Solution manual accounting 25th edition warren chapter 24

CHAPTER 24
PERFORMANCE EVALUATION FOR
DECENTRALIZED OPERATIONS
DISCUSSION QUESTIONS
1.

In a centralized operation, all major planning and operating decisions are made by top management.
In a decentralized operation, managers of separate divisions or units are delegated operating
responsibility. The division (unit) managers are responsible for planning and controlling the
operations of their divisions. Divisions are often structured around products, customers, or
regions.

2. The department manager of a profit center has responsibility for and authority over costs and
revenues, while the manager of an investment center has responsibility for and authority over
controlling investments in assets as well as costs and revenues.
3. Payroll: Number of checks issued. Accounts payable: Number of invoices paid. Accounts
receivable: Number of sales invoice payments collected. Database administration: Number of
reports generated.
4.

The major shortcoming of using income from operations as a measure of investment center
performance is that it ignores the amount of investment committed to each center. Since
investment center managers also control the amount of assets invested in their centers, they
should be held accountable for the use of invested assets.

5.

A division of a decentralized company could be considered the least profitable, even though
it earned the largest amount of income from operations, when its rate of return on investment
is the lowest. In this situation, the division would be considered the least profitable per dollar
invested in the division because it generated less profit out of each dollar of assets invested.

6. By dividing income from operations by the amount of invested assets, each division is placed
on a comparable basis of income from operations per dollar invested.
7. The balanced scorecard attempts to identify the underlying nonfinancial drivers, or causes, of
financial performance related to innovation and learning, customer service, and internal processes.
In this way, the financial performance may be improved. For example, customer satisfaction is
often measured by the number of repeat customers. By increasing the number of repeat customers,
sales and income from operations can be increased.
8.

The objective of transfer pricing is to encourage each division manager to work in the best
interests of the company. Thus, transfer prices should encourage managers to transfer goods
between divisions if the overall company income can be increased.

9. When unused capacity exists in the supplying division, the negotiated price approach is
preferred over the market price approach.
10.

When using the negotiated price approach to transfer pricing, the transfer price should be less
than the market price but greater than the supplying division’s variable cost per unit.

24-1
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CHAPTER 24

Performance Evaluation for Decentralized Operations

PRACTICE EXERCISES

PE 24–1A
$326,000 over budget ($252,000 + $74,000)

PE 24–1B
$250,000 under budget ($198,000 + $52,000)

PE 24–2A
Northeast Division Service Charge for Travel Department:
$195,750 = 1,800 billed reservations × ($435,000 ÷ 4,000 reservations)
Pacific Division Service Charge for Travel Department:
$239,250 = 2,200 billed reservations × ($435,000 ÷ 4,000 reservations)

PE 24–2B
Retail Division Service Charge for Computer Technology Department:
$118,800 = 1,125 billed hours × ($264,000 ÷ 2,500 hours billed)
Commercial Division Service Charge for Computer Technology Department:
$145,200 = 1,375 billed hours × ($264,000 ÷ 2,500 hours billed)

PE 24–3A

Sales………………………………………………………
Cost of goods sold……………………………………
Gross profit……………………………………………
Selling expenses………………………………………
Income from operations before service
department charges…………………………………
Service department charges…………………………
Income from operations………………………………

Northeast

Pacific

Division

Division

$1,155,000
590,800

$1,204,000
658,000

$ 564,200
231,000

$ 546,000
252,000

$ 333,200
195,750

$ 294,000
239,250

$ 137,450

$

54,750

PE 24–3B

Sales………………………………………………………
Cost of goods sold……………………………………
Gross profit……………………………………………
Selling expenses………………………………………
Income from operations before service
department charges…………………………………
Service department charges…………………………
Income from operations………………………………

Retail

Commercial

Division

Division

$945,000
504,000

$966,000
559,300

$441,000
156,800

$406,700
175,000

$284,200
118,800

$231,700
145,200

$165,400

$ 86,500

PE 24–4A
a.
b.
c.

