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Chapter

22

RESPONSIBILITY ACCOUNTING AND TRANSFER PRICING

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

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

Profit Center A part of the business that has control over both costs and revenues, but no control over investment funds.
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Revenues
Sales Interest Other

Costs
Mfg. costs Commissions Salaries Other

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Cost Centers, Profit Centers, and Investments Centers

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

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Corporate Headquarters

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Cost Centers, Profit Centers, and Investments Centers

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Evaluation Measures
Cost Center
Profit Center Investment Center
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Cost control Quantity and quality of services

Profitability Return on assets (ROA) Residual income (RI)
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Responsibility Accounting Systems

An accounting system that provides information . . .
Relating to the responsibilities of individual managers. To evaluate managers on controllable items.

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Responsibility Accounting Systems

Prepare budgets for

each responsibility center.

Measure performance of
each responsibility center.

Prepare timely performance reports

comparing actual amounts with budgeted amounts.
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Successful implementation of responsibility accounting may use organization charts with clear lines of authority and clearly defined levels of responsibility.
Board of Directors President Vice President of Finance Vice President of Operations Store Manager Department Manager
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Vice President of Marketing

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Responsibility Accounting Systems

Amount of detail varies according to level in organization.

A department manager receives detailed reports.

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A store manager receives summarized information from each department.

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Responsibility Accounting 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 Accounting 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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Assigning Revenue and Costs to Business Centers

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

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Assigning Revenue and Costs to Business Centers

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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 Center Reporting Webber, Inc. has two divisions.

Webber, Inc.

Computer Division

Television Division

Lets look more closely at the Television Divisions income statement.

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Profit Center Reporting

Income Statement Contribution Margin Format Television Division Sales $ 300,000 Variable COGS $ 120,000 Other variable costs 30,000 Total variable costs $ 150,000 Contribution margin $ 150,000 Traceable fixed costs 90,000 Responsibility margin $ 60,000

Cost of goods sold consists of variable manufacturing costs.

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Profit Center Reporting

Income Statement Contribution Margin Format Television Division Sales $ 300,000 Variable COGS $ 120,000 Other variable costs 30,000 Total variable costs $ 150,000 Contribution margin $ 150,000 Traceable fixed costs 90,000 Responsibility margin $ 60,000

Fixed and variable costs are listed in separate sections.

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Profit Center Reporting

Income Statement Contribution Margin Format Television Division Sales $ 300,000 Responsibility margin Variable COGS $ 120,000 is the Television Other variable costs 30,000 Divisions 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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Traceable Fixed Costs

Traceable fixed costs would disappear over time if the center itself disappeared.
No computer division means . . . No computer division manager.

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Common Fixed 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 division means . . . We still have a company president.

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Profit Center Reporting

Lets see how the Television Division fits into Webber, Inc.

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Profit Center Reporting

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

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

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Fixed costs that are traceable on one level can become common if the business is divided into smaller parts.
Lets see how this works!

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Profit Center Reporting

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

HDTV $ 100,000 (55,000) $ 45,000 (35,000) $ 10,000

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Profit Center Reporting

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

HDTV $ 100,000 (55,000) $ 45,000 (35,000) $ 10,000

$90,000 cost directly traced to the Television Division.

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$ 45,000 35,000 10,000 $ 90,000

To Color To HDTV Common TV Division

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

Profits

Time
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When is a Business Center Unprofitable?

Home Appliance Company Income Statement Laundry Division Washers Sales $ 300,000 $ 200,000 Variable costs (150,000) (95,000) CM $ 150,000 $ 105,000 Traceable FC (95,000) (45,000) Responsibility margin $ 55,000 $ 60,000 Common costs (10,000) Net income $ 45,000

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Dryers $ 100,000 (55,000) $ 45,000 (50,000) $ (5,000)

The Dryer Division is unprofitable because the responsibility margin is negative.

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Evaluating Business Center Managers

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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 Against Allocating Common Fixed 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 centers managers. Allocation of common fixed costs may imply changes in profitability that are unrelated to the centers performance.

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

Batteries
Battery Division
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Auto Division
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Transfer Prices
The transfer price affects the profit measure for both buying and selling divisions.
A higher transfer price for batteries means . . .
. . . greater profits for the Battery Division.

Battery Division
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Auto Division
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Transfer Prices
The transfer price affects the profit measure for both buying and selling divisions.
A higher transfer price for batteries means . . .

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

Auto Division
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Transfer Prices Many companies use the external market value of goods transferred as the transfer price.
Transfer prices have no direct effect upon the companys overall net income.
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Transfer Prices
When the external market value of goods transferred is unavailable . . .
Negotiated transfer price Cost-plus transfer price

Transfer prices have no direct effect upon the companys overall net income.
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Nonfinancial Performance Measures

Product Quality Number of defective parts Number of customer returns Number of customer complaints Marketing Number of new customers Number of sales calls initiated Market share Number of product stockouts Personnel Number of sick days taken Employee turnover Number of grievances filed Efficiency and Capacity Cycle time (manufacturing) Occupancy rates (hotels) Passenger miles (airlines) Patient days (hospitals) Transactions processed (banks)

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Overview of Traditional and Variable Costing

Traditional Costing
Direct Materials

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Variable Costing
Product Costs

Product Costs

Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead

Period Costs

Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses

Period Costs

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Unit Cost Computations

Dana, Inc. produces a single product with the following information available:

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Unit Cost Computations

Unit product cost is determined as follows:

Selling and administrative expenses are always treated as period expenses and deducted from revenue.
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Income Comparison of Traditional and Variable Costing

Dana had no beginning inventory, produced 25,000 units and sold 20,000 units this year.
Traditional Costing
Sales (20,000 $30) Less cost of goods sold: Beginning inventory $ Add COGM (25,000 $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 $16) 80,000 Gross margin Less selling & admin. exp. Variable Fixed Net operating income
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$ 600,000

320,000 280,000

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Income Comparison of Traditional and Variable Costing

Dana had no beginning inventory, produced 25,000 units and sold 20,000 units this year.
Traditional Costing
Sales (20,000 $30) Less cost of goods sold: Beginning inventory $ Add COGM (25,000 $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 $16) 80,000 Gross margin Less selling & admin. exp. Variable (20,000 $3) $ 60,000 Fixed 100,000 Net operating income
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$ 600,000

320,000 280,000

160,000 $ 120,000

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Income Comparison of Traditional and Variable Costing

Now lets look at variable costing by Dana, Inc.
Sales (20,000 $30) Less variable expenses: Beginning inventory $ Add COGM (25,000 $10) 250,000 Goods available for sale 250,000 Less ending inventory (5,000 $10) 50,000 Variable cost of goods sold 200,000 Variable selling & administrative expenses (20,000 $3) 60,000 Contribution margin Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 Net operating income
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Variable costs only.

Variable Costing
$ 600,000

All fixed manufacturing overhead is expensed.

260,000 340,000

250,000 $ 90,000

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Income Comparison of Absorption and Variable Costing

Lets compare the methods.

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Reconciliation
We can reconcile the difference between absorption and variable income as follows:
Variable costing net operating income $ 90,000 Add: Fixed mfg. overhead costs deferred in inventory (5,000 units $6 per unit) 30,000 Traditional costing net opearting income $ 120,000

Fixed mfg. overhead $150,000 = = $6.00 per unit Units produced 25,000 units
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End of Chapter 22

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