Solution manual cost accounting 9th by kinney rainborn ch13

CHAPTER

13

RESPONSIBILITY ACCOUNTING, SUPPORT
DEPARTMENT COST ALLOCATIONS,
AND TRANSFER PRICING

Learning Objectives
After reading and studying Chapter 13, you should be able to answer the following questions:
1.

Which factors determine whether a firm should be decentralized or centralized?

2.

How are decentralization and responsibility accounting related?

3.

What are the four primary types of responsibility centers, and what distinguishes them from
each other?

4.

How are revenue variances computed?

5.

Why and how are support department costs allocated to operating departments?

6.

What types of transfer prices are used in organizations, and why are such prices used?

7.

What difficulties can be encountered by multinational companies using transfer prices?

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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Terminology
Administrative Department: an organizational unit that performs management activities that benefit the
entire organization and include top management personnel, legal, payroll, insurance, and organization
headquarters
Advance pricing agreement: a binding contract between the IRS and a company that provides details of
how a transfer price is to be set and establishes that no adjustments or penalties will be made if the
agreed-upon methodology is used
Algebraic method: a method of allocating support department costs that considers all interrelationships
of the departments and reflects these relationships in simultaneous equations
Benefits-provided ranking: a listing of support departments in an order that begins with the one
providing the most service to all other corporate areas and ends with the support department providing
the least service to all other support areas

Centralization: term used to describe an organization’s approach to decision making in which top
management retains the major portion of decision-making authority
Cost center: a responsibility center in which the manager has the authority only to incur costs and is
specifically evaluated on the basis of how well costs are controlled
Decentralization: is a transfer of authority, responsibility, and decision-making rights from the top to the
bottom of the organization structure
Direct method: a process of support department cost allocation that assigns support department costs
only to operating areas
Dual pricing arrangement: a transfer pricing system that allows the selling division to record the transfer
of goods or services at a market or negotiated market price and the buying division to record the transfer
at a cost-based amount
Goal congruence: a situation that exists when the personal and organizational goals of decision makers
throughout the firm are consistent and mutually supportive
Investment center: an organizational unit in which the manager is responsible for managing revenues
and current expenses and has the authority to acquire, use, and dispose of plant assets in a manner that
seeks to earn the highest feasible rate of return on the center’s asset base
Negotiated transfer price: an intracompany charge for goods or services that has been set through a
process of bargaining between the selling and purchasing unit managers
Profit center: a responsibility center in which the manager is responsible for generating revenues and
managing expenses related to current activity
Pseudo-profit center: unit created when one responsibility center uses a transfer price to artificially “sell”
goods or services to another responsibility center thus creating artificial revenues and profits
Responsibility accounting system: a system that facilitates decentralization by providing information
about the performance, efficiency, and effectiveness of organizational subunits and their managers

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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Responsibility center: a cost object under the control of a manager such as a division, department, or
geographical region
Responsibility report: report that assist each successively higher level of management in evaluating the
performances of its subordinate managers and their respective organizational units
Revenue center: an organizational unit for which a manager is accountable only for the generation of
revenues and has no control over setting selling prices or budgeting costs
Sales price variance (SPV): the variance calculated by multiplying the actual number of units sold by the
difference between actual and budgeted sales prices; indicates the portion of the total revenue variance
that is related to a change in selling price
Sales volume variance (SVV): the variance calculated by multiplying the budgeted sales price by the
difference between the actual and budgeted sales volumes; indicates the portion of the total revenue
variance that is related to a change in sales volume
Service department: an organizational unit (e.g., maintenance department) that provides one or more
specific functional tasks for other internal units
Shared service: support function for various organizational units from a central location also referred to
as a "back office" function. Typical functions include accounting/cash management, HR, IT, legal, etc.
Step method: a process of support department cost allocation that allows a partial recognition of the
effects of interactions among support departments
Suboptimization: a situation in which individual managers pursue goals and objectives that are in their
own and/or their segments’ particular interests rather than in the company’s best interests
Support departments: service departments that provide one or more specific functional tasks for other
internal units and administrative departments that perform management activities that benefit the entire
organization
Transfer price: an internal price established for the exchange of goods or services between
organizational units of the same company

