Financial & Managerial

Accounting
The Basis for Business Decisions
FOURTEENTH EDITION

Williams Haka Bettner Carcello

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 Chapter

RESPONSIBILITY 22
ACCOUNTING AND
TRANSFER PRICING

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 Learning
Learning Objective
Objective

To distinguish among cost

centers, profit centers,
and investment centers.

LO1
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 Responsibility
Responsibility Centers
Centers

Large complex
businesses are
divided into
responsibility
centers enabling
managers to have
a smaller effective
span of control.
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 The
The Need
Need for
for Information
Information About
About
Responsibility
Responsibility Center
Center Performance
Performance

The accounting system provides information

about resources used and outputs achieved.

This information is used to:

 Plan and allocate resources.
 Control operations.
 Evaluate the performance
of center managers.
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 Cost
Cost Centers,
Centers, Profit
Profit Centers,
Centers, and
and
Investments
Investments Centers
Centers

Cost Center
A business section
that has control over
the incurrence of
costs, but no control
over revenues or
investment funds.

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 Cost
Cost Centers,
Centers, Profit
Profit Centers,
Centers, and
and
Investments
Investments Centers
Centers

Profit Center Revenues

A part of the business Sales
that has control over Interest
Other
both costs and Costs
revenues, but no Mfg. costs
Commissions
control over
Salaries
investment funds. Other

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 Cost
Cost Centers,
Centers, Profit
Profit Centers,
Centers, and
and
Investments
Investments Centers
Centers

Investment Center
A profit center where
management also
makes capital
investment
decisions.
Corporate Headquarters

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 Cost
Cost Centers,
Centers, Profit
Profit Centers,
Centers, and
and
Investments
Investments Centers
Centers

Evaluation Measures
Cost control
Cost
Quantity and quality
Center
of services

Profit
Profitability
Center

Investment Return on assets (ROA)

Center Residual income (RI)
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 Learning
Learning Objective
Objective

To explain the need for

responsibility center information
and describe a responsibility
accounting system.

LO2
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 Responsibility
Responsibility Accounting
Accounting Systems
Systems

An accounting system that

provides information . . .

Relating to the To evaluate

responsibilities of managers on
individual managers. controllable items.

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 Responsibility
Responsibility Accounting
Accounting Systems
Systems

 Prepare budgets for  Measure performance of

each responsibility center. each responsibility center.

 Prepare timely performance reports

comparing actual amounts with budgeted amounts.
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 Successful
Successful implementation
implementation ofof responsibility
responsibility
accounting
accounting may may use
use organization
organization charts
charts with
with
clear
clear lines
lines of
of authority
authority and
and clearly
clearly defined
defined
levels
levels of
of responsibility.
responsibility.
B o a r d o f D ir e c to r s

P r e s id e n t

V ic e P r e s id e n t V ic e P r e s id e n t V ic e P r e s id e n t
o f F in a n c e o f O p e r a tio n s o f M a r k e tin g

S to re M a n a g e r

D e p a rtm e n t M a n a g e r
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 Responsibility
Responsibility Accounting
Accounting Systems
Systems

Amount of detail varies according

to level in organization.

A department manager A store manager receives

receives detailed summarized information
reports. from each department.
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 Responsibility
Responsibility Accounting
Accounting Systems
Systems

Amount of detail varies according

to level in organization.
Management by exception:
Upper-level management
does not receive operating
detail unless problems arise.

The vice president of operations

receives summarized information
from each store.
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 Responsibility
Responsibility Accounting
Accounting Systems
Systems
To be of maximum benefit, responsibility
reports should . . .
 Be timely.
 Be issued regularly.
 Be understandable.
 Compare budgeted
and actual amounts.

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 Learning
Learning Objective
Objective

To prepare an income
statement showing
contribution margin and
responsibility margin.

LO3
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 Assigning
Assigning Revenue
Revenue and
and Costs
Costs to
to
Business
Business Centers
Centers
Revenue is easily and
automatically assigned to
specific departments using point
of sale entries from cash
registers.
Service
Department

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 Assigning
Assigning Revenue
Revenue and
and Costs
Costs to
to
Business
Business Centers
Centers

Two guidelines should be followed in

allocating costs to the various parts
of a business . . .
According to cost behavior patterns:
Fixed or variable.
According to whether the costs
are directly traceable to the
centers involved.