Profit Margin = $96,000 ÷ $1,200,000 = 8.0%
Investment Turnover = $1,200,000 ÷ $400,000 = 3.0
Rate of Return on Investment = 8.0% × 3.0 = 24%

PE 24–4B
a.
b.
c.

Profit Margin = $36,000 ÷ $720,000 = 5.0%
Investment Turnover = $720,000 ÷ $180,000 = 4.0
Rate of Return on Investment = 5.0% × 4.0 = 20%

PE 24–5A
Income from operations……………………………………………………………………
Less: Minimum acceptable income from operations as a
percent of assets ($450,000 × 10%)……………………………………………………
Residual income……………………………………………………………………………

$90,000
45,000
$45,000

PE 24–5B
Income from operations……………………………………………………………………
Less: Minimum acceptable income from operations as a
percent of assets ($910,000 × 8%)………………………………………………………
Residual income……………………………………………………………………………

$420,000
72,800
$347,200


PE 24–6A
Increase in South (Supplying)
Division’s Income from Operations

(Transfer Price – Variable Cost per Unit)
= × Units Transferred
($52 – $42) × 30,000 units = $300,000

Increase in South (Supplying)
Division’s Income from Operations

Increase in North (Purchasing)
Division’s Income from Operations
Increase in North (Purchasing)
Division’s Income from Operations

=

(Market Price – Transfer Price)
= × Units Transferred

= ($60 – $52) × 30,000 units = $240,000

PE 24–6B
Increase in Pembroke (Supplying)
Division’s Income from Operations

=

($82 – $75) × 15,000 units = $105,000

Increase in Pembroke (Supplying)
Division’s Income from Operations

Increase in Multinomah (Purchasing)
Division’s Income from Operations
Increase in Multinomah (Purchasing)
Division’s Income from Operations

(Transfer Price – Variable Cost per Unit)
× Units Transferred

=

(Market Price – Transfer Price)
= × Units Transferred

= ($90 – $82) × 15,000 units = $120,000


EXERCISES
Ex. 24–1
a.

(a)
(b)
(c)
(d)
(e)
(f)

$192,240
$195,072
$2,832
$592,056
$596,256
$4,848

(g)
(h)
(i)
(j)
(k)
(l)

$592,056
$596,256
$4,200
$1,876,536
$1,876,056
$4,200

Schedules of supporting calculations (answers in italics; the solution requires
working from the department level, up to the plant level, then to the vice president
of production level):
MAQUIRE COMPANY
Budget Performance Report—Vice President, Production
For the Month Ended May 31, 2014
Plant

Budget

Mid-Atlantic Region
West Region
South Region

$ 748,800
535,680

592,056 (g)
$1,876,536 (j)

Actual

$ 747,000
532,800
596,256 (h)
$1,876,056 (k)

Over
Budget

Under
Budget

$1,800
2,880
$4,200 (i)
$4,200 (l)

$4,680

MAQUIRE COMPANY
Budget Performance Report—Manager, South Region Plant
For the Month Ended May 31, 2014
Department

Chip Fabrication
Electronic Assembly

Final Assembly

Budget

Actual

Over
Budget

$192,240 (a)
153,216
246,600

$195,072 (b)
155,232
245,952

$2,832 (c)
2,016

$592,056 (d)

$596,256 (e)

$4,848 (f)

Under
Budget

$648

$648


Ex. 24–1 (Concluded)
MAQUIRE COMPANY
Budget Performance Report—Supervisor, Chip Fabrication
For the Month Ended May 31, 2014
Cost

Budget

Factory wages
Materials
Power and light
Maintenance

b.

$ 47,952
125,280
6,912
12,096
$192,240

Actual

$ 49,200
124,416
8,208
13,248

$195,072

Over
Budget

Under
Budget

$1,248
$864
1,296
1,152
$3,696

$864

MEMO
To: Holly Keller, Vice President of Production
The South Region plant has experienced a budget overrun, while the Mid-Atlantic and
West Region plants have experienced a budget surplus. The budget of the South
Region plant reveals that the Chip Fabrication Department causes the majority
of the budget overrun. The budget for the Chip Fabrication Department indicates
that the budget overrun was caused by a combination of budget overruns in
wages, power and light, and maintenance that exceeded a budget surplus in
materials. The supervisor of the Chip Fabrication Department should investigate
the reasons for the budget overruns in wages, power and light, and
maintenance. It is possible that all three of these budget overruns have the
same cause, such as a need for unplanned overtime or weekend work to meet
schedules.

