~The Renew School of UccounTamcy « Plomagemend Advisory Servvrces MAS-07: RESPONSIBILITY ACCOUNTING & TRANSFER PRICING RESPONSIBILITY ACCOUNTING - @ system of eccounting wherein performance, based on costs/revenues, are rerorued and evaluated by levels of responsibilty within an organization ! I TT 4 ‘ ‘ COST Center EVENLE Cenice PROEIT Center INVESTMENT Center 1+ Controtiable@— |~ Contraitasle + Controliable Controllable L. Non-controtiabie | LL Non-cs ble Non-controllat L. Non-controliable i | “Rot” frmgmmes |Report || Nature of Expenses | > | arainterance Expense | <——* vevay ‘Supplies Exnense i cet Labor or “Residual Income”. -- STEPS IN IMPLEMENTING RESPONSIBILITY ACCOUNTING 1) Responsibility accounting requires that costs and/or revenues be classified according to responsibility centers RESPONSIBILITY CENTER - 15 2 segment of an entity engaged in performing a single function or 2 group of related functions; it is usually governed by a manager who 1S hekl responsible for the outcome of the activities and attainment of goals of the segment. Types of Responsibility Centers: ‘COST center - managers are hwld resgonsible for costs incurred by the segment. REVENUE center - managers are held responsible for revenues generated by the segment. PROFIT center - manager: are held responsible for both revenues and costs of the segment. INVESTMENT center ~ managers are hed responsible for revenues, costs and investments. The central performance 1s measured in terms of the use of the assets as well as revenues. earned and the costs incurred The following may be used as basis of evaluating performance of investment centers « [Return on Investment (Rol) = Ovcraiing Income = Operating Assets Alternative formula: ROX = Mergin x Turnover Ingreting income = Sales sls = Operating Assets Rol is patterned after the DuPont technique to compute Return on Assets: Return on Assets = Return on Sales x Asset Turnover income , __ Sales Sale Assets «_ [ Reatauat income ~ Operating Tacome Required Tacoma Where: Required acme = Operating Assets x Minimum Rol + Economic Value Added (EVA) > imore specific version of residual income that measures the invesime it center's real economic gains. It uses the weighted-average cost of capital (WACC) to compute the -equired income. EVA = Operating incor Tax ~ Required income Where: Required Income = (Total Assets ~ Current Liabilities) x WACC Page t of 6 pagesREQ The Review School of Ceconrtoney RESPONSIBILITY ACCOUNTING & TRANSFER PRICING 2» Generally, ail costs are controtiab'e contro! the costs MAS-07 Within each responsibility center, costs are classified as either controllable or non-controliable. THe key difference hes in the level of management who can * CONTROLLABLE COSTS ave costs that may be directly regulated at lower levels of management. * NON-CONTROLLABLE COSTS are costs that cannot be regulated at a particular management level other than tne top level Costs may also be classified into DIRECT (attnbutable to @ particular segment) or INDIRECT (common to a number of segments), the latter being subject to arbitrary allocation, 2) Within the controtiable classitication, costs are classified according to the nature of expense. 4) A performance report is furnished by each center and reported to the appropriate level of management. The PERFORMANCE REPORT Js the end picduct of responsibilty accounting process. It 1s a report that shows and compares actual results with the intended (budgets or standards) results of 2 responsibility center, thereby tghiighting deviations that need corrective actions. ‘The “conteibution’ format to computing profit 1s emphasized in responsibilty accounting. This income statement presentation highlights contrallabiity of costs by behavioral classification. In addition to the usual vanable costs and fixed costs, a more detailed classification of costs may be made, Consider the following ilustrative exainple (al! amounts are assumed), sales » 500,000 Variable manufacturing costs (150,000) Manufacturing contribution mary ® 350,000 Variable selling and adminstratare costs __ (50,000) Contribution margin. ® 300,000 Controllable virect fixed costs Manufactunng ° 100,000 Selling and administrative ~__75,000___(175,000) Short-run performance marg n 125,000 Non-controllable direct fined costs Depreciation P 40,000 Rent and leases, insurance 