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Responsibility Accounting and Transfer Pricing

Chapter

21

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Responsibility CentersResponsibility Centers

Large complex businesses are

divided into responsibility

centers enabling managers to have a

smaller effective span of control.

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The accounting system provides information about resources used and outputs achieved. The accounting system provides information about resources used and outputs achieved.

The Need for Information About Responsibility Center PerformanceThe Need for Information About

Responsibility Center Performance

This information is used to:Plan and allocate resources.

Control operations.

Evaluate the performanceof center managers.

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Cost

Cost Centers, Profit Centers, and Investments Centers

Cost Centers, Profit Centers, and Investments Centers

Cost Center A business section

that has control over the incurrence

of costs, but no control over revenues or

investment funds.

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Cost Centers, Profit Centers, and Investments Centers

Cost Centers, Profit Centers, and Investments Centers

Profit Center A part of the

business that has control over both

costs and revenues, but no control over investment funds.

RevenuesSalesInterestOther

CostsMfg. costsCommissionsSalariesOther

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Corporate HeadquartersCorporate Headquarters

Cost Centers, Profit Centers, and Investments Centers

Cost Centers, Profit Centers, and Investments Centers

Investment Center

A profit center where management also makes capital

investment decisions.

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CostCenter

Cost controlQuantity and qualityof services

ProfitCenter

InvestmentCenter

Return on assets (ROA) Residual income (RI)

Evaluation Measures

Profitability

Cost Centers, Profit Centers, and Investments Centers

Cost Centers, Profit Centers, and Investments Centers

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An accounting system thatprovides information . . .

Responsibility Accounting SystemsResponsibility Accounting Systems

Relating to theresponsibilities of

individual managers.

To evaluatemanagers on

controllable items.

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Prepare budgets for each responsibility center.

Prepare timely performance reportscomparing actual amounts with budgeted amounts.

Measure performance ofeach responsibility center.

Responsibility Accounting SystemsResponsibility Accounting Systems

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Successful implementation of responsibility accounting may use organization charts with

clear lines of authority and clearly defined levels of responsibility.

Successful implementation of responsibility accounting may use organization charts with

clear lines of authority and clearly defined levels of responsibility.

Vice Presidentof F ina nce

D epa rtm ent Ma na ger

Store Ma na ger

V ice Presidentof O pera tions

V ice Presidentof Ma rketing

President

B oa rd of D irectors

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Amount of detail varies according to level in organization.

A department manager receives detailed reports.

A store manager receives summarized information from each department.

Responsibility Accounting SystemsResponsibility Accounting Systems

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The vice president of operations receives summarized information

from each store.

Management by exception:

Upper-level management does not receive operating

detail unless problems arise.

Amount of detail varies according to level in organization.

Responsibility Accounting SystemsResponsibility Accounting Systems

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Responsibility Accounting SystemsResponsibility Accounting Systems

To be of maximum benefit, responsibility reports should . . .Be timely.Be issued regularly.Be understandable.Compare budgeted

and actual amounts.

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$$$$$$ ServiceDepartment

Assigning Revenue and Costs to Business Centers

Assigning Revenue and Costs to Business Centers

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

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Assigning Revenue and Costs to Business Centers

Assigning Revenue and Costs to Business Centers

Two guidelines should be followed in allocating costs to the various parts

of a business . . . According to cost behavior patterns:

Fixed or variable.According to whether the costs are

directly traceable to the centers involved.

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Profit Center ReportingProfit Center Reporting

Webber, Inc. has two divisions.

Computer Division Television Division

Webber, Inc.

Let’s look more closely at the Television Division’s income statement.

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Income StatementContribution Margin Format

Television DivisionSales 300,000$Variable COGS 120,000$Other variable costs 30,000 Total variable costs 150,000$Contribution margin 150,000$Traceable fixed costs 90,000 Responsibility margin 60,000$

Cost of goodssold consists of variable manu-facturing costs.

Profit Center ReportingProfit Center Reporting

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Income StatementContribution Margin Format

Television DivisionSales 300,000$Variable COGS 120,000$Other variable costs 30,000 Total variable costs 150,000$Contribution margin 150,000$Traceable fixed costs 90,000 Responsibility margin 60,000$

Fixed andvariable costsare listed in

separatesections.

Profit Center ReportingProfit Center Reporting

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Income StatementContribution Margin Format

Television DivisionSales 300,000$Variable COGS 120,000$Other variable costs 30,000 Total variable costs 150,000$Contribution margin 150,000$Traceable fixed costs 90,000 Responsibility margin 60,000$

Responsibility marginis the Television

Division’s contributionto overall operations.

Profit Center ReportingProfit Center Reporting

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

No computerNo computerdivision manager.division manager.

Traceable Fixed CostsTraceable Fixed Costs

Traceable fixed costs Traceable fixed costs would disappear over time if the center itself disappeared.

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Common fixed costs Common fixed costs arise because of arise because of overall operation of the company and are not overall operation of the company and are not due to the existence of a particular center.due to the existence of a particular center.

No computer No computer division but . . .division but . . .

We still have aWe still have acompany president.company president.