Ex. 24–2
ENDLESS RIVER CONSTRUCTION COMPANY
Divisional Income Statements
For the Year Ended June 30, 2014
Commercial

Residential

Division

Division

Net sales
Cost of goods sold

$1,083,600
732,200

$595,000
338,940

Gross profit
Administrative expenses

$ 351,400
119,840

$256,060
102,900

$ 231,560
90,048
$ 141,512

$153,160
54,264
$ 98,896

Income from operations before service
department charges
Service department charges
Income from operations


Ex. 24–3
Expense

Activity Bases

a.
b.
c.

Legal
Duplication services
Electronic data processing

d.
e.
f.

Central purchasing
Telecommunications
Accounts receivable

Number of hours
Number of pages
Central processing unit (CPU) time, number of
printed pages, amount of memory usage
Number of requisitions, number of purchase orders
Number of lines, number of minutes
Number of invoices, number of customers

Ex. 24–4
a.
b.
c.
d.

1
4
6
7

e.
f.
g.
h.

8

5
3
2


Ex. 24–5
a.

Number of payroll checks:
Weekly payroll × 52…………
Monthly payroll × 12………
Total………………………
Number of purchase
requisitions per year…………

Residential

Commercial

Government
Contract

13,000
600

6,500
1,200

7,800
720

13,600

7,700

8,520

29,820

3,750

3,125

2,750

9,625

Service
Dept. Cost

Activity
Base

b.

Service department charge rates:
Payroll Department………………………
$119,280
Purchasing Department…………………… $57,750

Residential

Service department charges:
Payroll Department…………

$54,400

1
4

Purchasing Department…… 22,500
$76,900
Total………………………
1

13,600 checks × $4.00 per check

2

7,700 checks × $4.00 per check

3

8,520 checks × $4.00 per check

4

3,750 requisitions × $6.00 per requisition

5

3,125 requisitions × $6.00 per requisition

6

2,750 requisitions × $6.00 per requisition

÷
÷

Commercial

$30,800

÷

2

=

29,820
9,625

$34,080

Charge
Rate

= $4.00/check
= $6.00/req.

Government
Contract

5

18,750
$49,550

Total

3
6

16,500
$50,580

Total

$119,280
57,750

The service department charges are determined by multiplying the service
department charge rate by the activity base for each division.
c.

Residential’s service department charge is higher than the other two divisions
because Residential is a heavy user of service department services. Residential
has many employees on a weekly payroll, which translates into a larger number
of check-issuing transactions. This may be because residential jobs are less

productive per labor hour, compared to larger commercial and government
contract jobs. Additionally, Residential uses purchasing services more than the
other two divisions. This may be because the division has many different
smaller jobs requiring frequent purchase transactions.


Ex. 24–6
a.

Help desk:

Network center:

$735,000
9,800 devices

Electronic mail:

$100,000
10,000 accounts

Local voice support:
b.

$160,000
3,200 calls

= $50 per call

= $75 per device monitored

= $10 per user or e-mail account

$124,600
= $14 per phone extension
8,900 phone extensions

October charges to the COMM sector:
Help desk charge:
(5,200 employees × 25% × 96% × 1.5) × $50/call = $93,600
Network center charge:
[(5,200 employees × 25% × 96%) + 600] × $75/device = $138,600
Electronic mail:
(5,200 employees × 25% × 96% × 100%) × $10/user or e-mail account = $12,480
Local voice support:
(5,200 employees × 25%) × $14/phone extension = $18,200


Ex. 24–7
VAN EMBURGH TECHNOLOGY
Divisional Income Statements
For the Year Ended December 31, 2014
Consumer Division

