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Financial Control: Atkinson, Solutions Manual T/a Management Accounting, 6E
Financial Control: Atkinson, Solutions Manual T/a Management Accounting, 6E
Financial Control: Atkinson, Solutions Manual T/a Management Accounting, 6E
Chapter 11
Financial
Control
QUESTIONS
11-2 Internal financial control is the application of financial control tools to evaluate
organization units. The resulting information is used inside the organization and
is not provided to outsiders. External financial control is the application of
financial control tools by outside analysts to evaluate various aspects of
organization performance.
11-4 Control refers to the systems and tools that an organization uses to motivate
decentralized decision makers to pursue the organization’s goals.
11-6 A cost center is a responsibility unit that is evaluated based on its ability to
control costs relative to some standard. Revenues or investment level are not
controlled.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
11-7 A revenue center is assigned the responsibility to achieve, within its own
operating guidelines, a target level of revenues. Managers in a revenue center
do not control costs or the level of investment.
11-8 Organizations use profit centers when profit center employees have the ability
and responsibility to control significant levels of revenues and costs of the
products or services they deliver.
11-9 An investment center is a responsibility unit that is evaluated based on its return
on investment. The managers and other employees control revenues, costs, and
the level of investment.
11-10 The controllability principle requires that people should only be held
accountable for results that they can control. The manager of a responsibility
center should be assigned responsibility for the revenues, costs, or investments
controlled by responsibility center personnel.
11-11 Responsibility centers participate in developing the goods and services that the
organization supplies to its customers, sharing the use of many common
resources in this process. In most organizations, many revenues and costs are
jointly earned or incurred.
11-12 A segment margin is the difference between the revenues and costs that are
deemed to be directly controllable by a responsibility center. It is therefore an
important summary performance measure for each responsibility center.
11-14 A transfer price is the price at which a good or service is deemed to have been
transferred between two responsibility centers within an organization. The
transfer price is treated as revenue in the supplying division and as a cost in the
receiving division. The transfer price is a fiction created for control purposes
and does not affect external reporting.
11-15 The four bases for setting transfer prices are market, cost, negotiated, and
administered.
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Chapter 12: Financial Control
11-16 Organizations earn revenues by selling goods and services to customers. When
organizations use control systems that require revenue numbers for
responsibility centers, the revenue earned from the sale to the final customer
must be divided among the contributing responsibility centers. This process is
necessary to prepare responsibility center income statements, and in turn,
evaluate the center’s performance.
11-17 Organizations use many types of resources to make goods and services. When
organizations use control systems that require cost numbers for responsibility
centers, the costs of the resources that are used by two or more responsibility
centers must be divided between or among those responsibility centers. This
process is necessary to prepare responsibility center income statements, and in
turn, evaluate the center’s performance.
11-19 All other things being equal, as efficiency (the ratio of income to sales)
increases (decreases), return on investment increases (decreases).
11-20 All other things being equal, as productivity (the ratio of sales to investment)
increases (decreases), return on investment increases (decreases).
11-21 Residual income is the difference between reported accounting income and the
required return on the investment (economic cost of investment) used to earn
that income.
11-22 Economic value added (EVA) is a refinement of the residual income idea. The
EVA computation adjusts reported accounting income and asset levels for what
many consider the biasing effects on current results of the financial accounting
doctrine of conservatism. For example, GAAP requires the immediate
expensing of research and development costs; yet, when shareholder value
analysis income is computed, research and development costs are capitalized
and expensed over a certain time period, such as five years.
11-23 Whole Foods states, “We use EVA extensively for capital investment decisions,
including evaluating new store real estate decisions and store remodeling
proposals. We only invest in projects that we believe will add long-term value
to the Company. The EVA decision-making model also enhances operating
decisions in stores. Our emphasis is on EVA improvement …”
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11-24 Financial control alone may be an ineffective control scorecard for three
reasons. First, it focuses on financial measures that do not measure the
organization’s other important attributes, such as product quality and customer
service. Second, financial control measures the financial effect of the overall
level of performance achieved on the critical success factors, and it ignores the
performance achieved on the individual critical success factors. Third, financial
control is usually oriented to short-term profit performance.
EXERCISES
11-25 Decentralization creates the need to ensure that the decentralized decision
makers are pursuing the organization’s stated goals and are coordinated as they
make their independent decisions.