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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Lecture Outline
LO.1: Which factors determine whether a firm should be decentralized or centralized?
A. Introduction
1. One of the most common progressions made by high-growth companies is from highly
centralized organizational structures to highly decentralized structures.
2. This chapter describes the accounting methods that are appropriate in decentralized
organizations: responsibility accounting, support department cost allocations, and transfer pricing.
B. Decentralization
1. The degree of centralization can be viewed as a continuum.
a. Centralization exists when a single individual (normally the company owner or president)
performs all decision making and retains full authority and responsibility for that
organization’s activities.
b. Decentralization exists when authority, responsibility, and decision-making rights are
transferred from the top to the bottom of the organizational structure.
i.

Text Exhibit 13.1 (p. 503) summarizes the advantages and disadvantages of
decentralization.

2. Either extreme of the centralization-decentralization continuum represents an undesirable
arrangement.
a. In a totally centralized company, a single individual may not have the expertise or sufficient
and timely information to make effective decisions in all functional areas.

b. In a totally decentralized organization, subunits may act in ways that are not consistent with
the goals of the total organization.
c.

Most businesses tend to structure themselves according to the pure centralization versus
pure decentralization factors listed in text Exhibit 13.2 (p. 504).

d. The combination of managers’ personal characteristics, the nature of decisions required for
organizational growth, and the nature of organizational activities help a company find the
appropriate degree of decentralization.
3. Decentralization does not necessarily mean that a unit manager has the authority to make all of
the decisions concerning a unit, as top management selectively determines the types of authority
to delegate and the types to withhold from lower-level managers.
a. Many functions remain centralized even in a decentralized environment. These support
functions are often referred to as a shared service and include functions such as
accounting/cash management, HR, IT, legal, and procurement.
b. The need to address environmental issues has presented new challenges when deciding to
centralize or decentralize function addressing these environmental issues. Text Exhibit 13.3

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(p. 505) outlines considerations for both decentralizing and centralizing the responsibility and
decision making for environmental issues.

LO.2: How are decentralization and responsibility accounting related?
C. Responsibility Accounting Systems
1. A responsibility accounting system facilitates decentralization by providing information about
the performance, efficiency, and effectiveness of organizational subunits and their managers and
is the key management control tool in a decentralized organization.
2. Responsibility reports are reports that assist each successively higher level of management in
evaluating the performances of its subordinate managers and their respective organizational
units.
a. Text Exhibit 13.4 (p. 506) provides examples of information that can be shown in
responsibility reports.
b. A manager’s responsibility report should reflect his or her degree of influence and should
include only the revenues and/or costs under that manager’s control.
c.

Some unit costs are not entirely controlled by the unit manager, causing the responsibility
report to take one of two forms: a single report showing all costs incurred in the unit,
separately classified as either controllable or noncontrollable, or separate reports, one for the
organizational unit and one for the unit manager.

3. A responsibility accounting system helps organizational unit managers conduct the following
basic control functions:
a. prepare a plan (for example, using budgets and standards) and use it to communicate output
expectations and delegate authority;
b. gather actual data classified in accordance with the activities and categories specified in the
plan;
c.

monitor the differences between planned and actual data at scheduled intervals;

d. exert managerial influence in response to significant differences; and

e. continue comparing data and responding and at the appropriate time begin the process
again.
4. Responsibility reports reflect the upward flow of information from operational units to company top
management and illustrate the broadening scope of responsibility.
a. Managers receive detailed information on the performance of their immediate areas of control
and summary information on all organizational units for which they are responsible.
b. Reports at the lowest level of units are highly detailed, whereas more general information is
reported to the top of the organization.

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

i.

c.

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Text Exhibit 13.5 (p. 507) presents a responsibility report that illustrates this pyramiding
of information.

Variances are itemized in performance reports at the lower levels so that the appropriate
manager can take corrective action related to significant variances.
i.