Commercial Division

Revenues
Cost of goods sold

$5,944,000

3,298,400

$4,947,200
2,500,000

Gross profit
Operating expenses

$2,645,600
1,172,000

$2,447,200
1,236,800

$1,473,600

$1,210,400

Income from operations
before service
department charges
Less service department
charges:
Tech Support Department (Note 1)
Accounts Payable
Department (Note 2)
Income from operations

$422,500
87,040

$253,500
509,540
$ 964,060

168,960

422,460
$ 787,940

Supporting calculations for controllable service department charges:
Note 1:

Consumer Division ($676,000 ÷ 400 computers) × 250 computers = $422,500
Commercial Division ($676,000 ÷ 400 computers) × 150 computers = $253,500

Note 2:

Consumer Division ($256,000 ÷ 10,000 checks) × 3,400 checks = $87,040
Commercial Division ($256,000 ÷ 10,000 checks) × 6,600 checks = $168,960


Ex. 24–8
a. The reported income from operations does not accurately measure performance because
the service department charges are based on revenues. Revenues are not associated
with the profit center manager’s use of the service department services. For example,
the Reservations Department serves only the Passenger Division. Thus, by charging
this cost on the basis of revenues, these costs are incorrectly charged to the Cargo
Division. Additionally, the Passenger Division requires additional personnel. Since
these personnel must be trained, the training costs assigned to the Passenger Division

should be greater than the Cargo Division.
b.
WILD SUN AIRLINES INC.
Divisional Income Statements
For the Year Ended December 31, 2014
Passenger Division

Revenues
Operating expenses
Income from operations
before service department
charges
Less service department
charges:
Training (Note 1)
Flight Scheduling (Note 2)
Reservations (Note 3)
Income from operations

$175,000
86,400
302,400

Cargo Division

$3,025,000
2,450,000

$3,025,000
2,736,000

$ 575,000

$ 289,000

563,800
$ 11,200

$ 75,000
129,600
0

204,600
$ 84,400

Supporting calculations for controllable service department charges:
Training:

Passenger Division, ($250,000 ÷ 500 personnel trained) × 350
personnel trained
Cargo Division, ($250,000 ÷ 500 personnel trained) × 150
personnel trained

Flight Scheduling:

Passenger Division, ($216,000 ÷ 2,000 flights) × 800 flights
Cargo Division, ($216,000 ÷ 2,000 flights) × 1,200 flights

Reservations:

Passenger Division, ($302,400 ÷ 20,000 reservations) × 20,000
reservations
Cargo Division, ($302,400 ÷ 20,000 reservations) × 0 reservations


Ex. 24–9
FULL THROTTLE SPORTING GOODS CO.
Divisional Income Statements
For the Year Ended December 31, 2014

Sales
Cost of goods sold
Gross profit
Divisional selling expenses
Divisional administrative expenses
Income from operations before service
department charges
Less service department charges:
Advertising expense (Note 1)
Transportation expense (Note 2)
Accounts receivable collection expense (Note 3)
Warehouse expense (Note 4)
Total
Income from operations

Winter

Summer

Sports

Division

Sports
Division

$31,500,000
18,900,000
$12,600,000

$36,400,000
21,112,000
$15,288,000

$ 5,040,000
3,150,000
$ 8,190,000

$ 5,096,000
3,239,600
$ 8,335,600

$ 4,410,000

$ 6,952,400

$

$

611,000

285,600
98,400
1,245,500
$ 2,240,500
$ 2,169,500

746,900
309,400
141,600
1,404,500
$ 2,602,400
$ 4,350,000

Supporting Schedule:
Note (1)

Winter Sports Division:
Summer Sports Division:

$611,000
$746,900

Note (2)

Winter Sports Division:
Summer Sports Division:

(20,400 bills of lading × $14.00 per bill of lading)
(22,100 bills of lading × $14.00 per bill of lading)

Note (3)

Winter Sports Division:
Summer Sports Division:

(13,120 invoices × $7.50 per invoice)
(18,880 invoices × $7.50 per invoice)

Note (4)

Winter Sports Division:
Summer Sports Division:

($2,650,000/265,000 sq. ft.) × 124,550 sq. ft.
($2,650,000/265,000 sq. ft.) × 140,450 sq. ft.


