Solution manual cost and managerial accounting by barfield 3rd responsibility accounting and transfer pricing in decentralized organizations

Chapter 21
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Questions
1.

The extent to which decision-making responsibility is distributed
throughout an organization determines whether a firm is centrally or
decentrally organized. Decentralization refers to the end of the
continuum where decision making is widely dispersed; centralization
refers to the end of the continuum where decision making is made only
by top management.
Exhibit 18-1 reflects criteria that help to determine whether a
company should be decentralized. These characteristics are:
* Mature in age
* Large size
* Product development in a growth stage
* Rapid firm growth rate
* Low expected impact on profits of incorrect decisions
* High confidence in subordinates' abilities
* Less rigorous historical degree of top management control

2.

Even companies that are thought to be highly decentralized for most
functions will often perform some functions centrally. Some functions
which may be better handled centrally are:

* Capital project approval
* Cash management
* Inventory control
* Evaluation of division profitability
Thus, most firms are neither purely centralized nor purely
decentralized; rather, they have decision making activities that fit
in both categories.

219
219


220

3.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Four potential advantages of decentralization are:
* Executive training and development
* Job satisfaction
* Effectiveness and speed of decision making by local
managers with intimate knowledge of problems
* "Management by exception principle" frees top management
time
Three potential disadvantages of decentralization are:
* Suboptimization
* Disruption because top management has difficulty in
relinquishing control

* Potentially high costs of incorrect decisions by
subordinates

4.

Functions that are better
handled centrally
* Capital project approval

*

Cash management

Reasons
1) Major costs for long-term
commitments
2) Specialized knowledge
3) Need for coordination in the
selection and funding of
major projects
1) Cash and investment funds
are managed more efficiently
if they are pooled
2) When funds are needed,
tradition and good business
dictate that they are
acquired at the firm level

and allocated to segments as
needed

3) Cash is the most vulnerable
asset and merits tight
central control
* Inventory control

1) Inventory, being a near-cash
asset, is subject to theft
and misappropriation. Its
control is also crucial to
efficient and effective
production, delivery and
customer relations

* Evaluation of divisional
profitability

1) Top management must reward or
penalize division managers as
a matter of appropriate organizational hierarchical
prerogatives


5.

Chapter 18
221
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
The process of implementing or utilizing a decentralized
organizational structure can cause costs to be incurred. The

following are potential costs of decentralization:
* suboptimization,
* conflict created because top management cannot or will not
relinquish authority,
* significant adverse consequences of incorrect decisions by
subordinates, and
* a more expensive control system is required.
These costs can be minimized through effective training and,
if decentralization is to be effective, should be less than
the benefits derived from the use of such a structure.

6.

Decentralization is the degree to which decision-making
authority is delegated downward in an organization. Accounting
reports should be prepared to reflect how managers of
significant segments of the organization perform relative to
the authority delegated to them. The responsibility accounting
system must be kept in sufficient detail to permit segment
reporting.

7.

The two basic functions of responsibility reports are to:
* Provide operational managers with information needed for
planning, controlling, and decision making for their areas
of responsibility.
* Assist top managers in evaluating how well operational
managers fulfilled their responsibilities to the
organization.

8.

It is sometimes appropriate for a company to prepare a single
responsibility report for a division. However, many companies
prepare two different responsibility reports for a division:
one report, which is used to evaluate a manager's performance,
shows only the costs controllable by that manager; the other
responsibility report shows all costs incurred by and assigned
to the division so that a notion of the total performance of
the division can be gained. If the latter report can be
subdivided into controllable and noncontrollable costs of the
division manager, then one report can effectively accomplish
both purposes.

9.

Total amounts for actual costs, budgeted costs, and variances
of lower organizational levels are successively consolidated
in the performance reports of progressively higher-level
managers who are responsible for the results of the lowerlevel segments. Thus, the report for the higher-level manager
includes the direct costs of his/her segment and the total
costs incurred by lower-level segments which report to that
manager.


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10.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
The goal of measuring performance is to objectively capture
achievement of the organization's goals. To achieve goals,
firms identify critical success factors. Some critical
success factors are more easily measured in nonmonetary units
rather than monetary units. Examples of such factors include:
customer satisfaction, throughput, and product quality.

11.

The four types of responsibility centers are cost, revenue,
profit, and investment centers. Cost centers focus primarily
on costs. Revenue centers focus primarily on revenues. Profit
centers focus on both revenues and costs. Investment centers
focus on both profits and the investment base that is utilized
to generate those profits.

12.

While salaries are not the primary focus of a revenue center
report, they may, nonetheless, be included if the revenue
center manager has significant control over labor rates and/or
labor schedules.

13.