Under the management by exception principle, major deviations from expectations are
highlighted to assist upper-level managers in determining whether they need to become

involved in their subordinates’ operations.

d. The process of responsibility accounting creates some issues for management.
i.

The idea of rolling up information to each successively higher level allows potentially
important details to be buried.

ii.

Assuming different units within the responsibility accounting system are competing with
each other for resources, managers could try to promote their own agendas, thus leading
to a lack of goal congruence between or among organizational units.


Goal congruence exists when the personal and organizational goals of decision
makers throughout the firm are consistent and mutually supportive.

iii. Additionally, by partitioning each responsibility unit as a separate part of the report,
interdependencies among units might be obscured.
e. Responsibility accounting’s focus is on the manager who has control over a particular cost
object.
i.

In a decentralized company, the cost object is an organizational unit or responsibility
center.

ii.

A responsibility center is a cost object (e.g., a division, department, or geographical

region) under the control of a manager.

LO.3: What are the four primary types of responsibility centers, and what distinguishes them from
each other?
D. Types of responsibility centers
1. Responsibility accounting systems identify, measure, and report on the performance of
responsibility centers and their managers.
a. Responsibility centers are generally classified according to their manager’s scope of authority
and type of financial responsibility: costs, revenues, profits, and/or asset base.
b. The four primary types of responsibility centers are illustrated in text Exhibit 13.6 (p. 508).
2. Cost Center
a. A cost center is a responsibility center in which the manager has the authority only to incur
costs and is specifically evaluated on the basis of how well costs are controlled.

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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b. Cost centers commonly include service and administrative departments.
c.

In the traditional manufacturing environment, the production department is the largest cost
center.
i.

Cost center managers often concentrate only on the unfavorable standard cost variances

and ignore the efficient performance indicated by favorable variances.

ii.

If the management by exception principle is applied properly, top management should
investigate ALL variances (favorable and unfavorable) that fall outside the range of
acceptable deviations.

d. In some instances, a cost center can generate revenue, but the revenues are either not under
the manager’s control (e.g., tax dollars provided to a community library by the local taxing
authority) or are not effectively measurable (e.g., research and development center).
i.

Such revenues should not be included in the manager’s responsibility accounting report.

LO.4: How are revenue variances computed?
3. Revenue Center
a. A revenue center is an organizational unit for which a manager is accountable only for the
generation of revenues and has no control over setting selling prices or budgeting costs.
b. Actual performance in revenue centers (as well as in any other area that has control over
revenue) should be compared against budgeted performance to determine variances from
expectations.
c.

Budgeted and actual revenues may differ either because of volume of units sold or price of
units sold.
i.

The sales price variance is calculated by multiplying the actual number of units sold by
the difference between actual and budgeted sales prices. This variance indicates the

portion of the total revenue variance that is related to a change in selling price.

ii.

The sales volume variance is calculated by multiplying the budgeted sales price by the
difference between the actual and budgeted sales volumes.

iii. The model for computing revenue variances is as follows:
ASP x ASV

BSP x ASV

Sales Price Variance

BSP x BSV

Sales Volume Variance

Total Revenue Variance
where ASP = actual sales price;
BSP = budgeted sales price;

ASV = actual sales volume
BSV = budgeted sales volume

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iv. In most instances, pure revenue centers do not exist because managers are also
responsible for managing some costs in their centers. Thus, a more appropriate term for
this organizational unit is a revenue and limited cost center.
4. Profit Center
a. A profit center is a responsibility center in which the manager is responsible for generating
revenues and managing expenses related to current activity.
b. The major goal of a profit center manager is to maximize the center’s net income.
c.

Profit centers should be independent organizational units whose managers:
i.

have the ability to obtain resources at the most economical prices;

ii.

sell products at prices that will maximize revenue; and

iii. have a goal of maximizing the center’s profit.
5. Investment Center
a. An investment center is an organizational unit in which the manager is responsible for
managing revenues and current expenses and also has the authority to acquire, use, and
dispose of plant assets in a manner to earn the highest feasible rate of return on the center’s
asset base.
b. Many investment centers are independent free-standing divisions or corporate subsidiaries.
c.