10,000 _(50,000) Segment margin 75,000 Allocated common costs 30,000)_ Income P 43,000 DECENTRALIZATION DECENTRALIZATION - refers to the separation or division of the organization into more manageable units Wherein each unit is managed by an individual who 1s given decision authority and is. held accountable for his or her decisions DECENTRALIZATION-RELATED CONCEPTS ‘GOAL CONGRUENCE All unics of organization have incentives to perform for a common interest. The purpose of responsibility system is to motivate management performance tat auieres to company overall objectives. ‘SUB-OPTIMIZATION NOTE: Aside from its contro! function, responsibil ‘and to discourage sub-optimization within an organization, This happens when one segment of a company takes action that is in its own est interests but 1s detrimental to the firm as a whole. 'y accounting 1s designed to achieve goal congruence ORGANIZATIONAL CHART A chart that shows the responsibility relationship among managers in an It sets forth each principal organization. responsibility, and define authority, accountability. management position and helps A well-designed organizational chac* helps a decentralized organization in carrying out duties with clear lines of responsibilities delegated to each of the segment of an organization. Page 2 of 6 pages ©The Review School of Uecermfan MAS-07 ING RSG RESPONSIBILITY ACCOUNTING & TRANSFER PRI TRANSFER PRICING TRANSFER PRICE - the amount charged by one segment of a firm for products or services that are supplied to another segment of the seme firm, Its also known as intersegment price Primary objective To evaluate performance by witwaly transforming cost centers into proft centers so that performance of the manager of mairly cost centers can be measured reliably in terms of bo! revenues and expenses Seconcary obrective To save on costs involved in producing or buying a product by in-sourcing rather than outsourcing. vrtuaty transforms 2" ~ mo © Profi: Center >) from Senter Basis of Transfer Price 1) COST-BASED PRICE ¥ Variable cost Full cost (Vanable and fixed manufacturing and non-manufacturing costs) ¥ Full absorption cost (Variable and fixed manufacturing costs) + Cost-plus (Variable costs / Full costs / Full absorption costs plus mark-up) 2) MARKET-BASED PRICE v Market price (Regular selling price / Quoted price) ¥_ Modified market (Setling price adjusted for any allowance for discounts, etc.) 3) NEGOTIATED PRICE 4) ARBITRARY PRICE Maximum vs. minimum transfer prices For transfer pricing not to defeat ‘ts purpose, organization normally sets a limitation as to the transfer price being charged by one segment to another segment, To minimize the effect of sub= ‘optimization, a range for transfer price must be set based on the following limits. > UPPER LIMIT: Maximum transfer orice = Cost of buying from outside suppliers ** >» LOWER LIMIT: Minimum transfer orice = Venable cost per unit + Lost CM per unit on outside Sales ** Strictly speaking, upper limit shail be the higher amount of- 1) Cost of buying from outside suppliers, OR 2) Selling price to outside customers When 2 company segment is operating at ful capacity, the lost CM per unit on outside sales is the ‘opportunity cost of transferring products to another company segment Dual pricing concept Tye seling| center could transfer to anather segment at the usual market price that would be paid by an outsider. The ‘buying’ center, however, would record a purchase at the varable seer Brpduction. This practice ‘snow rarely applied Secause neither manager from both the buyive ora Selling center must exert much effort to show a profit on a segmental performance rererts Transfer pricing considerations * Goal congruence factors Wil the transter price promote the goats of company as a whole? * Segmental performance factors Wi fhe transfer price promate the interest of the segment under the manager's responsibility? 