Solution Chapter 22 PDF

CHAPTER 22
RESPONSIBILITY CENTER ACCOUNTING

AND TRANSFER PRICING
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Brief Learning
Exercises Topic Objectives Skills
B. Ex. 22.1 Contribution margin effects 22-5 Analysis
B. Ex. 22.2 Contribution margin vs. responsibility margin 22-2, 22-3 Analysis, judgment
B. Ex. 22.3 Responsibility center design 22-1, 22-2 Analysis, judgment
B. Ex. 22.4 Transfer Prices 22-6 Analysis
B. Ex. 22.5 Contribution margin ratios 22-2, 22-3 Analysis
B. Ex. 22.6 Identifying transfer prices 22-6 Analysis
B. Ex. 22.7 Tracing common costs 22-4 Analysis
B. Ex. 22.8 Common or traceable costs 22-1, 22-4 Analysis
B. Ex. 22.9 Responsibility accounting system 22-2 Analysis, judgment
B. Ex. 22.10 Evaluating responsibility center managers 22-4, 22-5 Analysis
Learning
Exercises Topic Objectives Skills
22.1 Accounting terminology 22-1, 22-4, Analysis
22-6
22.2 Types of responsibility centers 22-1 Analysis, judgment
22.3 Classification of costs in an income statement 22-4 Analysis
22.4 Real World: Home Depot’s segments 22-1, 22-2 Analysis, research
22.5 Preparing a responsibility income statement 22-1–22-5 Analysis
22.6 Evaluation of responsibility centers and center 22-1, 22-2 Analysis, judgment
managers
22.7 Closing an unprofitable business unit 22-1–22-3, Analysis
22.8 Cost-volume-profit analysis 22-1–22-4 Analysis
22.9 Transfer pricing 22-1, 22-2, Analysis, judgment
22-6
22.10 Types of responsibility centers 22-1–22-3 Analysis,
communication,
judgment
22.11 Corporate costs; traceable or common 22-2, 22-4 Analysis, judgment
22.12 Transfer prices and responsibility margins 22-3, 22-5, Analysis
22.13 Transfer price and international taxes 22-6 Analysis
22.14 Responsibility centers in a golf resort 22-1, 22-2 Analysis, judgment
22.15 Real World: Home Depot’s responsibility 22-1–22-3 Analysis,
centers 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 Learning
Sets A, B Topic Objectives Skills
22.1 A,B Preparing and using responsibility income 22-3–22-5 Analysis, communication
statements
22.2 A,B Preparing and using responsibility income 22-3–22-5 Analysis, communication
statements
22.3 A,B Preparing and using responsibility income 22-3–22-5 Analysis
statements
22.4 A,B Preparing responsibility income statements 22-3–22-5 Analysis, communication,
in a Responsibility accounting system judgment
22.5 A,B Analysis of responsibility income statements 22-3–22-5 Analysis
22.6 A,B Evaluating an unprofitable business center 22-3–22-5 Analysis, communication,
judgment
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 Analysis, communication,
judgment
Critical Thinking Cases

22.1 Allocating fixed costs to responsibility 22-1, 22-2, Analysis, communication,
centers 22-4 judgment
22.2 An ethical dilemma 22-1, 22-3, Analysis, communication,
22-6 judgment
22.3 Hospital profit centers 22-1, 22-2, Analysis, communication,
22-5 judgment
22.4 Real World: General Mills & Kirby 22-1–22-3 Analysis, communication,
(Internet) Comparing responsibility centers judgment, research,
technology
22. 5 Real World: University of Minnesota 22-1, 22-2 Analysis, communication,
(Ethics, fraud & corporate governance) judgment
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)

22.1 A,B Chocolatiers Company/Fasteners, Inc. 20 Easy
Students prepare responsibility income statements and determine the
product line in which it would be most advantageous to invest
advertising dollars.
22.2 A,B Regal Flair Enterprises/Brown Enterprises 30 Medium
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.
22.3 A,B Giant Chef Equipment Company/Glassware Company 30 Medium