Suboptimization is a condition whereby individual managers
work to achieve results that are in their own best interests

and that of their segments to the detriment of the overall
company. Top managers must guard against such behavior of
subordinates when authority is delegated to them in a
decentralized setting. Suboptimization results from segment
managers’ motivation to appear successful and gain rewards and
recognition. Sometimes, this motivation overrides the best
interests of the company.

14.

Service departments are internal departments that provide
goods/services to other internal departments. Service
departments typically provide few, if any, services to
external constituents. Examples of service departments
include training, personnel, accounting, electronic data
processing, and legal services. Service departments are
distinguished from operating departments in that service
departments do not directly make products for external buyers,
but instead, serve those departments that produce goods and
services that are sold to external consumers.


15.

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Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Service department costs may be allocated to revenue-producing
departments for a variety of reasons. Several of the more

common reasons include the following: to encourage managers
to use support areas in the most cost-beneficial manner; to
make performance comparisons with independent organizations;
to determine the full cost of production to make fair and
acceptable pricing decisions; and to support decision making.
(These are all enumerated in Exhibit 18-6.) Such allocations
are not always useful from a decision-making standpoint
because the allocations bring costs that are uncontrollable by
a department into that department.

16.

In addition to allocating service department costs to obtain a
full cost of products or other cost objects, there are
behavioral consequences associated with allocating service
department costs. Generally, managers become more sensitive
to the support provided by the service area, which leads them
to utilize this resource in a more cost-beneficial way and to
recommend cost control improvements to the service department.
However, such cost allocations can cause dysfunctional
behavior if the manager of the revenue-producing area
perceives the cost allocation to be unfair.

17.

The four criteria (benefits received, causation, equity, and
ability to bear) are all relevant to making service department
allocations and should, theoretically, be applied equally.
However, it is often not practical to apply the equity
criterion because it is too difficult to achieve agreement on

what is fair. Ability to bear is often not used because it
results in unrealistic or profit-detrimental actions.
Therefore, most service department allocations are based on
the benefits-received and causation criteria.

18. The direct method is the only method that does not allocate a
service department's costs to other service departments. The
step method does make such an allocation, but does so
sequentially based on a benefits-provided ranking. The
algebraic method, unlike the other methods, recognizes
reciprocal (give-and-take) exchanges of services among the
service departments by providing a set of simultaneous
equations to solve for the effects of such interchanges.
The only similarity among the methods is their ultimate
objective - the assignment of service department costs to
revenue-producing areas.


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Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
19. The direct method of allocating service department costs is
the simplest method of allocation. It does not take into
consideration services exchanged among service departments,
however. The step method does take into consideration
services used between service departments, but only after a
benefits-provided ranking order has been established. Because
of the necessity to rank services, all service department

interaction is not accounted for using the step method. This
method is more difficult than the direct method, but less
difficult than the algebraic method. The algebraic method of
allocating service department costs considers the
interrelationships of all departments through the use of
simultaneous equations. This method is very difficult to use
without the aid of a computer, however, when more than two or
three departments are involved. The algebraic method does
provide the best measure of the usage of costs among
departments.
20.

A benefits-provided ranking is necessary under the step method
of allocating service department costs because, once costs are
assigned out of an area, they cannot be reassigned to that
area. The method requires the allocation process to begin with
the area that provides the most service to all other areas and
end with the area that provides most of its services only to
revenue-producing departments. In this manner, some, but not
all, service interrelationships are considered. Such a
ranking is not necessary in the algebraic method because all
interrelationships among departments are considered.

21.

The added costs are fictional and are caused by the
cross-allocation process of solving simultaneous equations.
These fictional costs are ignored in the revenue-producing
areas for the purpose of developing an overhead application
rate.

22.

Computer technology has reduced the burden of making the
calculations that are required to solve simultaneous
equations. The computer handles such calculations at very low
cost and a high level of precision.

23.

Transfer prices are internally set (agreed on) prices with
which a “selling” division transfers goods or services to a
“buying” division. The objectives are goal congruence,
autonomy, motivation toward effectiveness and efficiency,
practicality, and credibility as a basis for performance
evaluation.


24.

Chapter 18
225
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Type of Center
Recommended Type of Transfer Price & Usage
Cost-Selling
Cost-based: consistent with objective of
Segment
this type of center; this use is a way of

allocating the center's cost to other
centers.
Cost-Buying
Segment

Preferably cost based: consistent with
this type of center; however, depending on
the demands of the selling segments, the
transfer price could be anywhere between
the lower limit (incremental costs plus
opportunity cost of facilities) and the
upper limit (lowest market price the buying segment would have to pay externally);
the services or materials received by the
center will be carried at the transfer
price at their cost for internal reporting
purposes.
Revenue-Selling
Segment

Market price: consistent with this type of
center; revenue from transfers of goods or
services is recorded at the transfer price
for internal reporting purposes.