2 eee + Capacty factors Does the seler have excess cepauity to accommodate further inter-segmen + Cost structure factors What portions of production costs are variable oF fixed, direct or mdlrect? it transfer? Page 3 of 6 pagesRSQ. The Rerrew School of cconecioncy MAS-07 RESPONSIBILITY ACCOUNTING & TRANSFER PRICING EXERCISES: RESPONSIILITY ACCOUNTING & TRANSFER PRICING 1, RESPONSIBILITY CENTERS. Indicate how each ot the business situations below Is most likely to be organized: cost center (CC), revenue center (RC), profit center (PC), cr investment center (IC) The accounting department of Reza Review Ezkul ‘The Ezem Mall car park ticket outlets, The Magnolia product division of Zan Miguel Corporation The repairs and maintenance department of Zebu Pazific. The Zampatoc branch of KFZ (Kinatay na Fried Zicken) The Cotlege of Accountancy of the Ezpaita University. The parts department of Zuzuxee Motorz Co-roration, The convenience store (Zeven-Eleven) tha" is owned by a chain organization; the head office supplies all the goods to be sold and deterraines che selling prices, ro7 TON eS 2. CONTROLLABLE/NON-CONTROLLAGLE COSTS, DIRECT/INDIRECT COSTS The supervisor of the ASSEMBLY DEFAR IMENT of Mazdah Cars is in-charge of (1) purchasing supplies, (2) authorizing repairs, and (3) hinng labor for the department. Various costs are given Sales, salaries and commission Salary, supervisor of Assembly departn Factory heat and light General office salaries Depreciation, factory Supplies, Assembly department Repairs and maintenance, Assembly department | Factory insurance Labor costs, Assembly department | Salary of factory supervis ee zanmone> REQUIRED: Determine the following 1. Total costs controllable by the superv.sor of the Assembly department 2. Total costs directly identified with the Assembly department 3. Total costs allocated to the factory departments, 3. SEGMENTED INCOME STATEMENT The following data pertain to Air Azia opzrations tor the year 2919. 20x Divisio zen % Sales - (100%) Less: Variable Expenses —() Contribution margin P 360,000 (60%) Less: Traceable fixed expenses (150,000) ¢ ) (P200,000) ¢ Division segment margin ()P:120,909 (30% ) Less: Common fixed expenses REQUIRED: ‘Compute for the missing stata. (Ad2pted* Managerial Accounting by Garrison & Noreen) 4. RETURN ON INVESTMENT vs. RESIDUAL INCOME For each of the following dependent cases, the minimum desired Return on Investment (Rol) is 20%. Divison "22" Division "25" Division "28" Sales 400,000 (5) _ P 700,000 Operating Income ap (o) 42,000 Operating Assets O P 300,000 (9) Margin 15% 8% (10) Turnover @) 3umes (11) Return on Investments 30% i?) (a2) Residual Income “ a P 22,000 REQUIRED. ‘Compute for each division’s missing steins (Adapted: Managerial Accounting by Louderback) Faget of ©RS - The Revsew School of lccoundoncy MAS-07 RESPONSIBILITY ACCOUNTING & TRANSFER PRICING SERVICE COST ALLOCATION The 7ingapore Airline has two service denartme! 7.ngapore Airline has two service departments (A and B) and two operating departments (X and Y) Service Departments Operating Departments B x Y A Direct costs F350 P300 Services performed by Dept. A 40% 40% 20% Services pertormed by Dept.8 20% 70% 10% SEQUIRED: Compute allocated cost to departments X and ¥ using the flows 1. Direct method ° oleae 2 top-cown method (cost of departent i located rst) Step-down method (cost of department 8s allecated fst 1. Rectprocal metho SOLUTION GUIDE ZINGAPORE AIRLINE Service Cost Allocation () oIRECT METHOD, (2) STEP DOWN METHOD - Dept. A_ f A ¥ A 8 P1s0 | 368 P 1504086 (P 150) (150) [ | 300 P 300 |_(P 300) tC) Allocation. t Allocation: (3) 3 | 300 a L¢P 300) [ C ( ) PISO [40% man 20% ma | 20% PIO |? fete ] i le Allocation | ] allocation Reciprocal/Algebraic/Simultaneous method Equation 1: A= 150 + 20% 6 Equation 2: B = 300 + 40% A Substitute Equation 1 to Equation 2. Substitute Value of B to Equation 1 B= 300 + 0.4 (150 + 0.28) ‘A= 150 + 0.2 (391.30) 360 + 0.92 A= 228.26 B = 391.30* (rounded) 6. TRANSFER PRICING Dayagzky Company's Division °S’ (selling division) produces a small tool used by other companies as a key part in their products. Cost and sales data related to the small tool are given below: Selling price perunt P50 Variable costs per unit P30 Fixed costs per unit* P12 * based on capacity of 40,000 tools per year. The company’s Division °B’ (buying division) 5 introducing @ new product that will use the same too! such as the one produced by Division S. An outside suppier has quoted the Division B a price of P 48 per tool. Division B would like to purchase the tools from Division S, only if an acceptable transfer price can be worked out REQUIRED: 1. Determine the lower limit of the transfer price assuming that: ‘A) Division S has ample idle capacity to handle all the Division B's needs. 