Suboptimization is a situation in which individual managers pursue goals and objectives that
are in their own and/or their segments’ particular interests rather than in the company’s best
interests.

6. A unique challenge for the design of responsibility centers arises from the instance in which one
center supplies its outputs largely to other internal centers.
a. Top management must make judgments about the nature and extent of the costs and
revenues to include in such responsibility centers.
b. Frequently, rather than attempting to make performance assessments about cost centers,
management assigns the costs incurred in cost centers to operating areas through a process
of support department cost allocation.
c.

Alternatively, management can attempt to “create” revenues for the cost center by using an
internal transfer pricing system to assign a price to the center’s tangible or intangible output
that is used by other company units.

LO.5: Why and how are support department costs allocated to operating departments?
E. Support Department Cost Allocation
1. General

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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a. Organizations incur two types of overhead costs: those directly related to the operating (or

primary revenue-generating) activities and those indirectly related to operating activities.
b. As the number of product lines or service types increases, so does the need for additional
indirectly-related activities. An organization’s support departments include both service and
administrative departments.

c.

i.

A service department is an organizational unit (such as central purchasing,
maintenance, engineering, security, or warehousing) that provides one or more specific
functional tasks for other internal units.

ii.

An administrative department is an organizational unit that performs management
activities that benefit the entire organization and include top management personnel,
legal, payroll, insurance, and organization headquarters.

All support department costs must be covered in the long run by sales of products and
services.
i.

Support department costs must therefore be allocated to production departments to meet
the objectives of full cost computation, managerial motivation, and managerial decision
making.

ii.

See text Exhibit 13.7 (p. 511) for the reasons for and against allocating support

department costs.

2. Allocation Bases
a. Four criteria must be considered in determining a rational and systematic allocation base:
i.

measure the benefits the operating department receives from the support department;

ii.

capture the causal relationship existing between factors in the operating department and
costs incurred in the support department;

iii. reflect the fairness or equity of the allocations between operating departments; and
iv. measure the ability of operating departments to bear the allocated costs.
b. Text Exhibit 13.8 (p. 512) provides alternative bases for assigning various types of support
department costs.
3. Methods of Allocating Support Department Costs
a. The idea underlying support department cost allocations is that the responsibility centers that
benefit from the services provided by support units should bear the costs of such support
units.
b. Three basic methods are used to allocate the pooled support department costs to the
operating departments:
i.

The direct method assigns support department costs only to operating areas;

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing


ii.

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This is the simplest method but may result in distorted cost allocations if there is
significant exchange of services among support departments as well as operating
departments.

The step method allows a partial recognition of the effects of interactions among support
departments in assigning costs; and


A benefits-provided ranking is a listing of support departments in an order that
begins with the one providing the most service to all other support areas and ends
with the support department providing the least service to all other support areas.
The two most common approaches used to implement the ranking are the dollar
volume of services and the percentage of total assistance to other support areas.

iii. The algebraic (or reciprocal) method considers all departmental interrelationships and
reflects these relationships in simultaneous equations.


The algebraic method is the most complex method but it is also the most theoretically
correct and, if relationships are properly formulated, provides the most accurate and
reliable allocations.

F. Support Department Cost Allocation Illustration
1. The text uses an example company, Athens Supplements Co. (ASC) to illustrate the three
methods of allocating budgeted support department costs.
a. Budgeted costs of each support department are first allocated to each operating division
using one of the three methods of support area cost allocation and are then added to the
budgeted overhead costs of those divisions to determine an appropriate divisional overhead
application rate.
b. Text Exhibit 13.9 (p. 513) provides an abbreviated budget of the direct and indirect costs for
each support department and operating division of ASC.
c.

Text Exhibit 13.10 (p. 514) presents the bases selected for allocating ASC’s support
department costs. These bases are proxies for the quantity of services consumed by each
service area and operating division.

2. Direct Method Allocation
a. The direct method assigns support department costs only to operating areas.
b. Text Exhibit 13.11 (p. 514) illustrates the direct method of allocating support department
costs to operating areas at ASC.
c.