Revenue-Buying
Segment

Goods or services transfer prices should
be between the lower and upper limits with
the lower limit giving this segment the

greatest gross margin on its internal
sales; whatever transfer price is
chosen is the cost of goods or services
purchased for this segment for internal
reporting.
Profit or
Investment
Centers-Selling
Segment

Transfer prices should be set between the
lower and upper limits; since these types
of centers are supposed to earn a profit,
their managers will try to negotiate a
price closer to the upper limit; whatever
price is set becomes the revenue measure
for internal sales for internal reporting
purposes.

Profit or
Investment
Centers-Buying
Segment

Transfer prices should fall between lower
and upper limits with managers of these
segments arguing for prices closer to the
lower limits to afford their segments the
highest gross margin; whatever price is
set becomes the cost of goods or services

acquired by the center for internal reporting purposes.


226

25.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
In negotiating transfer prices among segment managers, the
managers are expected to work together to (1) make choices
that will maximize the efficiency and effectiveness of their
respective divisions and (2) to contribute to overall company
performance. For example, when it is in the best interest of
the whole company for a buying division to purchase goods or
services internally from a selling division, segment managers
are expected to agree on a price to encourage this. If top
management has properly trained, motivated, and evaluated
these segment managers, the transfer price can be a device to
promote such goal congruence.
In contrast, sometimes segment managers become myopic in
their zeal to maximize the apparent performance of their own
divisions. For example, sometimes a buying segment manager
will choose to buy externally at a price lower than the
transfer price because it makes his division look better even
though analysis would reveal that the whole company would do
better were the acquisitions made internally. This is an
example of suboptimization.

26.

The upper limit is the lowest external market price for the
product because this measures the amount for which the buying
segment could acquire the product. The lower limit is the sum
of the incremental costs of producing the product plus the
opportunity cost of the facilities used; this is what the
selling segment sacrificed to make the product.

27.

Standard cost has the advantage of being known or agreed on in
advance and of being a measure of efficient production. Actual
cost may vary widely from month to month because of large
changes in production volume, seasonal variations, and
efficiencies.

28.

The biggest problem involves the definition and what is
included in the term "cost." Cost can mean any of the
following: incremental or variable; absorption (product costs
only); and absorption plus some portion of the segment's
nonproduction costs (selling and administrative). An amount
for estimated opportunity costs for use of the facilities can
be added to any of the above. In some cases, arguments can be
made for reducing absorption costs by estimated savings in
production or distribution costs on internal sales.
Another problem is that if actual costs include
inefficiencies, the transfer prices set on the basis of such

inefficiencies may lead to incorrect management decisions.


29.

Chapter 18
227
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Problems of using market-based transfer prices include
* the possibility that no objective market price is known
because the product has no exact counterpart in the market;
* market price ignores any production or distribution savings
on internally transferred goods; and
* current prices being temporarily nonrepresentative of a
long-run price.

30.

Negotiation can create teamwork and generate creative
solutions that better the whole company. It can, in contrast,
create an unhealthy adversarial climate in which fierce
competition can lead to suboptimization. This creates a
potential for exerting top management leadership to promote
the former situation.

31.

Dual pricing occurs when the selling division is permitted to
record one transfer price (higher) and the buying division to

record another (lower). This practice is intended to minimize
suboptimization and create goal-congruent incentives for both
divisions.

32.

Where (1) user departments have significant control over the
quantity and quality of services used and (2) there is a
reasonable surrogate measure of service benefits provided to
users, transfer prices can be an effective way of promoting
proper use of resources and of reassigning service department
costs. Setting the transfer price depends on (1) the nature of
the service center (cost or profit center) and (2) the nature
of the service itself (can it be acquired externally, is it
recurring and uniform, and is it expensive?).
Advantages of transfer prices over allocation include
* Motivation of user departments to suggest improvements and
monitor usage;
* Inclusion of costs in user department's performance report
(if user department controls the amount of service it
"buys");
* Promotion of services more beneficial to users;
* Requires that transfer prices be justified; and
* Transforms a service department from cost center to profit
center and this provides more performance measures.

33.

Transfer pricing arrangements can be costly in terms of
suboptimization. Also, the process of setting transfer prices

may be expensive when considering the time and effort that is
involved in the buying and selling division. Lastly, the use
of transfer pricing may be optimal in maintaining goal
congruence but be very costly for multinational firms that are
unable to use intraorganizational transfers to control their
income tax liabilities.


228

34.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Because transfer prices between multinational units of a
company can affect profits and inventory values reported in
two different countries, managers are cognizant of setting
prices, within legal and ethical limits, to minimize income
taxes and tariffs.

35.

Student answers will vary. No solution provided.

Exercises
36.

a. 8
b. 4

c. 2
d. 1
e. 5
f. 6
g. 7
h. 10
i. 3
j. 9

37.

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.

D
A
A
D
D
A
A
A

A
N

38.

