RESPONSIBILITY ACCOUNTING & TRANSFER PRICING

RESPONSIBILITY ACCOUNTING – a system of accounting wherein performance, based on

costs/revenues, are recorded and evaluated by levels of responsibility.

RESPONSIBILITY ACCOUNTING

COST Center REVENUE Center PROFIT Center INVESTMENT Center

Controllable Controllable Controllable Controllable

Non-controllable Non-controllable Non-controllable Non-controllable

“RoI” →
Nature of Expenses
Maintenance Expense
PERFORMANCE “EVA” →
Supplies Expense
REPORT
Direct Labor
“Residual Income” →

STEPS IN IMPLEMENTING RESPONSIBILITY ACCOUNTING

1. Responsibility accounting requires that costs and/or revenues be classified according to
responsibility centers.
RESPONSIBILITY CENTER – is a segment of an entity engaged in performing a single
function or a group of related functions and is usually governed by a manager, who is
accountable and responsible for the activities of the segment.

Types of Responsibility Centers:

1. COST center – managers are held responsible for the costs incurred by the segment.
2. REVENUE center – managers are held responsible primarily for revenues of the
segment.
3. PROFIT center – managers are held responsible for both revenues and costs of the
segment.
4. INVESTMENT center – managers are held responsible for revenues, costs and
investments.
The central performance is 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 (RoI) = Operating Income ÷ Operating Assets
Alternative Formula: RoI = Margin × Turnover
Where: Margin = Operating Income ÷ Sales
Turnover = Sales ÷ Operating Assets
RoI is patterned after the DuPont technique to compute Return on Assets:
Return on Assets = Return on Sales × Asset Turnover
Net Income = Net Income × Sales
Assets Sales Assets

Residual Income = Operating Income – Required Income

Where: Required Income = Operating Assets × Minimum RoI

Economic Value Added (EVA) → more specific version of residual income that
measures the investment center’s real economic gains. It uses the weighted-average
cost of capital (WACC) to compute the required income.
EVA = Operating Income after Tax – Required Income
Where: Required Income = (Total Assets – Current Liabilities) × WACC

2. Within each responsibility center, costs are classified as either controllable or non-controllable.
Generally, all costs are controllable. The key difference lies in the level of management who
can control the costs:
  CONTROLLABLE COSTS are 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 the top level.
Costs may also be classified into DIRECT (attributable to a particular segment) or INDIRECT
(common to a number of segments), the latter being subject to arbitrary allocation.

3. Within the controllable classification, 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 is the end product of responsibility accounting process. It is a

report that shows and compares actual results with the intended (budgets or standards)
results of a responsibility center, thereby highlighting deviations that need corrective actions.

The ‘contribution’ format to computing profit is emphasized in responsibility accounting. This

income statement presentation highlights controllability of costs by behavioral classification.
In addition to the usual variable costs and fixed costs, a more detailed classification of costs
may be made. Consider the following illustrative example (all amounts are assumed):

Sales P500,000
Variable manufacturing costs (150,000)
Manufacturing contribution margin P350,000
Variable selling and administrative costs (50,000)
Contribution margin P300,000
Controllable direct fixed costs:
Manufacturing P100,000
Selling and administrative 75,000 (175,000)
Short-run performance margin P125,000
Non-controllable direct fixed costs:
Depreciation P40,000
Rent and leases, insurance 10,000 (50,000)
Segment margin P75,000
Allocated common costs (30,000)
Income P45,000

DECENTRALIZATION
DECENTRALIZATION – refers to the separation or division of the organization into more
manageable units wherein each unit is managed by an individual who is given
decision authority and is held accountable for his or her decisions.

DECENTRALIZATION -RELATED CONCEPTS

GOAL CONGRUENCE All units of organization have incentives to perform
for a common interest. The purpose of a
responsibility system is to motivate management
performance that adheres to company overall
objectives.

SUB-OPTIMIZATION This happens when one segment of a company takes

action that is in its own best interests but is
detrimental to the firm as a whole.

NOTE: Aside from its control function, responsibility accounting is designed to achieve
goal congruence and to discourage sub-optimization within an organization.

ORGANIZATIONAL CHART A chart that shows the responsibility relationship

among managers in an organization. It sets forth
each principal management position and helps define
authority, responsibility, and accountability. A well-
designed organizational chart helps a decentralized
organization in carrying out duties with clear lines of
 responsibilities delegated to each of the segment of
an organization.

TRANSFER PRICING
TRANSFER PRICE – the amount charged by one segment of a firm for products that are
supplied to another segment of the same firm. It is also known as
intersegment price.
Primary objective
To evaluate performance by virtually transforming cost centers into profit
centers so that performance of the manager of mainly cost centers can be
measured reliably in terms of both revenues and expenses.
Secondary objective
To save on costs involved in producing or buying a product by in-sourcing
rather than outsourcing.

Transfer Price
Cost Center Cost Center

virtually
transforms into Profit Center

Basis of Transfer Price

1. COST-BASED PRICE
 Variable Cost
 Full Cost
 Full absorption cost
 Cost-plus
2. MARKET-BASED PRICE
 Market Price
 Modified market
3. NEGOTIATED PRICE
4. ARBITRARY PRICE
(Variable and fixed manufacturing and non-
manufacturing costs)
(Variable and fixed manufacturing cost)
(Variable costs / Full costs / Full absorption
costs plus mark-up)
(Regular selling price)
(Selling price adjusted for any allowance for
discounts, etc.)

Maximum vs. Minimum Transfer Price

For transfer pricing not to defeat its 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 price = Cost of buying from outside suppliers **
 LOWER LIMIT:
Minimum transfer price = Variable cost per unit + Lost CM per unit on outside sales
** Strictly speaking, upper limit shall be the higher amount of:
1. Cost of buying from outside suppliers, OR
2. Selling price to outside customers.