Prepare a responsibility income statement and use the data to perform
cost-volume-profit analysis.
22.4 A,B Muscle Bound Company/Freeze, Inc. 60 Strong
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.
22.5 A,B Butterfield, Inc./Sotheby, Inc. 45 Strong
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.
22.6 A,B Flywiz, Inc./Footware, Inc. 15 Easy

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.
22.7 A,B Tots-To-Go/Eastrise Corporation 20 Easy
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.
22.8 A,B Sparta and Associates/Westminster, Inc. 40 Medium
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.
Critical Thinking Cases
22.1 Land’s End Hotel 35 Medium
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
allocations—perhaps without recognizing the pitfalls.
22.2 Osborn Diversified Products, Inc. 40 Medium

A computer error results in the overstatement of a division manager’s
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.
22.3 Hospital Profit Centers 30 Medium

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

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.
22.5 University Ethics 20 Medium

Ethics, Fraud & Corporate Governance
Students evaluate the ethical implications when a university views
students as a profit center.
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 center’s 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 dealership’s 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 manager’s
salary would be classified as a traceable fixed cost.
8. The transfer price for a product will divide that product’s 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 unit’s 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 margin—revenue, variable costs, and traceable fixed
costs—will 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 manager’s 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 Six’s 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. Negotiated transfer price.
b. Cost-based transfer price.
c. Market-based transfer price.
d. 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. Traceable to each store.
b. Traceable to each store.
c. Traceable to stores department (Repair & Sales).
d. Traceable to company.
e. Traceable to company.
f. Traceable to company.
B. Ex. 22.9 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. Traceable fixed costs
b. Cost-plus transfer price
c. None (The statement describes controllable fixed costs.)
d. Performance margin
e. Contribution margin
f. Responsibility margin
g. 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.
b. A snack bar within one of the company’s 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.
c. A particular game within one of the company’s arcades will most likely
be evaluated as a profit center. However, if the company’s 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.
d. The security for each arcade will most likely be evaluated as a cost center
because security officers contribute no profit to the company.
Ex. 22.3 a. Common fixed costs

b. Traceable fixed costs—controllable
c. None (Sales taxes are a liability, not an expense.)
d. Traceable fixed costs—committed
e. Traceable fixed costs—controllable
f. Common fixed costs
g. 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
sales…the 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 Gemini’s responsibility income statement is shown below:

HEPRAS INCORPORATED
Responsibility Income Statement
For the Current Month
Ethernet
Entire Company Routers Line Switches Line
Dollars Percent of Dollars Percent of Dollars Percent of
Sales Sales Sales
Sales $ 1,400,000 100 $ 800,000 100 $ 600,000 100
Variable costs 590,000 42 320,000 40 270,000 45
Contribution
margin $ 810,000 58 $ 480,000 60 $ 330,000 55
Fixed costs
traceable
to product
lines $ 375,000 27 250,000 31.25 $ 125,000 20.8
Product
responsibility
margin $ 435,000 31 $ 230,000 28.8 $ 205,000 34.2
Common fixed
costs 220,000 15.7
Income from
operations $ 215,000 15.30%
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 margin—that is, revenue less all costs
directly traceable to the store. Store 1 has the highest responsibility margin—surpassing Store 2
by $6,000 per month, and Store 3 by $66,000 per month. Store 1 surpasses Store 3 in profitability,
despite Store 3’s higher contribution margin, because of Store 3’s excessive level of controllable
fixed costs. Store 1’s small advantage over Store 2 is in the area of committed fixed costs, which
probably stems from the lower depreciation charges on Store 1’s building.
Store 2. The effectiveness of the store manager’s strategies are best evaluated by looking at the
relationship of revenue to expenses under the manager’s 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 $ 600,000