Text Exhibit 13.12 (p. 515) presents the company’s total budget pre-tax profits by operating
area if support department costs are allocated using the direct method.

3. Step Method Allocation
a. The step method assigns support department costs to operating departments as well as to
certain other support departments.
b. The benefits-provided ranking was provided in text Exhibit 13.10.

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

c.

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Text Exhibit 13.13 (p. 516) illustrates the step method of allocating support department costs
to operating areas at ASC.

d. Note that under the step method allocation process, a support department is “eliminated”
once its costs have been assigned.
e. The step method is a hybrid between the direct and algebraic methods in that while it does
recognize relationships among support departments, it does so only partially.
4. Algebraic Method of Allocation
a. The algebraic method considers all interrelationships of the departments and reflects these
relationships in simultaneous equations.
b. Text Exhibit 13.14 (p. 517) presents the allocation proportional relationships for ASC’s
support departments.
c.

The simultaneous equations are developed in the text narrative and text Exhibit 13.15 (p.
518) presents the resulting allocations.

d. The algebraic method can be solved manually if the company has only a few departmental
interrelationships. However, a computer is needed if numerous variables are present.
5. Determining Overhead Application Rates
a. Regardless of the method used to allocate support department costs, the final step is to

determine the overhead application rates for the operating areas.
b. After support department costs have been assigned to production, they are included as part
of production overhead and allocated to products or jobs through normal overhead
assignment procedures.
c.

As shown in text Exhibit 13.16 (p. 518), the total allocated overhead costs of ASC’s two
operating areas will be divided by an appropriate overhead allocation base to assign both
manufacturing and non-manufacturing overhead to products.

6. In conclusion, allocating support department costs to operating divisions makes managers more
aware of, and responsible for, controlling support service usage.
a. However, if such allocations are made, evaluation of the operating manager’s performance
should exclude these allocations. While operating managers can control their usage of
support services, they cannot control the actual incurrence of support department costs.
b. An alternative to using cost allocation to assign support costs to operating units is to use a
transfer pricing system.

LO.6: What types of transfer prices are used in organizations, and why are such prices used?
G. Transfer Pricing
1. General

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a. Transfer prices are internal charges established for the exchange of goods or services
between organizational units of the same company.
b. Transfer prices may be established to promote goal congruence, make performance
evaluation among segments more comparable, to transform a cost center into a profit center,
and/or to motivate managers and make them more entrepreneurial.
c.

A pseudo-profit center is created when one responsibility center uses a transfer price to
artificially “sell” goods or services to another responsibility center: The selling center has
artificial revenues and profits, and the buying center has an artificially inflated product or
service cost.

d. The appropriate transfer price should be one that ensures optimal resource allocation and
promotes operating efficiency.
i.

Text Exhibit 13.17 (p. 520) presents the advantages of transfer prices for services
between organizational units.

e. The general rules for choosing a transfer price are as follows:

f.

i.

the maximum price should be no higher than the lowest market price at which the buying
segment can acquire the goods or services externally; and

ii.

the minimum price should be no less than the sum of the selling segment’s incremental
costs associated with the goods or services plus the opportunity cost of the facilities
used;

The difference between the upper and lower transfer price limits is the corporate profit (or
savings) generated by producing internally rather than buying externally.
i.

Transfer prices act to divide the corporate profit between the buying and selling
segments.

ii.

While divided profits are eliminated for external reporting purposes, leaving only the
actual cost of the items on balance sheets or income statements, divided profits can be
extremely important for internal reporting where unit managers compete.

iii. The supplier-segment manager tries to obtain the highest transfer (selling) price, whereas
the buying-segment manager tries to acquire the goods or services at the lowest transfer
(purchase) price.
2. Types of Transfer Prices
a. There are three traditional types of transfer prices: cost based, market based, and negotiated.
b. Text Exhibit 13.18 (p. 521) lists some questions that should be addressed for each type of
transfer price.
c.

Cost-Based Transfer Prices
i.

A cost-based transfer price is equal to total unit absorption cost, variable cost, or modified

variable and/or absorption cost.