When a company segment is operating at full capacity, the lost CM per unit on
outside sales is the opportunity cost of transferring products to another
company segment.

Dual pricing concept

The ‘selling’ center could transfer to another segment at the usual market price
that would be paid by an outsider. The ‘buying’ center, however, would record a
purchase at the variable cost of production. This practice is now rarely applied
 because neither manager from both the buying and selling center must exert
much effort to show a profit on a segmental performance reports.

Transfer pricing considerations

 Goal congruence factors
Will the transfer price promote the goals of company as a whole?
 Segmental performance factors
Will the transfer price promote the interest of the segment under the
manager’s responsibility?
 Capacity factors
Does the seller have excess capacity to accommodate further inter-
segment transfer?
 Cost struggle factors
What portions of production costs are variable or fixed, direct or
indirect?

EXERCISES

1. Responsibility Centers
Indicate how each of the business situations below is most likely to be organized: cost center (CC),
revenue center (RC), profit center (PC), or investment center (IC)
A. The accounting department of ABC Review School.
B. The Ezem Mall car park ticket outlets
C. The Magnolia product division of Zan Miguel Corporation.
D. The repairs and maintenance department of Zebu Pazific.
E. The Zampaloc branch of Jollibee Food Corporation.
F. The College of Accountancy of the Ezpaña University.
G. The parts department of Mitzubizhi Motorz Corporation.
H. The convenience store that is owned by a chain organization; the head office
supplies all the goods to be sold and determines the selling prices.

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

The supervisor of the ASSEMBLY DEPARTMENT of Toyota Cars is in-charge of (1) purchasing
supplies, (2) authorizing repairs, and (3) hiring labor for the department. Various costs are given:
(1) (2) (3)
A Sales, salaries and commission P10,000
B Salary, supervisor of Assembly department 9,000
C Factory heat and light 8,000
D General office salaries 7,000
E Depreciation, factory 6,000
F Supplies, Assembly department 5,000
G Repairs and maintenance, Assembly 4,000
department
H Factory insurance 3,000
I Labor costs, Assembly department 2,000
J Salary of factory supervisor 1,000
Total

REQUIRED: Determine the following:

1. Total costs controllable by the supervisor of the Assembly department.
2. Total costs directly identified with the Assembly department.
3. Total costs allocated to the factory departments.

3. Segmented Income Statement

The following data pertain to Zest-O Air operations for the year 2020:
TOTAL Zix Division Zeven Division
Amount % Amount % Amount %
Sales P1,000,000 (100%) (100%) (100%)
Less: Variable Expenses ( ) ( ) ( )
 Contribution margin ( ) P360,000 (60%) ( )
Less: Traceable fixed expenses ( ) (P150,000) ( ) (P200,000) ( )
Division segment margin ( ) ( ) P120,000 (30%)
Less: Common fixed expenses ( )
Income P40,000 ( )

REQUIRED:
Compute for the missing data.

4. Return on Investment vs. Residual Income

For each of the following independent cases, the minimum desired Return on Investment (RoI) is
20%.
Division “Z2” Division “Z5” Division “Z8”
Sales P400,000 (5) P700,000
Operating Income (1) (6) P42,000
Operating Assets (2) P300,000 (9)
Margin 15% 8% (10)
Turnover (3) 3 times (11)
Return on Investments 30% (7) (12)
Residual Income (4) (8) P22,000

REQUIRED:
Compute for each division’s missing items.

5. Service Cost Allocation

The Fatness First has two service departments (A and B) and two producing departments (X and Y).
Service Departments Operating Departments
A B X Y
Direct costs P150 P300
Services performed by Dept. A 40% 40% 20%
Services performed by Dept. B 20% 70% 10%

REQUIRED: Compute allocated cost to departments X and Y using the following methods:
1. Direct method
2. Step-down method (cost of department A is allocated first)
3. Step-down method (cost of department B is allocated first)
4. Reciprocal method

6. Transfer Pricing
Dayagsky Company’s Division ‘A’ (Antonia) produces a small tool used by other companies as a key
part in their products. Cost and sales data related to the small tool are given below:
Selling price per unit P50
Variable costs per unit P30
Fixed costs per unit* P12
* based on Antonia division’s capacity of 40,000 tools per year.

The company’s Division ‘B’ (Bonarita) is introducing a new product that will use the same tool such
as the one produced by Division ‘A’. An outside supplier has quoted the Division B a price of P48
per tool. Division B would like to purchase the tools from Division A, if an acceptable transfer price
can be worked out.

REQUIRED:
1. Determine the lower limit of the transfer price assuming that:
A. Division A has ample idle capacity to handle all the Division B’s needs.
B. Division A is 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 A (operating at capacity) or from outsides supplier? Why?
3. Assume that Division B requires 10,000 tools per year and the Division A is
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 A rather from the outside suppliers?

7. Price-Setting Methods
The Air-Phil Company is operating with two divisions. Division S is producing a product line that is
required as a component part of the product being manufactured by Division B.

For Division S, the costs of producing the component part per unit are:
Direct materials P10
Direct labor P8
Variable factory overhead P5
Fixed factory overhead P2
The product of Division S is being sold in a highly competitive market for P30 per unit.

Division B is currently buying 80% of the production output of Division S at a negotiated price of
P28 per unit. It is expected that 25,000 units of product will be produced by Division S.

With emphasis on divisional welfare rather than the company’s welfare, a new transfer price must
be developed. It is suggested that a 40% mark-up on cost will be added when transferring the
product from Division S to Division B.

An additional processing cost for Division B is P8 per unit. The selling price of the product of
Division B is P45 per unit.

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