Ex. 24–10
a.

Retail Division:
Commercial Division:
Internet Division:

b.

Internet Division

20% ($130,000 ÷ $650,000)
18% ($72,000 ÷ $400,000)

25% ($137,500 ÷ $550,000)

Ex. 24–11
a.

b.

Retail

Commercial

Internet

Division

Division

Division

Income from operations…………………………… $130,000
Minimum amount of income from
operations:
$650,000 × 8%……………………………………
52,000
$400,000 × 8%……………………………………
$550,000 × 8%……………………………………
Residual income…………………………………… $ 78,000

$72,000

$137,500

Internet Division

Ex. 24–12
a.
b.
c.
d.
e.

2.40
16%
10%
2.25
18%

= 12% ÷ 5%
= 8% × 2.00
= 14% ÷ 1.40
= 13.5% ÷ 6%
= 15% × 1.20

32,000
44,000
$40,000

$ 93,500

Ex. 24–13
a.

Rate of Return
on Investment
Rate of Return
on Investment

= Profit Margin × Investment Turnover

=

ROI =

Income from Operations
Sales
$1,750,000
$7,000,000

×

×

Sales
Invested Assets

$7,000,000
$5,000,000

ROI = 25% × 1.40

ROI = 35%
b.

The profit margin would increase from 25% to 30%, the investment turnover
would remain unchanged, and the rate of return on investment would increase
from 35% to 42%, as shown below.
Rate of Return
on Investment

= Profit Margin × Investment Turnover

Rate of Return
=
on Investment
ROI =

Income from Operations
Sales
$2,100,000 *
$7,000,000

ROI = 30% × 1.40
ROI = 42%
* $1,750,000 + $350,000

×

$7,000,000
$5,000,000

×

Sales
Invested Assets


Ex. 24–14
a.

Rate of Return
=
on Investment

Media Networks:

Income from Operations
Revenues

$6,146

×

$18,714

×

Revenues
Invested Assets

$18,714

$27,244

= 32.8% × 0.69
= 22.6% (rounded)

Parks and Resorts:

$1,553

×

$11,797

$11,797
$19,530

= 13.2% × 0.60
= 7.9% (rounded)

Studio Entertainment:

$618

×

$6,351

$6,351
$12,221

= 9.7% × 0.52
= 5.0% (rounded)

Consumer Products:

$816

×

$3,049

$3,049
$4,992

= 26.8% × 0.61
= 16.3% (rounded)
b.

The four sectors are different from each other. Media Networks combines a good profit
margin with a very low investment turnover. Media Networks is sensitive to advertising
revenue, while the Studio Entertainment sector is sensitive to producing box office hits.
The Parks and Resorts sector has a good profit margin at 13.2% with a fairly low
investment turnover. The combination produces a respectable ROI of 7.9%. Studio
Entertainment has a weak profit margin and a weak investment turnover generating only
a 5% return on investment. The Consumer Products division combines a good profit
margin with a good investment turnover. The combination produces a sound ROI of
16.3%.


Ex. 24–15

a.
b.
c.
d.
e.
f.

25.0% ($215,000 ÷ $860,000)
$146,200 ($860,000 × 17%)
$68,800 ($215,000 – $146,200)
$97,200 ($70,200 + $27,000)
18.0% ($97,200 ÷ $540,000)
13.0% ($70,200 ÷ $540,000)

g.
h.
i.
j.
k.
l.

$64,000 ($320,000 × 20%)
15.0% ($48,000 ÷ $320,000)
$16,000 ($64,000 – $48,000)
20.0% ($92,000 ÷ $460,000)
$73,600 ($460,000 × 16%)
$18,400 ($92,000 – $73,600)

Ex. 24–16
a.