11-28 Examples of revenue centers are: The sporting goods department in a large
department store where the corporation’s purchasing group makes all stocking
decisions, the counter department in a fast food restaurant, and the sales office
in an insurance company. What these responsibility centers have in common is
that they all deal with customers and have little control over the major cost of
the product that they are selling to the customer. They also do not control
investment levels.
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Chapter 12: Financial Control
11-29 The manager of a large department store may have little control over stock,
prices, and advertising but controls many of the other facets of performance.
How customers are treated and how displays are arranged will affect sales. How
staffing is done and service functions performed within the store will affect its
total costs. However, the main determinants of investment—building costs and
inventory, are likely not controllable by the manager. Therefore, it is likely that
the store should be evaluated as a profit center rather than as an investment
center. The maintenance department is likely to meet the conditions of a cost
center—it sells nothing to outside customers and only has a vague and
indeterminable effect on sales. A single department within a store is likely to be
treated as a revenue center since the manager of that department is likely to
have a minimal effect on the department’s costs.
11-30 Although many people assume that a foreign subsidiary will meet the
conditions to be treated as an investment center, the classification is not
automatic. As with divisions within a company, the key is the discretion that the
subsidiary’s management has over prices, product selection, product
development, costs, and investment levels.
11-32 The manager of the cinema does not control the movie that is playing, the
advertising that is done for the movie, the cost of the products sold at the snack
bar (these would likely be purchased by a central agency, which would also
make the decision about what products to sell), and the wages that are paid to
employees (this would likely be determined by a collective agreement between
the union representing all the employees at all the cinemas and the parent
company). The manager and her staff would control how customers are treated
(which might affect revenues), the scheduling of staff (which would affect total
staff costs and service), the amount of waste and pilferage in the snack bar, and
the organization of ticket and snack bar sales (which might affect total sales).
11-33 There are two generic problems in this setting. Are the revenues reported for
this division independent of the revenues reported for the other divisions? For
example: Are there interactions that require transfer pricing or do sales in
renovations affect sales in other departments? If these interactions exist, it is
difficult to interpret the revenue, and therefore the profits, reported by each
division as the contribution by that division to corporate profits.
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Similarly, if there are cost interactions (for example, the divisions use the same
expensive equipment and cost allocations are used to assign the cost of that
equipment to the divisions) then it is difficult to interpret the costs reported for
a division, and therefore its profits, with any certainty.
11-34 The response to this question will reflect the degree of autonomy the respondent
feels that the center manager has. It is likely that the fitness center manager
must follow head office policy concerning the wages paid, but the center
manager will control the number of hours worked by casual employees. If the
chain’s policy is to build identical buildings with identical equipment, then the
depreciation on the building and equipment is not controllable by the center
manager.
The manager should be held accountable for controllable costs and should not
be held accountable for costs that (1) were determined or incurred by someone
else and (2) cannot be changed. The reason for distinguishing between
controllable and uncontrollable costs is to identify which costs the manager
should be held accountable for. The controllability principle asserts that the
manager should only be held accountable for controllable costs.
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Chapter 12: Financial Control
should depend on their ability to control the quantity of raw materials used
rather than the cost.
Thus, managers, even when they cannot control costs entirely, can take steps to
influence final product costs. When more costs or even revenues are included in
performance measures, managers are more motivated to find actions that can
influence incurred costs or generated revenues.
11-36 Division C has sufficient excess capacity to supply the 200,000 units of C82 to
Division D, so neither Division C nor McCann Company will incur an
opportunity cost if the transfer takes place. The incremental cost for Division C
to manufacture the C82 for Division D is 200,000 × ($20 + $12 + $8) =
$8,000,000. If Division D purchases these units from the outside market, it will
spend 200,000 × $50 = $10,000,000 and both Division D and the McCann
Company will be $2,000,000 (= $8,000,000 − $10,000,000) worse off. For
Division C, the transfer price should at least cover variable costs of $40. For
Division D, the transfer price should be less than $50. So to induce an internal
transfer, the transfer price should be between $40 and $50.