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

ii.

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If only variable costs are used to set a transfer price, the selling division has little
incentive to sell to another internal division because no contribution margin is generated
on the transfer to help cover fixed costs.

iii. Transfer prices based on absorption cost at least provide a contribution toward covering
the selling division’s fixed production overhead.
iv. Modifications may be made to address various issues associated with cost-based
transfer prices.


When variable cost is used as a base, an additional amount can be added to cover
some fixed costs and provide a measure of profit to the selling division (i.e., a costplus arrangement).



Absorption cost can be modified by adding an amount equal to an average of the
non-production costs associated with the product and/or an amount for profit to the
selling division.



Because actual costs can vary according to the season, production volume, and
other factors, standard costs which can be specified in advance and are stable
measures of efficient production costs, provide a superior basis for transfer pricing.

d. Market-Based Transfer Prices
i.

A market-based transfer price is believed to be an objective, arm’s-length measure of
value that simulates the selling price that would be offered and paid if the subunits were
independent companies.

ii.

If operating efficiently relative to the competition, a selling division should be able to show
a profit when transferring products or services at market prices. Similarly, an efficiently
operating buying division would have to pay market price if the alternative of buying
internally did not exist.

iii. Several problems can be associated with the use of market-based transfer prices:


transferred products may have no exact counterpart in the external market, which
means there will be no established market price;



internal sales can reduce packaging, advertising, or delivery expenditures and

eliminate bad debts thereby making market prices inappropriate;



temporary downturns in market demand could result in the transfer price being set at
an artificially depressed price which could result in inappropriate performance
evaluation of the division; and



when different prices, discounts, and credit terms are offered to different buyers,
there is a question of what market price to use.

e. Negotiated Transfer Prices
i.

Negotiated transfer prices are often set through a process of bargaining between the
selling and purchasing unit managers.

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

ii.

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Such prices are typically below the normal market price paid by the buying unit but above

the selling unit’s combined incremental and opportunity costs.


If internal sales would eliminate any variable selling costs, such costs are not
considered.



If external sales do not exist or a division cannot downsize its facilities, no opportunity
cost is involved.

iii. Negotiated transfer prices are often used for services because their value—as shown
through expertise, reliability, convenience, or responsiveness—is often qualitative and
can be assessed only judgmentally from the perspective of the parties involved.


Negotiated transfer prices are commonly used for customized high-cost and highvolume services such as risk management and specialized executive training.

iv. When segment managers have the autonomy to sell or buy products externally if internal
negotiations fail, dysfunctional behavior and suboptimization are possible. Top
management may need to provide a means of arbitrating a price in the event that the
units cannot agree.
f.

Dual Pricing
i.

A dual pricing arrangement is a transfer pricing system that allows the selling division
to record the transfer of goods or services at a market or negotiated market price and the
buying division to record the transfer at a cost-based amount.

ii.

Dual pricing eliminates the problem of having to artificially divide the profits between the
selling and buying segments and allows managers to have the most relevant information
for decision making and performance evaluation.

3. Selecting a transfer pricing system
a. The final determination of what transfer pricing system to use should reflect the
circumstances of the organizational units and corporate goals; no one method of setting a
transfer price is best in all instances.
b. Transfer prices are not permanent; they are frequently revised in relation to changes in costs,
supply, demand, competitive forces, and other factors.
c.

Regardless of what transfer pricing system is used, transfer prices have the potential for both
positive and negative outcomes (Refer to the text for a comparison of bad and good
outcomes).

LO.7: What difficulties can be encountered by multinational companies using transfer prices?
H. Transfer Prices in Multinational Settings
1. The setting of transfer prices for products and services becomes quite difficult when the company
is engaged in multinational operations due to differences in tax systems, customs duties, freight
and insurance costs, import/export regulations, and foreign exchange controls.