(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)

$60,000 ($750,000 × 8%)
$300,000 ($60,000 ÷ 20%)
2.5 (20% ÷ 8%) or $750,000 ÷ $300,000
$630,000 ($75,600 ÷ 12%)
$350,000 ($630,000 ÷ 1.8)
21.6% (12% × 1.8)
$50,400 ($280,000 × 18%)
6.0% ($50,400 ÷ $840,000)
3.0 ($840,000 ÷ $280,000)
18.0% ($99,000 ÷ $550,000)
9.0% ($99,000 ÷ $1,100,000)
2.0 ($1,100,000 ÷ $550,000)

b.

North Division:

South Division:
East Division:
West Division:

c.

(1)
(2)

$30,000
$40,600
$22,400
$44,000

[$60,000
[$75,600
[$50,400
[$99,000

– ($300,000
– ($350,000
– ($280,000
– ($550,000

× 10%)]
× 10%)]
× 10%)]
× 10%)]

The South Division has the highest return on investment (21.6%).

The West Division has the largest residual income.


Ex. 24–17
Rate of Return
=
on Investment

a.

Hotel Ownership:

Income from Operations
Revenues
$571

×

$4,383

×

Revenues
Invested Assets

$4,383
$6,440

= 13.0% × 0.68
= 8.8% (rounded)

Vacation Ownership:

$105

×

$688

$688
$2,139

= 15.3% × 0.32
= 4.9% (rounded)
b.

Hotel

Ownership

Income from operations………………………………
Less: Minimum return (5% of assets)……………
Residual income (loss)………………………………

Vacation
Ownership

$571
322 *

$105
107 **

$249

$ (2)

* $6,440 × 5%
** $2,139 × 5%
c.

The Vacation Ownership (VO) segment has the weakest return on investment,
which is mainly the result of a weak investment turnover. The VO segment earns
profit margins that are higher than the profit margins in the Hotel Ownership (HO)
segment (15.3% vs. 13.0%). However, weak investment turnover is causing the ROI
for the VO segment to be less than the assumed minimum acceptable return.
The residual income is negative for VO, which is consistent with a ROI less than the
acceptable 5% minimum return. This weak performance is due primarily to the
deterioration in the real estate market that has occurred in recent years. The
profit margin and investment turnover in the VO segment are closely tied to the
strength of the real estate market and the overall economy, both of which
deteriorated significantly in the preceding years.
The HO segment ROI is also affected by the global economy, but is still generating
a solid ROI. Stable profit margins and investment turnover generate a ROI that is
above the minimum acceptable return. The residual income is positive, which is
consistent with a ROI that is greater than the 5% minimum return.


Ex. 24–18
Although there is some judgment in classifying each of these measures, the following

represents the author’s assessment with explanations:
Average card member spending

Customer—demonstrates the usefulness of
the card to the customer.

Cards in force

Customer—if customers did not value the
card, they would not have one.

Earnings growth

Financial

Hours of credit consultant training

Internal process—advisors will do their job
better if they are trained.

Investment in information technology

Internal process (or innovation)—shows the
investment in improving processes.

Number of Internet features

Internal process (or innovation)—shows new
process investments in a new channel.

Number of merchant signings

Customer—the larger the number of
merchants that honor the card, the more
valuable it is to cardholders.

Number of card choices

Customer—more choices are more valuable
to customers.

Number of new card launches

Innovation—measures the new cards
(affinity, regional, etc.) being developed and
marketed.

Return on equity

Financial

Revenue growth

Financial


Ex. 24–19
a.

UPS wanted a performance measurement system that would focus more on

the underlying drivers, or levers, of financial success. It believed that focusing on
the financial numbers by themselves would not reveal how financial objectives
were to be achieved, especially with new demands coming from customers in the
Internet age. The balanced scorecard provides information on how the financial
targets are to be achieved. Using common measures throughout the organization
also aligns the organization, while simultaneously communicating priorities.
Apparently, UPS determined that its future success as an organization depended
on “point of arrival” measures. These measures emphasized customer
performance to a much higher degree than would straight financial numbers.

b.

The employee sentiment number is common in service businesses. The
employees are the face of the company to the customer. If employees feel poorly
about the organization, or if they feel that they don’t make a difference, then they
are not likely to deliver premium service experiences to their customers. Just
think of the variety of fast food experiences you may have had in the past month.
Sometimes, the service is excellent with a smile; at other times, it’s poor with a
scowl. Measuring the improving employee morale is critical to organizations
relying on front-line employees that deliver the customer experience.