11-37 When transfer prices are used for internal purposes they are generally intended
to motivate the decision maker to act in the organization’s interest. However,
when transfer prices are used for international transfer pricing, managers have
an incentive to choose transfer prices to minimize the organization’s total tax
liability by locating most of its profit in the lower-tax country. The objectives
for internal purposes and international tax purposes are often conflicting. Tax
authorities are well aware of the tax incentives, and therefore examine
international transfer pricing policies of companies conducting business under
the authorities’ jurisdiction. The 1995 Organization for Economic Co-operation
and Development (OECD) guidelines (Transfer Pricing Guidelines for
Multinational Enterprises and Tax Administrations (Paris: OECD, 1995))
indicate that whenever possible, transfer prices should reflect market or
economic circumstances. If an organization’s domestic transfer pricing system
has been designed to reflect economic considerations, then its international
transfer pricing system should be the same. Moreover, using one system for
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11-38 Transfer prices can be based on market prices, based on costs, negotiated, or set
by some arbitrator or administrative rule. There are market prices for raw logs.
However, the number of logs that this company buys in these markets would
likely be small compared to the number of logs that are processed internally.
The transfer price could be based on the costs of maintaining the forests and
logging costs. However, logs suitable for a sawmill are more valuable than logs
suitable for a pulp mill, and cost-based transfer pricing would not reflect this. If
a reliable market price is available, it can be used as the transfer price.
The real issue here is the benefit to the organization of treating the logging and
finishing divisions (the saw mills and the pulp mills) as profit centers. If
company success is determined by having the appropriate supply of trees at the
appropriate time, those criteria might be a more useful basis for control than
financial controls organized around profit centers.
11-39 Assuming that the finished products are prepared especially for this fishing
products company, there are likely limited market prices for raw fish and semi-
processed fish, but little outside market opportunity to sell finished products.
Therefore, while transfers between harvesting and processing might be based on
market prices or costs, transfers between processing and selling would have to
be based on costs. One approach used by a fishing company in this situation is a
dual pricing system where the selling division is paid the net realizable value of
the product and pays the accumulated cost to date. Another fishing company in
this situation treats each unit as a cost center and evaluates the contribution that
each unit makes to product quality and timeliness of product availability.
11-41 Numbers that accountants report to outsiders in financial statements are hard in
the sense that they result from the application of strict rules. In a given
situation, there is some, but limited, opportunity for discretion in determining a
number’s value. Therefore, people tend to think of accounting numbers as hard
in the sense that two accountants faced with the same situation would likely
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Chapter 12: Financial Control
come up with numbers that are quite close together. For internal financial
control, however, many accounting numbers, such as profits and costs, result
from applying subjective rules such as transfer prices and cost allocations.
These subjective rules create the possibility of large differences resulting from
the application of different assumptions. The idea of a soft number was likely
developed to warn people that these internal accounting numbers have very
different properties than the accounting numbers that are reported to outsiders.
11-42One possibility is to assign building costs to the departments based on the floor
space that each occupies, on the assumption that the building size is the cost
driver for building costs.
Historical Division
Cost of Operating Return on Residual
Division Investments Income Investment Income
X $560,000 $66,500 11.88% $10,500
Y 532,000 64,400 12.11% 11,200
Z 350,000 43,120 12.32% 8,120
(b)
(c) Return on investment and residual income do not necessarily produce the
same rankings, as seen in part (a), where Division Z has the highest return
on investment but Division Y has the highest residual income. Part (a) also
illustrates that smaller divisions (for example, Division Z) will look less
favorable than larger divisions (Divisions X and Y) under residual income.
Note, however that Division X is the larger division in terms of investments
but has lower residual income than Division Y. The results in (b) show that,
as in part (a), Division Z has the largest return on investment, but now
Division X now has the largest residual income. Only the measurement of
the value of the investment is different between parts (a) and (b),
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illustrating that the measurement choice changes not only the return on
investment and residual income measures, but also potentially changes the
relative rankings across divisions.
(d) Managers will only find it attractive to invest in new, more costly equipment
if the investment brings a large enough increase in income to offset the
reduction in return on investment or residual income associated with the
new investment.
Division
Operating Return on Sales
Division Investment Income Sales Investment Margin Turnover
E $575,000 $75,000 $500,000 13.04% 15.00% 86.96%
F 700,000 91,000 542,000 13.00% 16.79% 77.43%
G 1,000,000 176,000 763,000 17.60% 23.07% 76.30%
(b) Divisions E and F have nearly identical return on investment, but E has
higher turnover, indicating that E generates more sales per dollar of
investment, while F has a slightly higher sales margin. Division G has the
highest return on investment and sales margin, but the division’s turnover is
the lowest of the three divisions. Division E has the highest turnover.