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.

D
C
D
C
C
D
C
I
I
I


Chapter 18
Responsibility Accounting and Transfer

Pricing in Decentralized Organizations
39.

40.

229

a.

From Personnel to Fabricating: (0.45 ÷ 0.85) × $70,000
= $37,059
From Maintenance to Fabricating: (0.60 ÷ 0.90) × $50,000
= $33,333

b.

From Personnel to Finishing: (0.40 ÷ 0.85) × $70,000
= $32,941
From Maintenance to Finishing: (0.30 ÷ 0.90) × $50,000
= $16,667
Checking:
Administration (.30÷0.80) ×
Personnel
(.30÷0.80) ×
Accounting
(.40÷0.80) ×
Direct costs

$90,000
$60,000

$90,000

Savings:
Administration (.40÷0.80) × $90,000
Personnel
(.20÷0.80) × $60,000
Accounting
(.20÷0.80) × $90,000
Direct costs
Loans:
Administration (.10÷0.80) × $90,000
Personnel
(.30÷0.80) × $60,000
Accounting
(.20÷0.80) × $90,000
Direct costs

$ 33,750
22,500
45,000
90,000
$191,250
$ 45,000
15,000
22,500
75,000
$157,500
$ 11,250
22,500
22,500

150,000
$206,250


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Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Administration Costs ($90,000)
Personnel
($90,000 × 0.10)
$ 9,000
Accounting
($90,000 × 0.10)
9,000
Checking
($90,000 × 0.30)
27,000
Savings
($90,000 × 0.40)
36,000
Loans
($90,000 × 0.10)
9,000
$90,000

41.

Personnel Costs ($60,000 + $9,000)

Accounting [$69,000 × (0.10÷.90)]
Checking
[$69,000 × (0.30÷.90)]
Savings
[$69,000 × (0.20÷.90)]
Loans
[$69,000 × (0.30÷.90)]

$ 7,667
23,000
15,333
23,000
$69,000

Accounting Costs ($90,000 + $9,000 + $7,667)
Checking [$106,667 × (0.40÷.80)]
$53,334
Savings [$106,667 × (0.20÷.80)]
26,667
Loans
[$106,667 × (0.20÷.80)]
26,667
$106,668
(rounded)
Checking = $90,000 + $27,000 + $23,000 + $53,334 = $193,334
Savings: $75,000 + $36,000 + 15,333 + $26,667 =
$153,000
Loans: $150,000 + $9,000 + $23,000 + $26,667 =
$208,667
42.

a.

Personnel Costs ($60,000)
Administration($60,000 ×
Maintenance
($60,000 ×
Stamping
($60,000 ×
Assembly
($60,000 ×

0.15)
0.10)
0.45)
0.30)

Administration Costs ($90,000 + $9,000)
Maintenance [$99,000 × (.15÷0.90)]
Stamping
[$99,000 × (.50÷0.90)]
Assembly
[$99,000 × (.25÷0.90)]

$ 9,000
6,000
27,000
18,000
$60,000
$16,500

55,000
27,500
$99,000

Maintenance Costs ($40,000 + $6,000 + $16,500)
Stamping [$62,500 × (.50÷0.85)]
$36,765
Assembly [$62,500 × (.35÷0.85)]
25,735
$62,500
b.

Stamping:
Assembly:

$27,000 + $55,000 + $36,765 = $118,765
$18,000 + $27,500 + $25,735 = $ 71,235


c.

Chapter 18
231
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
The cost allocation is affected by the order in which
costs are assigned because the cost allocated from a
particular service department depends on the amount of
cost allocated to that service department from other
service departments; the amount of costs allocated from

other service departments depends on the benefitsprovided ranking.

43.
Administration
Personnel
Accounting
Checking
Savings
Loans

Admin.
-0.10
0.10
0.30
0.40
0.10

Pers.
0.10
-0.10
0.30
0.20
0.30

Acctg.
0.10
0.10
-0.40
0.20
0.20

(A) Administration = $90,000 + 0.10B + 0.10C
(B) Personnel = $60,000 + 0.10A + 0.10C
(C) Accounting = $90,000 + 0.10A + 0.10B
B = $60,000 + 0.10($90,000 + 0.10B + 0.10C) + 0.10C
C = $90,000 + 0.10($90,000 + 0.10B + 0.10C) + 0.10B
B = $60,000 + $9,000 + 0.01B + 0.01C + 0.10C
B = $69,000 + 0.01B + 0.11C
.99B = $69,000 + 0.11C
C = $90,000 + $9,000 + 0.01B + 0.01C + 0.10B
C = $99,000 + 0.11B + 0.01C
0.99C = $99,000 + 0.11B
C = $100,000 + 0.1111B
0.99B = $69,000 + 0.11($100,000 + 0.1111B)
0.99B = $69,000 + $11,000 + 0.0122B
0.9778B = $80,000
B = $81,816
C = $100,000 + 0.1111($81,816) = $109,090
A = $90,000 + 0.10($81,816) + 0.10($109,090) = $109,091
Admin.
Pers.
Acctg.
Check.
Sav.
Loans
Direct costs $ 90,000 $ 60,000 $ 90,000 $ 90,000 $ 75,000 $150,000
Admin.
(109,091)
10,909
10,909

