethical
responsibility to maintain client confidentiality.
d. Once again, there is no correct answer to this question. However, if Jims daughter
decides to stay in Boston, she must live with the fact that her college education was
subsidized with stolen money. It would certainly be advantageous for her to graduate
with a degree from the prestigious university. Therefore, she should make every possible
effort to obtain financial aid (work-study, student loans, grants, etc.). If her efforts fail,
and Jim returns the money, she may have to finish her education in Ohio.
30 Minutes, Medium
CASE 22.3
HOSPITAL PROFIT CENTERS
a. Student answers will vary. However, suggested profit centers include: Emergency room,
pediatrics, intensive care, knee/hip replacement surgeries, cafeteria, dialysis center, etc.
Suggested cost centers include: housekeeping, admissions, laundry, building maintenance,
etc.
b. To be profitable, unit managers may try to generate more revenue. One way to generate
more revenue is to do more surgeries. This might encourage surgeons to schedule
unnecessary surgeries, which would be unethical. In addition, to be more profitable,
profit centers need to control costs. Skimping on costs could also raise ethical issues about
providing the highest level of care. Surgeries should probably be designated as cost
centers and performance should be evaluated against budgeted costs.
30 Minutes, Medium
CASE 22.4
GENERAL MILLS AND THE KIRBY COMPANY
a. Given the diverse nature of the products supplied by General Mills, there are many ways
in which to organize responsibility centers. One way would be to define responsibility
centers based on major product groups such as cereals, baked goods, snacks, dairy, and
vegetables. An example of an investment center might be one of General Mills major
brands, such as Green Giant. Examples of profit centers may be individual types of
Green Giant vegetables. Cost centers would likely include manufacturing plants.
b. The Kirby company produces one product line that is marketed through independent
sales managers. One way of assigning responsibility centers is by geographical region,
since sales managers are likely assigned specific territories. Investment and/or profit
centers may include such geographical regions. Cost centers are likely to include the
plants that manufacture Kirby products.
c. Two fundamental differences between General Mills and Kirby that drive the differences
in responsibility center systems are the scope of product lines and the sales methods.
20 Minutes, Medium
CASE 22.5
University Ethics
ETHICS, FRAUD & CORPORATE GOVERNANCE
Student answers will vary considerably, but one issue that can be discussed about the ethics
of considering students as profit centers is that it is inconsistent with the mission of
organizations that purport to be focused on higher education. Rather than focusing on
meeting assurance of learning objectives for students, the focus may shift to using access to
students through university channels as a means of increasing university profits. This seems
to be the case with the deal University of Minnesota made with TCF Financial. One could
imagine other types of deals that universities might be tempted to make with potential
recruiters that want access to students or companies that want to advertise to students.
Imagine dorm rooms painted with advertisements designed to sell products to students.

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CHAPTER 22

RESPONSIBILITY CENTER ACCOUNTING

Types of responsibility centers

Real World: Home Depots segments

Types of responsibility centers

Corporate costs; traceable or common

Transfer pricing decisions

Transfer pricing with external market prices

Critical Thinking Cases

Hospital profit centers

Real World: General Mills & Kirby

Real World: University of Minnesota

DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES

Regal Flair Enterprises/Brown Enterprises

Giant Chef Equipment Company/Glassware Company

Muscle Bound Company/Freeze, Inc.

Butterfield, Inc./Sotheby, Inc.

Flywiz, Inc./Footware, Inc.

Sparta and Associates/Westminster, Inc.

Critical Thinking Cases

Osborn Diversified Products, Inc.

Hospital Profit Centers

General Mills and the Kirby Company

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

SOLUTIONS TO BRIEF EXERCISES

$300,000 sales .75 contribution margin = $225,000

Negotiated transfer price.

Traceable to each store.

The three characteristics are: 1) preparing budgets prior to operations; 2)

Disadvantages of allocating common costs are: 1) Because common fixed costs

Traceable fixed costs

An individual video arcade within a chain of video arcades will be

Common fixed costs

Student responses will differ. Below are some suggested measures:

Geminis responsibility income statement is shown below:

Decrease in monthly sales from closing Store 3

Expected increase in monthly contribution margin:

Strategy 1: Advertise the name Drexel-Hall:

Responsibility centers assist managers in evaluating the overall performance of

The total variable costs incurred in Repairs is $8,000. Twenty-five percent of

Student responses will vary, but here is one organizational design:

Jasper Golf Resort*

Key: * = investment center, **= profit center, ***= cost center.

Home Depots Note 1 in Appendix A outlines a couple of different scenarios for

SOLUTIONS TO PROBLEMS SET A

a. Responsibility income statement:

Results of investment in each product line:

Expected increase in contribution margin:

a. Responsibility income statemen

GIANT CHEF EQUIPMENT COMPANY

Incremental revenue ($900,000 5%)

Responsibility income statement of

Responsibility income statement of

MUSCLE BOUND COMPANY

MUSCLE BOUND COMPANY

* Minor rounding difference

Each territorys return on assets:

Key: * = investment center, = profit center, *= cost center.