(c)
Division E Division F Division G
Operating income $75,000 $91,000 $176,000
Cost of capital:
8% × division investment 46,000 56,000 80,000
Residual income $29,000 $35,000 $96,000
11-45 (a) The new return-on-sales ratio will be 0.8 × 1.2 = 0.96. The turnover will be
2.0 × 0.8 = 1.6. Therefore, the return on investment will be 0.96 1.6 =
1.536. The previous return on investment was 0.8 × 2 = 1.6. Therefore, the
percentage change is (1.536 – 1.6)/1.6 = –4%.
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Chapter 12: Financial Control
(b) Let x = the desired increase in the return-on sales ratio to achieve a 10%
increase in return on investment
x = 0.375
= ($420,000/$1,400,000) = 30%
(b)
Division income $420,000
Cost of capital:
10% × division investment 140,000
Residual income $280,000
11-47 The response is problematic and reflects the respondent’s image of different
businesses. One industry that relies on a low ratio of profits to sales and a high
ratio of sales to assets is the grocery store business. One industry that relies on a
high ratio of profits to sales and a low ratio of sales to assets is the quality
jewelry business. The business strategy in a grocery business is to promote sales
based on low costs. The business strategy in the quality jewelry business is to
promote a high price based on the nature of the merchandise.
11-48 Recall that the productivity ratio is output divided by input. Consider
processing a side of beef. The input is the weight of the side of beef. If the
output measure is simply the weight of the final products produced from the
side of beef, it makes no difference how the side of beef is processed—if it is all
turned into hamburger, the productivity ratio will be the same. However, if the
output measure is the value of the products produced from the side of beef, then
the productivity ratio will assess the skill used to turn the side of beef into
finished products. In general, whenever skill is involved in turning raw
materials into finished products, the organization should consider using the
value of the output in the numerator of the productivity measure and base the
evaluation of the process on the value of the output produced relative to the
potential given the quality of the inputs.
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Based on this analysis, the golfing line is marginally acceptable and the tennis
lines and football lines are unacceptable. It is only the ski line that appears to be
providing a return that would justify the investment level. These results must be
interpreted with caution. The accountant must determine whether there are
revenue and cost allocation assumptions underlying the reported income figures
that could cause the reported results to be quite different than if other
assumptions were used. There should be a determination of whether this is an
unusual year or an average year. If the income numbers seem hard and the
results typical of an average year’s operations, this company must improve its
performance in the tennis and football lines substantially or think seriously of
abandoning them.
PROBLEMS
11-51 One interpretation, with reasoning, is given for each of the following items.
Other interpretations are possible but should be provided with appropriate
reasoning.
(a) The role is to minimize the cost of the tests while performing them
properly (quality) and when they are required (service). This is a cost
center since the responsibility unit does not affect demand.
(b) The role is to provide profits to the store by providing customers with the
services (food and how it is presented) and controlling the costs
associated with providing those services. This is a profit center since the
responsibility unit can affect sales and costs but is unlikely to affect the
investment level significantly.
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Chapter 12: Financial Control
(c) The role is to provide a range and quality of services that meet customer
requirements while controlling costs. This is probably a cost center since
the responsibility unit does not affect revenues. However, in this setting
the company might treat this group as a profit center and allow users to
buy computing services outside if they wish.
(d) The role is to minimize the cost of the maintenance services provided
while performing them properly (quality) and when they are required
(service). This is a cost center since the responsibility unit does not affect
demand.
(e) The role is to minimize the cost of the customer services provided while
performing them properly (quality) and when they are required (service).
This is a cost center since the responsibility unit likely has an
indeterminable effect on demand.
(f) The role is to minimize the cost of warehousing services provided while
performing them properly (quality) and when they are required (service).
This is a cost center since the responsibility unit likely has an
indeterminable effect on demand.
11-52 One of the first questions to ask is whether there is any purpose served by
allocating factory building depreciation space to the individual cost centers. If
there is none, then there is no point in allocating these costs—cost allocation
takes time and inevitably causes controversies. For example, some accounting
systems allocate these costs in proportion to other costs, such as labor wages.
There is no point served by allocations such as these.