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 Profit
Profit Center
Center Reporting
Reporting

Webber, Inc. has two divisions.

W e b b e r , In c .

C o m p u te r D iv is io n T e le v is i o n D iv is io n

Let’s look more closely at the Television

Division’s income statement.

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 Profit
Profit Center
Center Reporting
Reporting

Income Statement
Contribution Margin Format
Television Division Cost of goods
Sales $ 300,000 sold consists of
Variable COGS $ 120,000 variable
Other variable costs 30,000 manufacturing
Total variable costs $ 150,000 costs.
Contribution margin $ 150,000
Traceable fixed costs 90,000
Responsibility margin $ 60,000

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 Profit
Profit Center
Center Reporting
Reporting

Income Statement
Contribution Margin Format
Television Division
Sales $ 300,000
Variable COGS $ 120,000 Fixed and
Other variable costs 30,000 variable costs
Total variable costs $ 150,000 are listed in
Contribution margin $ 150,000 separate
Traceable fixed costs 90,000 sections.
Responsibility margin $ 60,000

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 Profit
Profit Center
Center Reporting
Reporting

Income Statement
Contribution Margin Format
Television Division
Sales $ 300,000
Variable COGS $ 120,000
Responsibility margin
is the Television
Other variable costs 30,000
Division’s contribution
Total variable costs $ 150,000
to overall operations.
Contribution margin $ 150,000
Traceable fixed costs 90,000
Responsibility margin $ 60,000

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 Learning
Learning Objective
Objective

To distinguish between
traceable and
common fixed costs.

LO4
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 Traceable
Traceable Fixed
Fixed Costs
Costs

Traceable fixed costs would disappear over

time if the center itself disappeared.

No computer No computer
division means . . . division manager.

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 Common
Common Fixed
Fixed Costs
Costs
Common fixed costs arise because of
overall operation of the company and are not
due to the existence of a particular center.
No computer We still have a
division means . . . company president.

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 Profit
Profit Center
Center Reporting
Reporting

Let’s see how the Television

Division fits into Webber, Inc.

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 Profit
Profit Center
Center Reporting
Reporting
Income Statement
Company Television Computer
Sales $ 500,000 $ 300,000 $ 200,000
Variable costs (230,000) (150,000) (80,000)
CM $ 270,000 $ 150,000 $ 120,000
Traceable FC (170,000) (90,000) (80,000)
Responsibility margin $ 100,000 $ 60,000 $ 40,000
Common costs (25,000)
Net income $ 75,000

Common costs arise because of overall

operating activities and are not due to the
existence of a particular division.
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 Traceable
Traceable Costs
Costs Can
Can Become
Become
Common
Common Costs
Costs

Fixed costs that are traceable on

one level can become common if
the business is divided into smaller
parts.
Let’s see how this works!

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 Profit
Profit Center
Center Reporting
Reporting
Income Statement
Television
Division Color HDTV
Sales $ 300,000 $ 200,000 $ 100,000
Variable costs (150,000) (95,000) (55,000)
CM $ 150,000 $ 105,000 $ 45,000
Traceable FC (80,000) (45,000) (35,000)
Responsibility margin $ 70,000 $ 60,000 $ 10,000
Common costs (10,000)
Net income $ 60,000

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 Profit
Profit Center
Center Reporting
Reporting
Income Statement
Television
Division Color HDTV
Sales $ 300,000 $ 200,000 $ 100,000
Variable costs (150,000) (95,000) (55,000)
CM $ 150,000 $ 105,000 $ 45,000
Traceable FC (80,000) (45,000) (35,000)
Responsibility margin $ 70,000 $ 60,000 $ 10,000
Common costs 10,000
Net income $ 60,000
$ 45,000 To Color
35,000 To HDTV
$90,000 cost directly traced 10,000 Common
to the Television Division. $ 90,000 TV Division

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 Learning
Learning Objective
Objective

To explain the usefulness of

the contribution margin
and responsibility margin
in making short-term
and long-term decisions.