32,728
43,636
10,909
Pers.
8,182
(81,816)
8,182
24,545
16,363
24,545
Acctg.
10,909
10,909 (109,090) 43,636
21,818
21,818
Total costs $
0 $
0 $
0 $190,909 $156,817 $207,272
Note: The Personnel and Accounting columns do not actually sum
to $0 because of rounding.


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Chapter 18
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44.

Department
Admin. (A)
Pers. (P)
College Texts
Prof. Pubs.
Total

Administration
Base
%
n/a
n/a
$
75,000
6.25
600,000
50.00
525,000
43.75
$1,200,000 100.00

Personnel
Base
%
10
11.11
n/a
n/a
50
55.56

30
33.33
90 100.00 rounded

A = $225,000 + 0.1111P
P = $175,000 + 0.0625A
A = $225,000 + 0.1111(175,000 + 0.0625A)
A = $225,000 + $19,443 + 0.0069A
0.9931A = $244,443
A = $246,141
P = $175,000 + 0.0625($246,141)
P = $190,384
Dept.
Direct costs
Admin.
Pers.
Total

Admin.
$225,000
(246,141)
21,152
$
0

Pers.
$175,000
15,384
(190,384)
$

0

College
Texts
$1,125,000
123,071
105,777
$1,353,848

Prof. Pubs.
$475,000
107,686
63,455
$646,141

Note: The Administration column does not actually sum to zero
because of rounding.
45.

46.

a.

The upper limit is the best external price = $15.00
The lower limit is variable production cost = $7.20 +
opportunity cost

b.

Minimum price is regular price = $21.75

a.

Lower limit is the variable cost ($1.50 + $1.90 + $0.80)
+ $7.30 lost CM = $11.50; this is the normal selling
price less the normal variable costs excluding the $0.50
variable selling expense.

b.

Under these conditions, Goodbrake Division could accept
any price that at least covers variable production costs:
DM $1.50 + DL $1.90 + VOH $0.80 = $4.20


c.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
$217,187.50 ÷ 1.25 = $173,750 cost for 25,000 units
= $6.95 cost per unit
DM $1.50 + DL $1.90 + VOH $0.80 + FOH $2.75 = $6.95

233

$131,250 ÷ 1.25 = $105,000 for 25,000 units
= $4.20 per unit
DM $1.50 + DL $1.90 + VOH $0.80 = $4.20
Mr. Leon is defining cost as variable cost, while

Goodbrake Division defines cost as absorption cost.
47.

48.

a.

Total variable cost
Variable production cost
Variable selling cost

$14
3
$17 per unit

b.

Full production cost
Variable
$14.00
FOH ($300,000 ÷ 200,000)
1.50
$15.50 per unit

c.

Total variable production + necessary selling
Variable production
$14
Necessary selling

2
$16 per unit

d.

Market price
$25.60 per unit
or $25.60 - $1 for advertising = $24.60

a.

The rapid increase in food costs has created a
significant difference between the “historical cost” of
items and the “replacement cost” of items. Because
transfers between stores are made at historical costs,
the transferring store loses in the transaction because
it must replace the transferred item at replacement cost.
This situation creates an incentive for stores to
misrepresent the actual inventories on hand when
transfers are requested by sister stores.

b.

The transfer pricing policy could be changed to allow
transfers to take place at replacement cost rather than
historical cost. This would remove the disincentive of
the existing policy.


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Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations

49.

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.

A
D
A
D
D
N
D
A
A
D

50.

a.

$297,500 ÷ 350,000 minutes = $0.85 per minute

b.

$297,500 ÷ 437,500 minutes = $0.68 per minute

c.

Total variance = $300,000 - $297,500 = $2,500 U
The variance could have been caused by volume of activity
being above the expected level, or by operating costs
exceeding the expected level. We would need more
information to determine the actual causes.

Problems
51.

a.

b.