One purpose of allocating these costs might be to motivate the cost center
managers to use less floor space for storing work in process. (That is, to
motivate them to work toward using just-in-time manufacturing.) In this case,
you might allocate the factory depreciation costs using floor space occupied by
each organization unit. In summary, the method used to allocate these costs
should serve some desired decision-making purpose or motivate some desired
behavior.
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(b) The idea is that by insisting that someone be held accountable for a cost,
that person will be motivated to discover a way to control that cost. This
results in making costs that were formerly thought to be uncontrollable
controllable. For example, one might try to change a spot market
transaction, where the cost is variable, into a contractual transaction
where the cost is fixed.
(b) The common interpretation is that the segment margin is the stand-alone
profit of each segment, or the financial effect on the organization if the
segment is eliminated after the fixed capacity used by the segment is
either redeployed or sold off. Beyond issues relating to the allocation of
joint costs and revenues, the major problem with this interpretation is the
effects that the segments have on each other. For example, in a financial
institution, the need for checking accounts may draw customers to the
institution; if the financial institution does not offer checking accounts,
customers may take all their business elsewhere. As another example,
consider the role of a restaurant in a large hotel. On the surface,
restaurants are money losers. However, eliminating a restaurant would
likely have a negative effect on room occupancy, particularly if the hotel
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11-55 Such a search should locate many useful illustrations. As of February 2010, a
PDF file on RadioShack® Corporation’s decision to close some
underperforming stores was available at http://media.corporate-
ir.net/media_files/NYS/RSH/presentations/bearstearns/bear_sterns_pres.pdf.
The report discusses the corporation’s plans to take a more proactive approach
to closing stores and managing slow-moving inventory, and discusses use of
gross margin per square foot of shelf space to evaluate the performance of its
inventory. The corporation also describes various measures to control costs,
including closing several distribution centers.
11-56 Transfer prices based on market prices invite, and in many cases are designed to
invite, comparisons with the costs of outside suppliers. Given cost, reliability,
and quality comparisons, many organizations are abandoning self-supply and
relying on outside experts. (This phenomenon is sometimes called hollowing-
out.) Governments all over the world are now using this tool to evaluate and
improve or eliminate, internal operations. In fact, in New Zealand, government
agencies are required to sell their services to the government as if they were
independent outside suppliers.
The key is that the services must be comparable. Not only must cost
comparisons be made, but also quality and service comparisons must be made.
If the outside supplier meets, or exceeds, the potential of the insider supplier
and there are no security issues (for example, the government cannot rely on an
outside printer to print classified government documents or contract with a gang
of hooligans to provide security services), then the outsider supplier should be
used.
11-57 (a) Most commentators on transfer price state flatly that, if a market price is
available, that is the price the organization should use to price internal
transfers. In this case the amount of $650 appears to be a legitimate
market price since the commodity is well specified and the purchaser is
willing to sign a long-term contract. Therefore, it is inappropriate to
argue in this setting that the $650 is not a legitimate market price. If the
organization wishes to maintain the credibility, the motivational effect,
and the economic insights of transfer pricing, it must allow the selling
division a price of $625 (which is the net realizable value of selling
outside) for the boards.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
Income $600,000
11-58 (a) ROI 15%
Investment $4,000,000
Income $650,000
(b) ROI 14.44%
Investment $4,500,000
(c) Because the overall ROI is higher without the new investment, Michelle’s
compensation will be much higher if she does not undertake the new
investment. Therefore, the compensation scheme does not provide incentives
for a manager to undertake an investment that would benefit the corporation.
(d) A variety of changes are possible. For example, the manager could receive a
flat bonus upon achieving a target ROI or target residual income. Another
alternative is to base the manager’s compensation on a combination of
financial and nonfinancial measures. Current-period actions that decrease the
current period’s financial performance may be creating future value. Such
actions include investments in research and development, employee training,
new distribution channels, and customer service. Conversely, companies that
decrease their investments in these activities may show good current-period
financial performance but they will have likely diminished future value.
Therefore, a mixture of financial and non-financial measures can provide
information about the current period’s success in generating both current
financial performance and growth options for the future.
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11-59 (a)
Net Book Value (The franchise cost is fully amortized.)
Income $3,000,000
Return on investment
Net book value ($1 $10,000)
= 29,997%
Historical Cost
Income $3,000,000
Return on investment
Historical cost ($5,000,000 $10,000 $100,000)
= 58.71%
Historical Cost
11-60 In this setting, economic value added requires that the bank can compute the
revenue, costs, assets, and asset values associated with each product line. This
will require allocations of revenues, costs and assets in a bank where many
revenues are jointly earned and many costs are jointly incurred. A remaining
problem concerns the valuation of assets.