Less: Increases in sales expected at Stores 1 and 2
($60,000 + $120,000) 180,000
Net decrease expected in total monthly sales $ 420,000
Store 1 Store 2
b. Expected increase in monthly contribution margin:
Store 1: ($60,000 additional sales × 38%) $ 22,800
Store 2: ($120,000 additional sales × 37%) $ 44,400
Less: Additional traceable fixed costs 0 0
Expected increases in monthly responsibility margin $ 22,800 $ 44,400
c. Increase in income from operations from elimination of

the negative responsibility margin of Store 3 $ 6,000
Expected increase in income from operations resulting

from increase in responsibility margin of Stores 1 and 2
($22,800 + $44,400, per part b) 67,200
Expected increase in monthly operating income from
closure of Store 3 $ 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) $ 11,400
Store 2: ($222,000 × 5% increase) 11,100
Store 3: ($270,000 × 5% increase) 13,500
Total expected increase in monthly contribution margin* $ 36,000
Monthly cost of advertising campaign 15,000
Expected increase in monthly income from operations $ 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) $ (11,400)
Store 2: ($150,000 increase in sales × 37% contribution margin ratio) 55,500
Store 3: ($30,000 decrease in sales × 45% contribution margin ratio) (13,500)
Total expected increase in monthly contribution margin $ 30,600
Monthly cost of advertising campaign 15,000
Expected increase in monthly income from operations $ 15,600
Ex. 22.9 The higher each division’s responsibility margin, the higher each division’s
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 division’s 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) Profit center

(2) Cost center
(3) Investment center
(4) Profit center
(5) Profit center
(6) 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 Harry’s 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 Repairs
Department Department
Sales $ 180,000 $ 24,000
Variable Costs 94,000 8,000
Contribution Margin $ 86,000 $ 16,000
Fixed Traceable Costs 18,000 14,000
Responsibility Margin $ 68,000 $ 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 UK Mexican
Company Division Division
Sales £ 1,500,000 £ 1,500,000 £ 650,000
Operating Expense 550,000 350,000 200,000
Cost of goods transferred 650,000
Taxable Income £ 950,000 £ 500,000 £ 450,000
Tax Rate 20% 30%
Tax Liability £ 235,000 £ 100,000 £ 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 UK Mexican
Sales £ 1,500,000 £ 1,500,000 £ 750,000
Operating Expense 550,000 350,000 200,000
Cost of goods transferred 750,000
Taxable Income £ 950,000 £ 400,000 £ 550,000
Tax Rate 20% 30%
Tax Liability £ 245,000 £ 80,000 £ 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** Golf Courses**
Grounds***
House- Restaurants** Weddings & & ProShops**
keeping*** Meetings** Carts**
Maintenance
Key: * = investment center, **= profit center, ***= cost center.
Ex. 22.15 Home Depot’s 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 PROBLEM 22.1A

CHOCOLATIERS COMPANY
a. CHOCOLATIERS COMPANY
Entire Company Solid Chocolate Powdered Chocolate
Dollars Percent Dollars Percent Dollars Percent
Sales $ 1,720,000 100 $ 850,000 100 $ 870,000 100
Variable costs 859,000 50 467,500 55 391,500 45
Contribution margin $ 861,000 50 $ 382,500 45 $ 478,500 55
Fixed costs traceable to product lines 425,000 25 175,000 21 250,000 29
Product responsibility margin $ 436,000 25 $ 207,500 24% $ 228,500 26%
Common fixed costs 125,000 7
Income from operations $ 311,000 18%
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 PROBLEM 22.2A
REGAL FLAIR ENTERPRISES
a. Responsibility income statement: REGAL FLAIR ENTERPRISES
Entire Company Jewelry Line Apparel Line
Sales $ 1,250,000 100.0 $ 800,000 100.0 $ 450,000 100.0
Variable costs 566,000 45.3 440,000 55.0 126,000 28.0
Contribution margin $ 684,000 54.7 $ 360,000 45.0 $ 324,000 72.0
Fixed costs traceable to product lines 450,000 36.0 200,000 25.0 250,000 55.6
Product responsibility margin $ 234,000 18.7 $ 160,000 20.0% $ 74,000 16.4%
Common fixed costs 100,000 8.0
Income from operations $ 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 Apparel
Expected increase in contribution margin:
Jewelry ($150,000 × 45%) $ 67,500
Apparel ($150,000 × 72%) $ 108,000
Less: Increase in advertising expenditures 75,000 75,000
Expected increase (decrease) in operating income $ (7,500) $ 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 Apparel
Jewelry ($300,000 × 45%) $ 135,000
Apparel ($300,000 × 72%) $ 216,000
Less: Increase in traceable fixed costs (75%) 150,000 187,500
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
line’s 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%).
GIANT CHEF EQUIPMENT COMPANY
a. Responsibility income statemen GIANT CHEF EQUIPMENT COMPANY
For June
Entire Company Commercial Sales Division Home Products Division
Sales $ 2,400,000 100.0 $ 1,500,000 100.0 $ 900,000 100.0
Variable costs 1,440,000 60.0 990,000 66.0 450,000 50.0
Fixed costs traceable to product
divisions 360,000 15.0 180,000 12.0 180,000 20.0
Division responsibility margin $ 600,000 25.0 $ 330,000 22.0% $ 270,000 30.0%
Operating Income $ 480,000 20.0%
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%) $ 45,000