Revenues
Variable costs:
Meals
Lodging
Supplies
Contribution margin

Direct fixed costs:
Facilities rent
Advertising
Speakers
Segment margin
Allocated fixed costs
Net operating income

$40,000
$ 4,500
13,500
1,000
$3,600
2,100
5,000

Revenues
Variable costs:
Meals
$ 5,400
Lodging
16,200
Supplies
1,200
Contribution margin
Direct fixed costs:
Facilities rent
$4,200
Advertising
2,900

Speakers
7,500
Segment margin
Allocated fixed costs
Net operating income (loss)

(19,000)
$21,000

(10,700)
$10,300
(2,500)
$ 7,800
$38,500

(22,800)
$15,700

(14,600)
$ 1,100
(2,500)
$(1,400)


c.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Budget

Actual
Revenues
$40,000
$38,500
Variable costs:
Meals
$ 4,500
$ 5,400
Lodging
13,500
16,200
Supplies
1,000
1,200
Contribution margin
$21,000
$15,700
Direct fixed costs:
Facilities rent
$3,600
$ 4,200
Advertising
2,100
2,900
Speakers
5,000
7,500
Segment margin
$10,300
$ 1,100

Allocated fixed costs
2,500
2,500
Net operating income
(loss)
$ 7,800
$(1,400)

235

Variance
$(1,500)
$

(900)
(2,700)
(200)
$(5,300)
$

(600)
(800)
(2,500)
$(9,200)
0
$(9,200)

By far, the biggest contributor to the financial failure
of the seminar was the inability to achieve the budgeted
level of revenue per participant. Expected revenue,

based on the actual number of participants, would have
been 120 × $400 = $48,000. However, actual revenues fell
well below this amount; in fact, actual revenues were
below the original budgeted amount despite the fact that
volume was 20 percent above the level in the original
budget. Also contributing to the unexpected loss were
higher than expected fixed costs for rent, advertising,
and the speakers.


236

52.

a.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
The report is not in accordance with the concept of
responsibility accounting. In responsibility accounting,
each manager's performance is judged by how well (s)he
manages those items directly under his/her control.
Responsibility accounting does not recognize the
allocation of common costs to segments. While including
the corporate costs may be useful in calling attention to
these activities, differences between budgeted and actual
for these items are beyond the control of the Machining
Department supervisor and are not properly chargeable to
him/her. Thus, corporate costs should not be included in

the report.
The report compares actual performance to a static
budget. A static budget fails to distinguish between the
production control and the cost control responsibilities
of the department supervisor. Cost control is involved
with seeing that output is produced at the least possible
cost, consistent with quality standards. All dollar
amounts in the report deal with cost control and tell
nothing about how well variable costs were controlled
during the month. The budget costs are based on an
activity level of 3,000 units per month, whereas actual
costs were incurred at an activity level of 3,185 units
per month. A flexible budget should be used in the report
because it can be tailored for any level of activity
within a relevant range. This would result in the
meaningful comparison of the actual cost of producing
3,185 units with the budgeted cost of producing 3,185
units.
Many of the fixed manufacturing overhead items may
not be controllable at the department level. The degree
of controllability of these cost items is not stated in
the question. If there is some degree of control at the
department level, that should be included in the report.
Furthermore, the inclusion of these costs communicates
that these costs are a necessary part of the
manufacturing activity.


Chapter 18
237

Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
b.
Western Plains, Inc.
Machining Department Performance Report
For the Month Ended October 31, 2003
Under/(Over) Budget
Budget
Actual
Variance
Units
3,185
3,185
0
Controllable costs
Var. Mfg. Costs
DM
$ 8.00 $25,480
$ 7.80
$24,843
$0.20 $ 637
DL
9.25
29,461
9.20
29,302
0.05
159
VOH
11.10

35,354
11.00
35,035
0.10
319
Total
$28.35 $90,295
$28.00
$89,180
$0.35 $1,115
Noncontrollable
Mfg. Costs
Indirect Labor
$ 3,300
$ 3,334
$ (34)
Depreciation
1,500
1,500
0
Taxes
300
300
0
Insurance
240
240
0
Other
930

1,027
(97)
Total fixed OH
$ 6,270
$ 6,401
$(131)
Total Mfg. Costs
$96,565
$95,581
$ 984
c.

Review favorable unit and component variances to
determine if realistic budgets were set. Note that all of
the controllable manufacturing cost variances were
favorable. The only variance exceeding 5 percent was the
small $97 variance for the "other" category and perhaps
this should be analyzed.
(CMA adapted)

53.
Surgery
In-patient
Out-patient

Assets
Employed
$1,974,250
1,229,250
521,500

$3,725,000

Administration
Public Relations
Maintenance
Total

Surgery
$1,060,000
140,000
175,000
$1,375,000

%
53
33
14

# of
Employees
10
18
22
50
In-Patient
$ 660,000
252,000
125,000
$1,037,000

%
20
36
44

Hours of.
Operation
12,425
8,875
14,200
35,500

Out-Patient
$280,000
308,000
200,000
$788,000

%
35
25
40


238

54.

a.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Administration Costs
($750,000)
Base
Allocation
Accounting
5÷146
$ 25,685
Promotion
6÷146
30,822
Commercial
21÷146
107,877
Residential
101÷146
518,836
P. Mgmt.
13÷146
66,781
$750,001*
*Rounded
Accounting Costs ($495,000 + $25,685 = $520,685)
Base
Allocation
Promotion
$360,000÷$1,760,000
$106,504