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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a. In addition, as shown in text Exhibit 13.20 (p. 525), the internal and external objectives of
transfer pricing policies differ in multinational entities.
2. Transfer pricing policies should be followed consistently.
a. For example, a company should not price certain parent company services to foreign
subsidiaries in a manner that would send the majority of those costs to the subsidiary in the
country with the highest tax rate unless that method of pricing is reasonable and equitable to
all subsidiaries.
b. The general test of reasonableness is that a transfer price should reflect an arm’s-length
transaction.
c.

As indicated in text Exhibit 13.19 (p. 524) Individuals who represent numerous discipline
areas should be involved in establishing a transfer pricing system.

3. Tax authorities in both the home and host countries carefully scrutinize multinational transfer
prices because such prices determine which country taxes the income from the transfer.
a. In the U.S., the IRS can be quick to investigate U.S. subsidiaries that operate in low-tax areas
and have unusually high profits.
4. Advance pricing agreements (APAs) are binding contracts between the IRS and a company
that provide details of how transfer prices are to be set and establish that no adjustments or
penalties will be made provided agreed-upon methodologies are used.
a. These agreements usually run for three to five years and may be renewed if no major
changes occur.
b. APAs also help eliminate the possibility of double taxation on the exchange of goods or
services.
c.

One disadvantage of seeking an APA is that several years typically pass before it acquires
approval from the IRS.

d. An important advantage is that APAs may fulfill documentation requirements under the
Sarbanes-Oxley Act to substantiate “proper allocation of revenues and expenses” making the
“development of effective, SOX-compliant internal controls more attainable and acceptable.”
5. Transfer pricing audits by tax authorities are becoming the rule rather than the exception.
6. More countries are adopting transfer pricing legislation and, as multinational enterprises (MNEs)
begin doing business in a new country, they must comply with that country’s tax requirements
relative to transfer pricing.
a. The Organization for Economic Cooperation and Development (OECD) has been actively
involved in helping establish internationally accepted procedures for APAs.
i.

In 2007, the European Community adopted OECD recommended guidelines to "simplify
or prevent costly and time-consuming tax examinations into the transactions included in
the APA", and eliminate double taxation.

7. Multi-state firms can also employ transfer pricing strategies to move profits from state to state.

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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a. Firms can take advantage of different income tax rates across states and the fact that a few
states impose no income taxes at all.

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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Multiple Choice Questions
1. (LO.1) Select the incorrect statement concerning decentralization.
a. When top management delegates decision-making authority to subunit managers,
decentralization exists.
b. The degree of centralization can be viewed as a continuum.
c. Decentralized companies often centralize certain functions such as the treasury function.
d. When functions and the decision-making authority for those functions are delegated, top
management no longer retains any responsibility for those functions.
2. (LO. 1) All of the following are advantages of decentralization except:
a. reduces decision-making time.
b. helps top management recognize and develop managerial talent.
c. requires less communication between organizational units.
d. All of the above are advantages.
3. LO.2) A responsibility accounting system is the key management control tool in
a. decentralized organizations.
b. centralized organizations.
c. sole proprietorships.
d. none of the above.
4. (LO.2) Which of the following is not a basic control function of a responsibility accounting system?
a. Monitor the differences between planned and actual data at scheduled intervals
b. Prepare a plan and use it to communicate output expectations

c. Exert managerial influence in response to significant differences
d. Insure the company’s books do not get out of balance
5. (LO.3) The men’s shoe department at Macy’s is most likely organized as
a. an investment center.
b. a cost center.
c. a revenue center.
d. none of the above.
6. (LO.3) Select the incorrect statement from the following.
a. Another term for investment center is profit center.
b. Service departments (e.g., maintenance and housekeeping) are commonly organized as cost
centers.
c. Responsibility accounting systems identify, measure, and report on the performance of
responsibility centers and their managers.
d. In most instances, pure revenue centers do not exist because their managers are also
responsible for managing some costs in the center.
7. (LO.4) The following sales data is provided for one of J Company’s products:

Unit Selling Price
Unit sales volume

Budgeted
$10
10,000

Actual
$8
12,000

What was the product’s total revenue variance?
a. $24,000 unfavorable

b. $20,000 favorable
c. $4,000 favorable
d. $4,000 unfavorable

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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8. (LO.5) In allocating the factory utilities support department costs to producing departments, which
one of the following would most likely be used as an activity base?
a. Units of products sold
b. Salary of support department employees
c. Units of electric power consumed
d. Direct materials usage
The next three questions are based on the following information:
M Company wishes to allocate the costs of its support departments, Housekeeping (HK) and
Maintenance (MN) to its production departments, Machining and Finishing. The following
information is provided:

Overhead costs

HK
$35,000

MN
$20,000

Machining
$200,000

Finishing
$100,000

Total
$355,000

The company plans to use budgeted service hours as the allocation base and provides the
following information:
S e r v i c e s P r o v I d e d T o:
HK
MN
Machining Finishing Total
Service provided by HK
—
7,000
21,000
7,000
35,000
Service provided by MN
10,000
—
18,000
12,000
40,000
9. (LO.5) If the direct method of allocating support department costs is used, the total service costs
allocated to the Finishing Department would be:

a. $8,000.
b. $8,750.
c. $12,000.
d. $16,750.
10. (LO.5) If the step-down method of allocating support department costs is used, how much
Maintenance Department costs would be allocated to the Finishing Department if the allocation
process begins with Housekeeping?
a. $7,000
b. $10,800
c. $16,200
d. $20,000
11. (LO.5) If the reciprocal method of allocating service costs is used, what total amount of
Housekeeping costs (rounded to the nearest dollar) will ultimately be allocated to the other
departments?
a. $42,105
b. $35,000
c. $33,684
d. $28,421

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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12. (LO.5) The following information is provided for V Company which has two service departments
(S1 and S2) and two production departments (P1 and P2):

Overhead costs

S1
$10,000

Service provided by S1
Service provided by S2

S2
$15,000

S1
—
15%

P1
$125,000

Services ProvIded
S2
P1
10%
45%
—
40%

P2
$150,000
T o:
P2

45%
45%

Total
$300,000

Total
100%
100%

Select the correct equation for use in allocating S1 costs under the reciprocal method.
a. S1 = $10,000
b. S1 = $10,000 + .15(S2)
c. S1 = $10,000 + .10(S2)
d. S1 = $10,000 + .10(S2) + .45(P1) + .45(P2)
13. (LO.6) Which of the following is not a type of transfer price used by companies that transfer
products or components among sister divisions?
a. Negotiated
b. Market-based
c. Standard-based
d. Cost-based
14. (LO.6) Transfers between units often have lower packaging, advertising, and delivery costs than
similar sales to external customers. This can be a problem for which of the following transfer
pricing systems?
a. Negotiated
b. Market-based
c. Standard-based
d. Cost-based
15. (LO.7) Which of the following is a difficulty encountered by multinational companies?
a. Differences in tax systems, customs duties, freight and insurance costs, import/export

regulations, and foreign-exchange controls
b. The ability to determine what transfer price would be considered reasonable as though
generated in an arm’s-length transaction
c. The increase in transfer pricing audits by tax authorities
d. All of the above are difficulties

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Chapter 13: Responsibility Acctg., Support Dept. Cost Allocations & Transfer Pricing

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Multiple Choice Solutions
1.

d

2.

c

3.

a

4.

d

5.

c

6.

a

7.

d

8.

c

9.

d (CMA Adapted)
HK to Finishing: $35,000 x 7/(21+ 7) = $ 8,750
MN to Finishing: $20,000 x 12/(18+12) = $ 8,000
Total allocation to Finishing
= $16,750

10.

b (CMA Adapted)
HK to MN: $35,000 x (7/35) = $7,000;
Therefore:

MN = $20,000 + $7,000 = $27,000
MN to Finishing: $27,000 x (12/30) = $10,800

11.

a (CMA adapted)
HK = $35,000 + .25MN; MN = $20,000 + .2HK
Therefore:
HK = $35,000 + .25($20,000 + .2MN)
HK = $35,000 + $5,000 + .05HK
.95HK = $40,000
HK = $42,105

12.

b

13.

c

14.

b

15.

d

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publicly accessible website, in whole or in part.