Less: Incremental variable costs ($45,000 × 50%) 22,500
Increase in contribution margin $ 22,500
Less: Incremental increase in fixed costs 15,000
Incremental increase in responsibility margin $ 7,500
60 Minutes, Strong PROBLEM 22.4A
MUSCLE BOUND CO.
a. Responsibility income statement of MUSCLE BOUND COMPANY
the Eastern Territory: Responsibility Income Statement
Eastern Territory
For January
Eastern Territory FasTrak RowMaster
Sales $ 1,350,000 100.0 $ 600,000 100.0 $ 750,000 100.0
Variable costs 720,000 53.0 270,000 45.0 450,000 60.0
Product responsibility margin $ 400,000 30.0 $ 250,000 42.0% $ 150,000 20.0%
Common fixed costs 120,000 9*
Operating income $ 280,000 21.0%
b. Responsibility income statement of MUSCLE BOUND COMPANY

the entire company: Responsibility Income Statement
For January
Entire Company Eastern Territory Western Territory
Sales $ 1,950,000 100.0 $ 1,350,000 100.0 $ 600,000 100.0
Variable costs 990,000 50.8 720,000 53.0 270,000 45.0
Fixed costs traceable to territories 480,000 24.6 350,000** 26.0 130,000 21.7
* 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 territory’s return on assets:
Eastern Western
Territory Territory
Responsibility margin $ 280,000 $ 200,000
÷ Average assets 14,000,000 12,000,000
Return on assets 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 RowMaster
Incremental revenue $ 120,000 $ 120,000
Less: Incremental variable costs (45%, 60%) 54,000 72,000
Incremental increase in contribution margin (55%, 40%) $ 66,000 $ 48,000
Less: Incremental fixed costs 50,000 50,000
Increase (decrease) in responsibility margin $ 16,000 $ (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:
(1) Product A (2) Product B

Expected increase in sales $ 30,000 $ 30,000
Product contribution margin ratio × 48% × 36%
Expected increase in contribution margin $ 14,400 $ 10,800
Expected change in fixed costs (advertising) 10,000 10,000
Expected change in responsibility margin $ 4,400 $ 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)
e. BUTTERFIELD, INC.
Income Statement by Divisions
For the Month Ended April 30
Divisions
Butterfield, Inc. Division 1 Division 2
Sales $ 500,000 100 $ 300,000 100 $ 200,000 100
Variable costs 240,000 48 180,000 60 60,000 30
Fixed costs traceable to divisions 135,000 27 63,000 21 72,000 36
Division responsibility margin $ 125,000 25 $ 57,000 19 $ 68,000 34
Common costs 45,000 9
Income from operations $ 80,000 16
FLYWIZ, INC.
a. Based solely on the financial data given, closure of the Rod Division would have increased
the company’s 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, you’ll need a fishing reel, and if you buy a fishing reel, you’ll 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 division’s 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
TOTS-TO-GO COMPANY
a. Using the market price, the contribution margins for each division and for the company as a
whole:
Entire Seat Stroller