Commercial
$500,000÷$1,760,000
147,922
Residential
$725,000÷$1,760,000
214,487
P. Mgmt.
$175,000÷$1,760,000
51,773
$520,686*
*Rounded
Promotion Costs ($360,000 + $30,822 + $106,504
= $497,326)
Base
Allocation
Commercial
$4,500,000÷$14,500,000
$154,343
Residential
$9,500,000÷$14,500,000
325,834
P. Mgmt.
$ 500,000÷$14,500,000
17,149
$497,326
Summary of allocations:
Commercial: $107,877 + $147,922 + $154,343 = $410,142
Residential: $518,836 + $214,487 + $325,834 = $1,059,157
P. Mgmt.: $66,781 + $51,773 + $17,149 = $135,703

b.
Revenues
Direct costs
Indirect costs
Income

Commercial
$ 4,500,000
(5,245,000)
(410,142)
$(1,155,142)

Residential P. Management
$ 9,500,000
$ 500,000
(4,589,510)
(199,200)
(1,059,157)
(135,703)
$ 3,851,333
$ 165,097

The Residential Department is the most profitable with
a return on revenues of 40.5%.


55.

a.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Case 1 upper limit = $65
Case 1 lower limit = ($30 + 10 + 3 + ($6 - 1)) +
(Lost CM of $26) = $74
Lost CM = $75 – ($30 + $10 + $3 + $6)

239

Case 2 upper limit = $52
Case 2 lower limit = ($20 + 8 + 2 + ($4 - 1)) +
(Lost CM of $26) = $59
Lost CM = $60 – ($20 + $8 + $2 + $4)
Interpretation: When, as in both cases in this problem,
the lower limit exceeds the upper limit, the intracompany
transfers should not be made because the company will be
worse off.
b.

Selling price = Variable cost + $10
Case 1 selling price = ($30 + 10 + 3 + (6-1)) + $10 = $58
Case 2 selling price = ($20 + 8 + 2 + (4-1)) + $10 = $43

c.

Dual transfer prices for Case 1:
Speaker’s selling price (from part (b)) = $58
Sound System’s purchase price = ($65 - 10) = $55
Speaker's Division manager should demonstrate that the

whole company will be worse off if this is done based on
the answer to part (a):
Contribution margin lost by Speaker Division
$26
Savings to Sound System by "purchasing"
below the external purchase price ($65 - $55)
10
Loss to company per unit transferred
$16


240

56.

a.

*

*

*

*

b.

57.

Chapter 18

Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Current external selling price, $2,616
Selling Division -fair value since most are produced
and sold at this price externally.
Buying Division -price is higher than what could be
purchased elsewhere so this would make its
performance report appear worse than by buying
externally.
Total variable production cost ($1,050)+ 20% = $1,260
Selling Division - contributes minimally to covering
fixed costs and therefore no profit is shown from
these "sales" as opposed to external sales. There
is little incentive to sell internally if the
selling division can sell all its output
externally.
Buying Division -less than external purchase price,
therefore it is more beneficial to the bottom line
of Construction Equipment Company.
Total product ($1,500) cost + 20% = $1,800
Selling Division -covers some but not all costs for
this division, therefore incentive to sell
internally isn't there if Engine Division can sell
its output externally.
Buying Division -purchase price below external so
better for margin in this division.
Bid price from external supplier ($2,320)
Selling Division- allows for some profit which is an
incentive to sell internally unless it can sell
all its output externally.

Buying Division -no incentive to buy internally
since it costs the same as to buy from an external
supplier.

Upper limit = $2,320
Lower limit = costs of $1,200 + contribution margin of
$1,416 = $2,616
Since the lower limit exceeds the upper limit, the
company would be better off not making the internal
transfers.

a.
Athlete’s Companion
A/R - Div. TA
80,000
Intraco. Sales
80,000
Intraco. CGS
46,000
Finished Goods
46,000

Travel America
Inventory
80,000
A/P – Div.AC

80,000

b.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Variable cost = $10 + $3 + $4 + $2 = $19; $19
+ (0.15)($23)= $22.45

Athlete’s Companion
A/R -Div.TA
44,900
Intraco. Sales
44,900

241

Travel America
Inventory
44,900
A/P – Div.AC

44,900

Intraco. CGS
46,000
Finished Goods
46,000
c.
Athlete’s Companion
A/R - Div.TA

34,000
Intraco. Sales in
Excess of Assigned
Cost
46,000
Intraco. Sales
80,000

Travel America
Inventory
34,000
A/P - Div.AC

34,000

Intraco. CGS
46,000
Finished Goods
46,000
d.
Athlete’s Companion
A/R - Div.TA
46,000
Intraco. Sales
46,000

Travel America
Inventory
46,000
A/P - Div.AC

46,000

Intraco. CGS
46,000
Finished Goods
46,000
58.