Common Fixed CostsCommon Fixed Costs

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Let’s see how the TelevisionDivision fits into Webber, Inc.

Profit Center ReportingProfit Center Reporting

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Income StatementCompany Television Computer

Sales 500,000$ 300,000$ 200,000$ Variable costs (230,000) (150,000) (80,000) CM 270,000$ 150,000$ 120,000$ Traceable FC (170,000) (90,000) (80,000) Responsibility margin 100,000$ 60,000$ 40,000$

Common costs (25,000) Net income 75,000$

Common costs arise because of overall Common costs arise because of overall operating activities and are not due to the operating activities and are not due to the

existence of a particular division.existence of a particular division.

Profit Center ReportingProfit Center Reporting

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Let’s see how this works!Let’s see how this works!Let’s see how this works!Let’s see how this works!

Traceable Costs Can Become Common Costs

Traceable Costs Can Become Common Costs

Fixed costs that are traceable on one level can become common if the business is

divided into smaller smaller parts.

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Income StatementTelevision Division Color

Black and White

Sales 300,000$ 200,000$ 100,000$ Variable costs (150,000) (95,000) (55,000) CM 150,000$ 105,000$ 45,000$ Traceable FC (80,000) (45,000) (35,000) Responsibility margin 70,000$ 60,000$ 10,000$

Common costs 10,000 Net income 60,000$

Profit Center ReportingProfit Center Reporting

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Income StatementTelevision Division Color

Black and White

Sales 300,000$ 200,000$ 100,000$ Variable costs (150,000) (95,000) (55,000) CM 150,000$ 105,000$ 45,000$ Traceable FC (80,000) (45,000) (35,000) Responsibility margin 70,000$ 60,000$ 10,000$

Common costs 10,000 Net income 60,000$

45,000$ To Color35,000 To B & W10,000 Common90,000$ TV Division

$90,000 cost directly tracedto the Television Division.

Profit Center ReportingProfit Center Reporting

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TimeTime

Pro

fits

Pro

fits

Responsibility MarginResponsibility Margin

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

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Home Appliance CompanyIncome Statement

Laundry Division Washers Dryers

Sales 300,000$ 200,000$ 100,000$ Variable costs (150,000) (95,000) (55,000) CM 150,000$ 105,000$ 45,000$ Traceable FC (95,000) (45,000) (50,000) Responsibility margin 55,000$ 60,000$ (5,000)$

Common costs (10,000) Net income 45,000$

The Dryer Division is unprofitable becausethe responsibility margin is negative.

When is a BusinessCenter Unprofitable?When is a Business

Center Unprofitable?

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The key issue is controllability.

Evaluating BusinessCenter Managers

Evaluating BusinessCenter Managers

Managers should be evaluated on the portion of responsibility margin they control.

Common fixed costs can not be traced to theDryer Division or the Washer Division, so theyare excluded from the responsibility margin.

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Arguments Against Allocating Common Fixed Costs

Arguments Against Allocating Common Fixed Costs

Common fixed costs would not change even if a business center were eliminated.

Common fixed costs are not under the direct control of the center’s managers.

Allocation of common fixed costs may imply changes in profitability that are unrelated to the center’s performance.

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Let’s change topics!

Transfer PricesTransfer Prices

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

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

Battery Division Auto Division

Batteries

Transfer PricesTransfer Prices

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A higher transferprice for batteries

means . . .

. . . greaterprofits for the

Battery Division.

Auto DivisionBattery Division

Transfer PricesTransfer Prices

The transfer price affects the profit measure for both buying and selling divisions.

The transfer price affects the profit measure for both buying and selling divisions.

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. . . lowerprofits for theAuto Division.

Auto DivisionBattery Division

A higher transferprice for batteries

means . . .

Transfer PricesTransfer Prices

The transfer price affects the profit measure for both buying and selling divisions.

The transfer price affects the profit measure for both buying and selling divisions.

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Many companies use the externalmarket value of goods transferred

as the transfer price.

Transfer PricesTransfer Prices

Transfer prices have no direct effect uponthe company’s overall net income.

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Transfer prices have no direct effect uponthe company’s overall net income.

When the external market value of goods

transferred is unavailable . . .

Transfer PricesTransfer Prices

Negotiatedtransfer

price

Cost-plustransfer

price

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Product Quality PersonnelNumber of defective parts Number of sick days takenNumber of customer returns Employee turnoverNumber of customer complaints Number of grievances filed

Marketing Efficiency and CapacityNumber of new customers Cycle time (manufacturing)Number of sales calls initiated Occupancy rates (hotels)Market share Passenger miles (airlines)Number of product stockouts Patient days (hospitals)

Transactions processed (banks)

Nonfinancial Performance Measures

Nonfinancial Performance Measures

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This information isfar less detailed than

the responsibilitycenter information

developed for management.

This information isfar less detailed than

the responsibilitycenter information

developed for management.

Segment Reporting inFinancial Statements

Segment Reporting inFinancial Statements

Companies engaged in different lines of business are required to report certain

information about each segment.

Revenue. Operating profits or losses. Identifiable segment assets. Depreciation and amortization. Capital expenditures.

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End of Chapter 21End of Chapter 21