For example, consider the profitability associated with the provision of safety
deposit boxes. The bank would need to determine the revenues associated with
these boxes, which is straightforward if the boxes are billed separately but can
be complicated if the boxes are part of larger customer service packages sold to
customers. (For example, the customer might pay a monthly fee that includes a
credit card, a checking account, a safety deposit box and direct payment
privileges.) The bank would need to determine the costs associated with these
boxes.
Out-of-pocket costs such as purchasing and maintenance costs on the boxes are
straightforward. However, other costs are more problematic. Such costs include
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cost of space for the boxes in the vault, which is also used to store money and
records, and the time of bank staff devoted to safety deposit box activities,
when the staff are also engaged in other activities. Finally, the cost of long-term
facilities, such as the vault and bank itself, needs to be evaluated to determine
the investment base for the residual income calculation.
11-61 This is a terrible idea. Economic value added analysis is useful to identify the
economic benefits of an existing investment—it is not intended to assess a
manager’s ability to manage that investment. For example, a manager might be
doing a good job managing the investment in an asset that should be liquidated.
Unless the manager controls both the investment and the management of the
investment, the two functions should be evaluated separately. The investment
should be evaluated using economic value added, and the manager should be
evaluated using budgets or benchmarking the manager’s performance to
comparable organizations.
11-62 No. The reported results might be soft numbers resting on subjective
allocations. Moreover, there may be a high degree of interaction between the
manufacturing business and installing business. If the product has an excellent
reputation, installation sales might fall if another manufacturer’s product is
substituted. Finally, the current period’s results might be unusually low. The
company owner needs more investigation and data before making the decision.
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11-63Note: The solution below draws on net present value analysis, which is covered
in other courses but not in this book.
Since the net present value of this project is positive, from the point of
view of the company, it should be accepted.
With the new investment in the first year, income after taxes will increase
to $10,900,000 = ($7,000,000 + $16,000,000 – $10,000,000 –
$2,100,000) and the new investment level will increase to $90,000,000 =
($50,000,000 + $50,000,000 – $10,000,000). Therefore, the return on
investment for the first year of operations with the new trucks will be
12.1% = $10,900,000 $90,000,000.
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11-64 The following are suggestions; individual responses may vary depending on
what performance the respondent deems critical to the organization’s success.
(a) Rate of adding or losing customers, contribution per customer, and cost
of installation—an important item not assessed by this financial control
system is why customers are signing up or leaving the company.
(b) Contribution per performance, other costs and revenues, and committed
costs—an important item not assessed by this financial control system is
the type of program that audiences find attractive.
(c) Contribution per unit, cost of developing new recipes and incorporating
feedback on existing recipes, and committed costs—an important item
not assessed by this financial control system is the rate of new product
innovation.
(d) Cost per unit of work, number of clients, and services per client—an
important item not assessed by this financial control system is the degree
of client satisfaction with the services being offered by this agency.
(e) Percent available time used, profit contribution per job, and selling and
administrative support costs—an important item not assessed by this
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(f) Design cost per line, contribution per unit, and profit per line—an
important item not assessed by this financial control system is the
training, future potential and public image of the organization’s design
group.
11-65 Software writers are highly skilled and creative. Many organizations believe
that to attract and keep this type of person, they have to give them freedom to
exercise their skill and creativity. However, unlimited freedom can lead to
products that do not meet customers’ requirements. Moreover, in a large project
the activities of independent writers must be coordinated to achieve the
project’s overall objectives. Therefore, many people believe that the
organization should control and coordinate the activities of these independent
agents as they create. The example provided for an organic organization should
be clearly one where there are relatively few rules and where decision makers
are free to make decisions.
Governments are mechanistic because they believe this is how they can ensure
accountability to the legislative authority for the expenditures that they
undertake and so that they will not do anything unless it has been authorized by
the legislative body. Most people believe that governments should be less
mechanistic. The legislative body should delegate the authority to public
servants to meet the spirit of the legislation without tying them down with
burdensome rules and procedures. The example provided for a mechanistic
organization should be clearly on where there are many rules and decision-
making responsibilities are highly constrained.