(IMA)
To maximize short-run contribution margin, the Quayside
Division should accept the contract from Saxon Company.
This conclusion is supported by the following
calculations.

a.

1. Quayside transfer to Ridgetop:
Transfer price (3,000 × $1,500)
Variable cost
Purch.from Park (3,000 × $600)
Proc by Quayside (3,000 × $500)
Contribution Margin

$4,500,000
$1,800,000
1,500,000 (3,300,000)
$1,200,000

2. Quayside accepts Saxon contract:

Selling price (3,500 ×× $1,250)
$4,375,000
Variable cost
Purch.from Park (3,500 × $500)
$1,750,000
Proc. by Quayside (3,500 × $400) 1,400,000 (3,150,000)
Contribution Margin
$1,225,000
Conclusion:
Contribution margin from Saxon contract
Contribution margin from Ridgetop sale
Difference in favor of Saxon contract

$1,225,000
(1,200,000)
$
25,000


242

b.

Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations
Quayside's Division decision to accept the contract from
Saxon Company is in the best interest of the company as
the decision increases the overall contribution margin of
the company. This conclusion is supported by the

following calculations.

Revenues and cost savings to Providence Products Inc:
Sales by Quayside to Saxon (3500 × $1,250) $4,375,000
Sales by Park to Essex (3000 × $400)
1,200,000
Cost savings (variable costs avoided by
not accepting the Ridgetop order)
Park's savings (3,000 × $300)
900,000
Quayside’s savings (3,000 × $500)
1,500,000 $7,975,000
Expenditures incurred by Providence Products
Variable costs incurred for Saxon order
Quayside (3,500 × $400)
$1,400,000
Park (3,500 × $250)
875,000
Variable cost incurred for purchase
Ridgetop from Essex (3,000 × $1,500)
4,500,000
Essex from Park (3,000 × $200)
600,000 7,375,000
Positive contribution margin
$ 600,000
(CMA)
59.

a.

Total EDP hours used (1,220 + 650 + 190) = 2,060
Transfer price revenue = 2,060 × $40 = $82,400
Actual Var. EDP Costs = $90,000 = $43.69 trans. price
Total hours used
2,060
Therefore, $40 proved to be a less-than-adequate transfer
price because it left the EDP Department with a loss
(for internal evaluation purposes) of $7,600 ($90,000 $82,400).

b.

Allocate administration costs of $450,000 and fixed EDP
costs of $300,000:

A&A
Administration ($450,000)
(10/18, 5/18, 3/18) $250,000
EDP-Fixed ($300,000)
(80/345, 240/345,
25/345)
69,565
c.

Total allocated
Transfer costs
Direct costs
Total

$319,565
48,800

200,000
$568,365

T

C

$125,000

$ 75,000

208,695

21,740

$333,695
26,000
255,000
$614,695

$ 96,740
7,600
340,000
$444,340

Total
$

450,000
300,000

$

750,000
82,400
795,000
$1,627,400


Chapter 18
Responsibility Accounting and Transfer
Pricing in Decentralized Organizations

243

Cases
60.

To achieve Fashion's goals, the manager of the department
should purchase the materials needed at the lowest price
available to Fashion Division at the present time. The three
possible prices are as follows:
Koenig’s price is
$8.00
Deluxe Products LeatherWorks
Division's price is
9.00
Thompson Company's price is
7.00
Fashion Division should purchase from Thompson.

For the Fashion Division of Deluxe Products to achieve the
overall company's goals, the following analysis is required to
compare the costs of the three bidders:
Koenig's price is
$8.00
LeatherWorks Division's price [intercompany
transfer price is computed as follows:
Sales price - Profit margin
[$9.00 - (0.40 × $9.00)] =
5.40
Thompson Company's price is $7.00. However,
the profit margin of Ridley Chemical should
be deducted [$7.00 - (0.30 × $2.00)]
6.40
From the company's standpoint, the costs that should be
considered for the make-or-buy decision are the variable costs
per square foot as long as there is available capacity and no
additional fixed costs would be incurred. For any division to
achieve the overall company goals to maximize profit, variable
costs to the company must be minimized. The purchasing
division (Fashion in this case) must choose the best price
available to it. LeatherWorks should consider lowering its
price to meet the competition from Thompson.
(IMA adapted)

61.

a.

Regular selling price

$6.50

Regular selling price less variable selling and
distribution expenses ($6.50 - $0.60)

$5.90

Standard manufacturing cost plus 15%
[($3.20 + $1.20) × 1.15]

$5.06

Standard variable manufacturing cost plus 20%
($3.20 × 1.20)

$3.84