Sales (1) $4,200,000 $2,400,000 $3,000,000
Variable Costs (2) 2,650,000 1,900,000 1,950,000
Contribution Margin $1,550,000 $500,000 $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
(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
b. Using the discount price, the contribution margins for each division and for the company as
a whole:
Entire Seat Stroller

Sales (1) $4,200,000 $2,300,000 $3,000,000
Variable Costs (2) 2,650,000 1,900,000 1,850,000
Contribution Margin $1,550,000 $400,000 $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 division’s 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.
SPARTA AND ASSOCIATES
a. Using the market price, the pre-tax operating profit for each division and for the company as
a whole:
Entire Green White

Sales (1) $ 525,000 $ 300,000 $ 450,000
Variable Costs (2) 242,500 130,000 337,500
Contribution Margin $ 282,500 $ 170,000 $ 112,500
Fixed Costs 157,500 100,000 57,500
Operating Profit $ 125,000 $ 70,000 $ 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:
Entire Green White

Sales (1) $ 525,000 $ 277,500 $ 450,000
Variable Costs (2) 242,500 130,000 315,000
Fixed Costs 157,500 100,000 57,500
(1) Green Division Sales = (1,500 units × $135) + (500 units × $150) = $277,500
White Division Sales = 1,500 units × $300 = $450,000
(2) Green Division Variable Costs = 2,000 units × $65 = $130,000

White Division Variable Costs = 1,500 units × ($135 + $75) = $315,000
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 company’s 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:
Entire Green White

Sales (1) $ 750,000 $ 300,000 $ 450,000
Variable Costs (2) 482,500 130,000 352,500
Fixed Costs 157,500 100,000 57,500
(1) Green Division Sales = 2,000 units  $150 = $300,000

White Division Sales = 1,500 units  $300 = $450,000
(2) Green Division Variable Costs = 2,000 units  $65 = $130,000

White Division Variable Costs = 1,500 units  ($160 + $75) = $352,500
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
20 Minutes, Easy PROBLEM 22.1B
FASTENERS INC.
a. FASTENERS INC.
Entire Company Zippers Line Buckles Line
Sales $ 355,000 100 $ 135,000 100 $ 220,000 100
Variable costs 126,000 35 27,000 20 99,000 45
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.
30 Minutes, Medium PROBLEM 22.2B
BROWN ENTERPRISES
a. Responsibility income statement: BROWN ENTERPRISES
Entire Company Bag Line Shoe Line
Sales $ 1,500,000 100 $ 1,000,000 100 $ 500,000 100
Variable costs 750,000 50 600,000 60 150,000 30
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 Shoes
Bags ($100,000 × 40%) $ 40,000
Shoes ($100,000 × 70%) $ 70,000
Less: Increase in advertising expenditures 50,000 50,000
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 Shoes
Bags ($250,000 × 40%) $ 100,000
Shoes ($250,000 × 70%) $ 175,000
Less: Increase in traceable fixed costs (60%) 150,000 165,000
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 line’s 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.
GLASSWARE COMPANY
a. Responsibility income statement for August: GLASSWARE COMPANY
For August
Entire Company Etched Glass Division Clear Glass Division
Sales $ 13,500,000 100.0 $ 7,500,000 100.0 $ 6,000,000 100.0
Variable costs 7,950,000 59.0 4,650,000 62.0 $ 3,300,000 55.0
Contribution margin $ 5,550,000 41.0 2,850,000 38.0 $ 2,700,000 45.0
Fixed costs traceable to product
divisions 2,400,000 18.0 1,200,000 16.0 1,200,000 20.0
Division responsibility margin $ 3,150,000 23.0 $ 1,650,000 22.0% $ 1,500,000 25.0%
Operating income $ 3,050,000 22.6%
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%) $ 240,000