11-66 The key in this question is to identify how many performance measures can
motivate organization units to behave in ways that are inconsistent with the
good of the whole organization. The most interesting examples are highly
integrated organizations where success depends on cooperation between the
units. Examples include: A courier, any organization using just-in-time, and an
operating team in a hospital. The response should explore why organizations
tend to use measures of individual performance and the undesirable behavior
they promote.
11-67 Organizations use the functional approach to organization design to capture the
economies of scale due to specialization in task and information. The problem
is coordinating a functional organization where functional experts make
decisions about their own function without regard to the contribution by other
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Atkinson, Solutions Manual t/a Management Accounting, 6E
11-68 (a) The regional offices meet all the criteria to be managed as investment
centers. They control sales, costs, and the level of investment.
11-69 (a) The issue turns on the respondent’s view of the role of accountability in
organizations. If the respondent believes that individuals can be
motivated to improve the organization’s performance without holding
them specifically accountable for certain facets of performance, then the
issue of controllable and uncontrollable can be avoided. However, if the
respondent believes that people must be held accountable for something
to make them interested in improving performance, then the issue of
controllable versus uncontrollable must be addressed.
(b) The organization would likely move to team rather than individual
measures of performance. All members of the team would be expected to
deal with opportunities to improve performance. Therefore the question
of whether any one item is controllable or not by an individual would
disappear and be replaced by questions about group performance.
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Chapter 12: Financial Control
11-70 The major issue in choosing a transfer price is motivating the managers of the
two divisions to behave in a way that makes the organization’s profits as large
as possible.
For existing home kits, the manager of the sales division will want to buy home
kits as long as the sales division can realize a profit on selling the home kits to
the final customers. Therefore, the transfer price must not exceed $35,000,
which is the selling price of $40,000 less the selling division’s cost of $5,000
per home.
The manager of the manufacturing division will want to sell existing home kits
as long as the manufacturing division can realize a profit on selling the homes
to the selling division. Therefore, the transfer price must exceed $30,000
($33,000 1.1), which is the variable cost of making the home kits.
Therefore, any transfer price between $30,000 and $35,000 for the existing
homes will cause the manufacturing division to make, and the selling division
to buy and sell, all the home kits that the manufacturing division is capable of
making.
Turning to the proposal to make cottage kits, recall that the manufacturing
division is currently operating at capacity and will therefore have to give up
production of home kits in order to manufacture cottage kits. From the
company’s perspective, the company’s contribution margin per home kit is
$5,000 = ($40,000 – $30,000 $5,000). Let P = the price at which the
company is indifferent (with respect to profit) between selling all home kits or
all cottage kits. Home kits require 10 machine hours (mh) per unit and cottage
kits require 13 mh per unit, and 5,000 mh are available per year. Assuming that
the selling cost of the cottage kit is the same as the selling cost of the home kit
($5,000 per unit), equating the total contribution margins for the two options
requires the following:
Note that $6,500 is the opportunity cost of producing and selling a cottage kit
instead of a home kit. This opportunity cost is the $500 of contribution margin
per mh for home kits, multiplied by the 13 mh required per cottage kit. (If one
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Atkinson, Solutions Manual t/a Management Accounting, 6E
wishes to take into account only production in whole numbers, then 5,000 13
= 384.62 will have to rounded down to 384, and the necessary price will be
approximately $44,511.)
This transfer price incorporates the original variable cost of $30,000, the
incremental manufacturing cost of $3,000, and the $3,900 opportunity cost to
the manufacturing division for making a cottage kit instead of a home kit, given
the existing transfer price for home kits.
Thus, the manufacturing division will not be willing to accept a transfer price
less than $36,900 per cottage kit. Assuming a selling price per cottage kit of
$44,500, the selling division will not be willing to pay more than $39,500
($44,500 – $5000). Therefore, a transfer price between $36,900 and $39,500
should induce both managers to be willing to engage in the transfer.
11-71 This question explores some of the practical problems of using the return on
investment criterion to evaluate on-going investments in fixed assets. The return
on investment tool was originally designed to evaluate new investments rather
than on-going investments. In the case of new investments, there is no
confusion about the investment amount. When this tool is used to evaluate on-
going investments important valuation problems have to be resolved.
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Chapter 12: Financial Control
plus the change in the net realizable value of the asset during the year, divided
by the net realizable value of the asset at the end of the year.