LO5
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 Responsibility
Responsibility Margin
Margin
Responsibility margin is the best gauge of the
long-run profitability of a business center.
Profits

Time
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 When
When isis aa Business
Business
Center
Center Unprofitable?
Unprofitable?
Home Appliance Company
Income Statement
Laundry
Division Washers Dryers
Sales $ 300,000 $ 200,000 $ 100,000
Variable costs (150,000) (95,000) (55,000)
CM $ 150,000 $ 105,000 $ 45,000
Traceable FC (95,000) (45,000) (50,000)
Responsibility margin $ 55,000 $ 60,000 $ (5,000)
Common costs (10,000)
Net income $ 45,000

The Dryer Division is unprofitable because

the responsibility margin is negative.
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 When
When isis aa Business
Business
Center
Center Unprofitable?
Unprofitable?
Home Appliance Company
Income Statement
Laundry
Division Washers Dryers
Sales $ 300,000 $ 200,000 $ 100,000
Variable costs (150,000) (95,000) (55,000)
CM $ 150,000 $ 105,000 $ 45,000
Traceable FC (95,000) (45,000) (50,000)
Responsibility margin $ 55,000 $ 60,000 $ (5,000)
Common costs (10,000)
Net income $ 45,000

While contribution margin is used for short-run decisions,

responsibility margin is used for long-run decisions? Should the Dryer
Division be discontinued because the responsibility margin is negative?
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 Evaluating
Evaluating Business
Business
Center
Center Managers
Managers

Managers should be evaluated on the portion

of responsibility margin they control.

Common fixed costs can not be traced to the

Dryer Division or the Washer Division, so they
are excluded from the responsibility margin.

The key issue is controllability.

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 Arguments
Arguments Against
Against Allocating
Allocating
Common
Common Fixed
Fixed Costs
Costs

 Common fixed costs would not change

even if a business center were eliminated.
 Common fixed costs are not under the
direct control of the center’s managers.
 Allocation of common fixed costs may
imply changes in profitability that are
unrelated to the center’s performance.

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 Learning
Learning Objective
Objective

To describe three transfer

pricing methods and
explain when each is used.

LO6
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 Transfer
Transfer Prices
Prices

The
The amount
amount charged
charged when
when one
one division
division sells
sells
goods
goods or
or services
services to
to another
another division.
division.

Batteries

Battery Division Auto Division

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 Transfer
Transfer Prices
Prices

The transfer price affects the profit measure

for both buying and selling divisions.

A higher transfer
price for batteries
means . . .

. . . greater
Battery Division profits for the Auto Division
Battery Division.
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 Transfer
Transfer Prices
Prices

The transfer price affects the profit measure

for both buying and selling divisions.

A higher transfer
price for batteries
means . . .

. . . lower
Battery Division profits for the Auto Division
Auto Division.
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 Transfer
Transfer Prices
Prices

Many companies use the

external market value
of goods transferred
as the transfer price.

Transfer prices have no direct effect upon

the company’s overall net income.

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 Transfer
Transfer Prices
Prices

When the external

market value of goods
transferred is unavailable . . .

Negotiated Cost-plus
transfer transfer
price price

Transfer prices have no direct effect upon

the company’s overall net income.
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 Nonfinancial
Nonfinancial Objectives
Objectives
and
and Information
Information

Product Quality Personnel

Number of defective parts Number of sick days taken
Number of customer returns Employee turnover
Number of customer complaints Number of grievances filed

Marketing Efficiency and Capacity

Number of new customers
Number of sales calls initiated
Market share
Number of product stockouts
Cycle time (manufacturing)
Occupancy rates (hotels)
Passenger miles (airlines)
Patient days (hospitals)
Transactions processed (banks)

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 Ethics,
Ethics, Fraud,
Fraud, and
and
Corporate
Corporate Governance
Governance

Many companies provide investors and creditors

with non-GAAP information and pro forma results.

The Sarbanes-Oxley Act attempts to reduce or

eliminate the abuses that can be associated with pro
forma reporting by requiring public companies to
provide a reconciliation of the differences between any
non-GAAP financial measures provided to to investors
and creditors and the comparable GAAP-based result.

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 End
End of
of Chapter
Chapter 22
22

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