8) Division S 1s presently selling all the tools it can produce to outside customers. 2. From the standpoint of the entire company, should the Division B purchase the tools from the Division § (operating at capacity) or fiom outside supplier? Why? 3. Assume that the Division B requires 10,000 too!s per year and the Division S #s presently selling 36,000 tools per year to outside customers: ‘A) Determine the lower limit of the transfer price, B) What would be overall effect on company profits if all 10,000 tools were acquired from the Division $ rather than from the outside suppliers? (Adapted: Managerial Accounting by Garrison & Noreen) Page 5 of 6 pages ©% Sli - The Review ! Resa R School of lecomn? rey MAS-07 RESPONSIBILITY ACCOUNTING & TRANSFFR PRICING 7 PRICE-SETTING METHODS: Division S 1s producing 2 product line that is required The Ar Ful Company is operating with tne eivisions as 9 component part of the product being man: fected by Division B. For Dwvisten S, the costs of producing the ccmponent part per unit are. Direct materials P10 Direct tabor PB Venable factor) everhead Ps F.xed factory overieac P2 The product vision S i 7 product of Division S is being sold in @ high.» competitive market for P 30 per unit. Division B 1s currently buying 80% of the prod.scuon out a heen fe pr0¢.scu0n output of Division S at a negotiated price of P 28 per t Its expected that 25,000 units »* product will be produced by Division S. sith emphans on dvrsionl welfare cathe: then the company’s welfare, 2 new transfer pres must De gevelopes, Is suggested that @ 40% marcup on cost wll be added when transfering the product from An getttional processing cost for Divison B 5? 8 per unit. The sling ance ofthe proguct of Divison Bis REQUIRED. Determine the gross profit per unt of Division 1 ger each of the following independent assumptions: A) Transfer Price is fuli-cost based. GP = 45- (8+ 25)= P12 8) Transfer price is cost-based plus mark-up. GP = 45 - (8 + 25(1.4)} =P2 ©) Transfer price is based 2n 2 vayotiatea price. «GP = 45 - (6 + 28) = PS ‘D) Transfer pnce is market-based. GP = 45 -(8 + 30)=P7 (Adapted: Cost Accounting by Barfield) WRAP-UP EXERCISES (TRUE OR FALSE; MULTIPLE-CHOICE) 2. Which sequence reflects increasing level of responsibilty? 2. Cost center, savestment center. orcfit center bD. Cost center, profit center, investment center Profit center, cost cente’. i vestment center 4d. Investment Center, cost center, grofit center 2. In responsibility accounting, what 1 the IMOST RELEVANT classification of costs? 2. Fixed and vanable © Controllable and non-controllable b. Discretionary and committed Incremental and non-incremental 5. Whuh technique »s most apprepnate to evaltiate the management performance of a COST CENTER? ‘a. Payback method c. Return on assets ratio b. Variance anaiysis 4. Return on investment ratio 4. The segment margin of the Division A8Z of ZEN Carporatian should NOT include 2. Net sales of ABZ c. Variabie selling expenses of ABZ b. Fixed selling expenses of ABZ ¢_ABL's snare of company president's salary 5. Which method of allocating the costs © cepartments provides the broadest recognition of departments serves” 2. Direct allocation <. Step-down allocation b. Arpitrary allocation Reciprocal allocation 6. Which of the following describes the computation of Return on Investment (Rol)? ‘a. Sales x Investment Turnover c. Income ~ (Investment x Minimum Rol) b. Return on Sales x Investment d. Retum on Sales x Investment Turnover ?. cost neced price considered 25 the ideal transfer once {0 use in charging co-segment within a company 0 FrmpENY, sion is operating at capacty, tne transfer price to other divisions should include an element of opportunity cost. Items 9 and 10 are based on the for owing infermetan Division § sells one of its products to Gi "swn 'B in the same group. The cost of the said product consists of P 1,600 for materials P 602 'o" Girect labor, F 100 for vanable overhead ‘and P 1,100 for fixed overhead. Division S sets its prute margin equal to 40% of the variable cost. 9. What 1s the appropriate transfer price if Divs on S 1s operating at less than full capacity? P4,760 cP 3,400 b P4320 4. P2,300 10. wnve is the appropnate transfer price # S.w.sior Ss operating at full capacity” 2. P 4,760 cP 3,400 bd. P4320 a =P 2,300 Page 6 of 6 pages