Less: Incremental variable costs ($240,000 × 55%) 132,000
Increase in contribution margin $ 108,000
Less: Incremental increase in advertising costs 12,000
Incremental increase in responsibility margin $ 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.
60 Minutes, Strong PROBLEM 22.4B
FREEZE, INC.
a. FREEZE, INC.
Northern Territory
For January
Northern Territory Economy Efficiency
Sales $ 1,500,000 100.0 $ 500,000 100.0 $ 1,000,000 100.0
Variable costs 850,000 56.7 150,000 30.0 700,000 70.0
b. FREEZE, INC.
For January
Entire Company Northern Territory Southern Territory
Sales $ 2,300,000 100.0 $ 1,500,000 100.0 $ 800,000 100.0
Variable costs 1,202,000 52.3 850,000 56.7 352,000 44.0
Contribution margin $ 1,098,000 47.7 $ 650,000 43.3 $ 448,000 56.0
Fixed costs traceable to territories 705,000 30.7 * 415,000 27.6 290,000 36.0
*$415,000 = $125,000 common fixed costs of Northern territory + $290,000 traceable fixed costs
PROBLEM 22.4B
FREEZE, INC. (concluded)
c. Each territory’s return on assets:
Northern Southern
Territory Territory
Responsibility margin $ 235,000 $ 158,000
÷ Average assets 16,000,000 10,000,000
Return on assets 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 Efficiency
Incremental revenue $ 100,000 $ 100,000
Less: Incremental variable costs (30%, 70%) 30,000 70,000
Incremental increase in contribution margin (70%, 30%) $ 70,000 $ 30,000
Less: Incremental fixed costs 40,000 40,000
Increase (decrease) in responsibility margin $ 30,000 $ (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.
45 Minutes, Strong PROBLEM 22.5B
SOTHEBY, INC.
a. Computation of expected change in responsibility margin:
(1) Product C (2) Product D

Expected increase in sales $ 25,000 $ 25,000
Product contribution margin ratio × 50% × 19%
Expected increase in contribution margin $ 12,500 $ 4,750
Expected change in fixed costs (advertising) 8,000 8,000
Expected change in responsibility margin $ 4,500 $ (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
Divisions
Sotheby, Inc. Division 1 Division 2
Sales $ 540,000 100 $ 340,000 100 $ 200,000 100
Variable costs 318,000 59 238,000 70 80,000 40
Fixed costs traceable to divisions 132,000 24 68,000 20 64,000 32
Division responsibility margin $ 90,000 17 $ 34,000 10% $ 56,000 28%
Common costs 46,000 9
FOOTWARE, INC.
a. Closure of the Sandal Division would increase the company’s 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 on-
line 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 division’s 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
EASTRISE CORPORATION
a. Using the market price, the contribution margins for each division and for the company as a
whole:
Entire Motor Mower

Sales (1) $ 14,000,000 $ 12,000,000 $ 6,000,000
Variable Costs (2) 7,600,000 6,600,000 5,000,000
Contribution Margin $ 6,400,000 $ 5,400,000 $ 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:
Entire Motor Mower

Sales (1) $ 14,000,000 $ 11,800,000 $ 6,000,000
Variable Costs (2) 7,600,000 6,600,000 4,800,000
Contribution Margin $ 6,400,000 $ 5,200,000 $ 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.
WESTMINSTER, INC.
a. Using the market price, the pre-tax operating profit for each division and for the company as
a whole:
Entire Frame Works

Sales (1) $ 1,162,500 $ 742,500 $ 825,000
Variable Costs (2) 651,000 396,000 660,000
Fixed Costs 384,000 280,000 104,000
(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 Frame Works

Sales (1) $ 1,162,500 $ 727,500 $ 825,000
Variable Costs (2) 651,000 396,000 645,000
Fixed Costs 384,000 280,000 104,000
(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
company’s 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 Frame Works