Ex. 24–20
a.

b.

c.

Increase in Dart Industries’

Market

Variable Cost

Unit

Income from Operations

=

Price

–

per Unit

×

Transferred

$2,200,000

=

($180

–

$125)

×

40,000

Increase in the Instrument Division’s

Market

Transfer

Unit

Income from Operations

=

Price

–

Price

×

Transferred

$1,400,000

=

($180

–

$145)

×

40,000

Increase in the Components Division’s

Transfer

Variable Cost

Unit

Income from Operations

=

Price

–

per Unit

×

Transferred

$800,000

=

($145

–

$125)

×

40,000


Ex. 24–21
a.

Increase in Dart Industries’
Income from Operations

=

Market
Price

$2,200,000

=

($180

Variable Cost
–

per Unit

×

Units
Transferred

–

$125)

×

40,000

This amount is the same amount by which Dart Industries’ income from
operations increased in Ex. 24–20, when a transfer price of $145 was used.
b.

Increase in the Instrument Division’s

Market

Transfer

Units

Income from Operations

=

Price

–

Price

× Transferred

$880,000

=

($180

–

$158)

×

40,000

This is the amount the Instrument Division saves by purchasing from the
Components Division at an internal price that is lower than the market price.
c.

Increase in the Components Division’s

Transfer

Variable Cost

Units

Income from Operations

=

Price

–

per Unit

×

$1,320,000

=

($158

–

$125)

×

Transferred

40,000

This is the amount the Components Division earns by using available excess capacity
to produce and sell products above variable cost to the Instrument Division.
d.

Any transfer price will cause the total income of the company to increase,
as long as the supplier division capacity is used toward making materials for
products that are ultimately sold to the outside. However, transfer prices should
be set between variable cost and selling price in order to give the division
managers proper incentives. A transfer price set below variable cost would
cause the supplier division to incur a loss, while a transfer price set above
market price would cause the purchasing division to incur opportunity costs.
Neither situation is an attractive alternative for an investment center manager.
Thus, the general rule is to negotiate transfer prices between variable cost and
market price when the supplier division has excess capacity. The range of
acceptable transfer prices for Dart Industries would be between $180 and $125.


PROBLEMS
Prob. 24–1A
E-NET COMPANY

Budget Performance Report—Director, Consumer Products Division
For the Month Ended January 31, 2014

1.

Customer service salaries
Insurance and property taxes
Distribution salaries
Marketing salaries
Engineer salaries
Warehouse wages
Equipment depreciation
Total
2.

Budget

Actual

$ 390,600
81,900
623,100
734,550
597,750
418,650
131,280
$2,977,830

$ 500,040
79,440

616,800
822,600
585,720
401,880
131,250
$3,137,730

Over
Budget

Under
Budget

$109,440
$ 2,460
6,300
88,050

$197,490

12,030
16,770
30
$37,590

The customer service and marketing salaries are significantly over budget. The
director should investigate the cause of these results. One possibility is that the
company is having an increase in sales, requiring greater marketing effort and
customer service. However, the warehouse and distribution costs have not
shown similar increases. Thus, it’s also possible that marketing and customer

service salaries are increasing because of service problems and unplanned
efforts to market the company’s service.


Prob. 24–2A
1.
TRAXONIA RAILROAD INC.
Divisional Income Statements
For the Quarter Ended December 31, 2014
East

West

Central

Revenues
Operating expenses

$870,000
563,300

$1,032,000
618,240

$1,872,000
1,166,940

Income from operations before service
department charges

$306,700

$ 413,760

$ 705,060

$100,000
67,500
$167,500
$139,200

$ 120,000
108,000
$ 228,000
$ 185,760

$ 180,000
94,500
$ 274,500
$ 430,560

Less service department charges:
Customer Support (Note A)
Legal (Note B)
Income from operations
Supporting Schedule:

Service department charge rates for the two service departments, Customer
Support and Legal, are determined as follows:

Number of customer contacts……
Number of hours billed……………

East

West

5,000
1,350

6,000
2,160

Central

9,000
1,890

Note (A)

East Division:
West Division:
Central Division:

($400,000/20,000 contacts) × 5,000 contacts
($400,000/20,000 contacts) × 6,000 contacts
($400,000/20,000 contacts) × 9,000 contacts

Note (B)

East Division:
West Division:
Central Division:

($270,000/5,400 hours) × 1,350 contacts
($270,000/5,400 hours) × 2,160 contacts
($270,000/5,400 hours) × 1,890 contacts

Note: The Shareholder Relations Department and general corporate officers’
salaries are not controllable by division management and thus are not included
in determining division income from operations.

Total

20,000
5,400


Prob. 24–2A (Concluded)
2.

The CEO evaluates the three divisions using income from operations as a
percent of revenues (profit margin). This measure is calculated for the three
divisions as follows:
East Division:
West Division:
Central Division:

16% ($139,200 ÷ $870,000)
18% ($185,760 ÷ $1,032,000)

23% ($430,560 ÷ $1,872,000)

According to the CEO’s measure, the Central Division has the highest
performance.
3.

To: CEO
The method used to evaluate the performance of the divisions should be
reevaluated. The present method identifies the amount of income from
operations per dollar of earned revenue. However, this company requires a
significant investment in fixed assets, for production and distribution facilities.
The amount of assets may not be related to the revenue earned. The present
measure fails to incorporate these differences in asset utilization into the measure.
Naturally, the amount of assets used by a division in earning a return is a very
important consideration in evaluating divisional performance. Therefore, a better
divisional performance measure would be either (a) rate of return on investment
(income from operations divided by divisional assets) or (b) residual income (income
from operations less a minimal return on divisional assets). Both measures
incorporate the assets used by the divisions.


Prob. 24–3A
E.F. LYNCH COMPANY
Divisional Income Statements
For the Year Ended June 30, 2014

1.

Fee revenue
Operating expenses

Income from operations
2.

Mutual

Electronic

Investment

Fund
Division

Brokerage
Division

Banking
Division

$4,140,000
2,980,800
$1,159,200

$3,360,000
3,091,200
$ 268,800

$4,560,000
3,739,200
$ 820,800

Rate of Return
= Profit Margin × Investment Turnover
on Investment
Rate of Return
on Investment

=

Mutual Fund Division:

Income from Operations
Sales
$1,159,200

ROI =

×

$4,140,000

$4,140,000
$5,175,000

ROI = 28.0% × 0.80
ROI = 22.4%
Electronic Brokerage Division:

$268,800

ROI =

×

$3,360,000

$3,360,000
$1,120,000

ROI = 8.0% × 3.00
ROI = 24.0%
Investment Banking Division:

$820,800

ROI =
$4,560,000
ROI = 18.0% × 1.20
ROI = 21.6%

×

$4,560,000
$3,800,000

×

Sales
Invested Assets

Prob. 24–3A (Concluded)
3.

Per dollar of invested assets, the Electronic Brokerage Division is the most
profitable of the three divisions. Assuming that the rates of return on
investments do not change in the future, an expansion of the Electronic
Brokerage Division will return 24 cents (24%) on each dollar of invested assets,
while the Mutual Fund and Investment Banking divisions will return only 22.4
cents (22.4%) and 21.6 cents (21.6%), respectively. Thus, when faced with limited
funds for expansion, management should consider an expansion of the
Electronic Brokerage Division first.
Note to Instructors: The Mutual Fund Division has excellent profit margins, but the
investment turnover is very low. The investment in the “bricks and mortar” of
the Mutual Fund Division offices causes the rate of return on investment to be
depressed. However, the Electronic Brokerage Division has very thin margins
because the fees earned per trade are very small. However the assets required
to execute trades are much less than the Mutual Fund Division because there is no
need for offices (trades are executed over the Internet). As a result of the high
investment turnover in the Electronic Brokerage Division, the rate of return on
investment is much better.