(a) In this case we do not know the change in the net realizable value of the
property during the year. Therefore we could compute the return on
investment as 7.43% = [$130,000 ($2,000,000 – $250,000)], which is
net profit divided by selling price less disposal costs (the highest
realizable value for the land).
(b) The first question to resolve is whether the current results are typical. The
second question to resolve is the basis that will be used to make this
decision. If the basis is purely financial and if the company requires a
return on investment greater than 7.43%, the asset should be put to its
most profitable use, which would be to demolish the building and sell the
land, netting $1,750,000.
CASES
11-72 (a) Shellie is likely to focus her efforts on layout design, the product line that
shows the highest reported profit. With the information provided up to
this point, one can conjecture that Shellie may be undercharging for
layout design because there is great demand for Shellie’s layout design
services, but no other lawn and garden businesses in the city are
attempting to compete for the layout design business. If Shellie is
undercharging for layout design and thereby not adequately covering
associated costs, profits will continue to deteriorate.
(b)
Shellie’s Lawn and Garden
Resource Use Information
Cost Capacity Rate Used Allocation Unused
Trucks and
related costs $50,000 800 $62.50 600 $37,500 $12,500
Lawn mowing
equipment 37,500 1,500 25.00 1,200 30,000 7,500
Layout design
equipment 150,000 400 375.00 400 150,000 0
Other
maintenance
equipment 87,500 700 125.00 500 62,500 25,000
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Atkinson, Solutions Manual t/a Management Accounting, 6E
(c)
Shellie’s Lawn and Garden
Product Line Income Statements
Lawn Layout Other
Mowing Design Maintenance Total
Revenues $287,500 $218,750 $312,500 $818,750
Direct costs 156,250 70,000 181,250 407,500
Margin 131,250 148,750 131,250 411,250
Cost of used capacity
Own 30,000 150,000 62,500 242,500
Trucks 12,500 12,500 12,500 37,500
Cost of unused own 7,500 0 25,000 32,500
capacity
Product line profit $81,250 –$13,750 $31,250 $98,750
Cost of unused shared
capacity (trucks) 12,500
General business
costs 50,000
Organization profit $36,250
Note that the product line profit numbers do not include the $50,000 of
general business costs and the $12,500 of costs of unused truck capacity,
since there is no practical way of allocating these costs to any one of the
three lines of business. They must be covered by the margins created by each
of the three business lines.
(d) Based on the exhibits in parts (b) and (c), cutting back on lawn mowing and
other maintenance is undesirable if capacity stays the same. Both these
product lines have unused capacity. The layout design business is draining
profits. The prices charged for layout do not reflect the costs of the
associated specialized equipment, confirming the conjecture in part (a) that
Shellie’s low prices are generating demand and discouraging competition.
Shellie can raise prices on the layout design business and try to increase
volume in the lawn mowing and other maintenance business, to use
available capacity.
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Chapter 12: Financial Control
11-73 (a) This is an organization where the activities of all the elements of the
system must work together and be very highly integrated. This is a setting
where basing rewards on individual measures of performance can be very
dysfunctional. Since the investment center approach requires that the
costs, profit, and investment levels of each responsibility center be
computed, it would seem, on the surface at least, that this is not the type
of organization where an investment center approach can be properly
used.
11-74 (a) This is a situation where historical and political issues, combined with an
inappropriate delegation of organization responsibilities to organization
units, created a problem that caused customer and safety concerns and
organization frictions. Given the structure and the division of
responsibilities, the event described in the case was virtually certain to
occur at some point in time. Moreover, the bureaucracy and inability to
handle priority calls relating to citizen safety issues exacerbated the
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Atkinson, Solutions Manual t/a Management Accounting, 6E
(b) Within the existing structure this incident could have been avoided by
creating a multi-department team to handle emergency and safety prob-
lems that cut across departmental lines.
(c) The city manager should accept the blame for what happened and ensure
the public that: Steps will be taken to ensure that this event will not
happen again, that these steps will be taken promptly, and that the
manager will report back to the public within 2 weeks with the change
proposal.
(d) The city must be reorganized so that related activities fall under the same
department. The cost focus of each department might be replaced by a
focus on accomplishing service objectives, within the constraint of not
overspending. Response teams, consisting of members from appropriate
departments should be organized to deal with predictable emergency and
safety incidents. These teams should be ready to respond to situations
without requiring time for approval and scheduling.
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