Sales (1) $ 1,567,500 $ 742,500 $ 825,000
Variable Costs (2) 1,071,000 396,000 675,000
Fixed Costs 384,000 280,000 104,000
(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
LAND’S END HOTEL
a. Evaluation of Chamberlain’s 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
manager’s 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, Chamberlain’s 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 Mettenburg’s comments:

Mettenburg is also correct in her criticism of Chamberlain’s 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 center’s manager’s
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
costs—those that jointly benefit several profit centers—should not be allocated among the
centers deriving benefit. Thus, the responsibility income statement includes only those
costs directly traceable to the center’s 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 center’s operations that are
readily controllable by the center manager.
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 Jim’s attorney to suggest that he keep the money. The attorney’s
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 profession’s legal and ethical
responsibility to maintain client confidentiality.
d. Once again, there is no correct answer to this question. However, if Jim’s 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.
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.
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.
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.

Solution Chapter 22 PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Solution Chapter 22 PDF

Uploaded by

Copyright:

Available Formats

CHAPTER 22

RESPONSIBILITY CENTER ACCOUNTING

Critical Thinking Cases

Problems (Sets A and B)

22.3 A,B Giant Chef Equipment Company/Glassware Company 30 Medium

22.6 A,B Flywiz, Inc./Footware, Inc. 15 Easy

22.2 Osborn Diversified Products, Inc. 40 Medium

22.3 Hospital Profit Centers 30 Medium

22.4 General Mills and the Kirby Company 30 Medium

22.5 University Ethics 20 Medium

Ex. 22.3 a. Common fixed costs

--Country level investment center measures:

Ex. 22.5 Gemini’s responsibility income statement is shown below:

a. Decrease in monthly sales from closing Store 3 $ 600,000

c. Increase in income from operations from elimination of

Expected increase in income from operations resulting

Strategy 1: Advertise the name Drexel-Hall:

Strategy 2: Advertise low prices at Store 2:

Ex. 22.10 (1) Profit center

Jasper Golf Resort*

Hotel** Golf Courses**

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

20 Minutes, Easy PROBLEM 22.1A

Division Sales = [Division Fixed Costs + Responsibility Margin] ÷ Contribution

c. The decision to increase monthly advertising expenditures is supported by the

Incremental revenue ($900,000 × 5%) $ 45,000

b. Responsibility income statement of MUSCLE BOUND COMPANY

* Minor rounding difference

(1) Product A (2) Product B

Entire Seat Stroller

(1) Seat Division Sales = 20,000 units × $120 = $2,400,000

(2) Seat Division Variable Costs = 20,000 units × $95 = $1,900,000

Entire Seat Stroller

Entire Green White

(1) Green Division Sales = 2,000 units × $150 = $300,000

(2) Green Division Variable Costs = 2,000 units × $65 = $130,000

Entire Green White

(2) Green Division Variable Costs = 2,000 units × $65 = $130,000

Entire Green White

(1) Green Division Sales = 2,000 units  $150 = $300,000

(2) Green Division Variable Costs = 2,000 units  $65 = $130,000

Division Sales = [Division Fixed Costs + Responsibility Margin]

c. The decision to increase monthly advertising expenditures is supported by the following

Incremental revenue ($6,000,000 × 4%) $ 240,000

(1) Product C (2) Product D

Entire Motor Mower

(1) Motor Division Sales = 30,000 units × $400 = $12,000,000

(2) Motor Division Variable Costs = 30,000 units × $220 = $6,600,000

Entire Motor Mower

(2) Motor Division Variable Costs = 30,000 units × $220 = $6,600,000

Entire Frame Works

(1) Frame Division Sales = 5,500 units × $135 = $742,500

(2) Frame Division Variable Costs = 5,500 units × $72 = $396,000

Entire Frame Works

(2) Frame Division Variable Costs = 5,500 units × $72 = $396,000

Entire Frame Works

(1) Frame Division Sales = 5,500 units × $135 = $742,500

(2) Frames Division Variable Costs = 5,500 units × $72 = $396,000

Evaluation of Mettenburg’s comments:

You might also like

Hotel Golf Courses

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