AND RESPONSIBILITY CENTER REPORTING
Exercises 22.6, 22.7, and 22.8 are based on the following data
Shown below is a segmented income statement for Drexel-Hall during the current month:
Lasers Circuits
Sales . . . $600,000 $900,000 Variable costs (as a percentage of sales) . . . 40% 60%
Traceable fixed costs . . . $275,000 $225,000
Confirming Pages
Exercises 977
All stores are similar in size, carry similar products, and operate in similar neighborhoods.
Store 1 was established first and was built at a lower cost than were Stores 2 and 3. This lower cost results in less depreciation expense for Store 1. Store 2 follows a policy of minimizing both costs and sales prices. Store 3 follows a policy of providing extensive customer service and charges slightly higher prices than the other two stores.
Use the data presented above for Drexel-Hall to answer the following questions:
a. Assume that by spending an additional $15,000 per month in advertising a particular store, Drexel-Hall can increase the sales of that store by 10 percent. Which store should the company advertise to receive the maximum benefit from this additional advertising expenditure? Explain.
b. From the viewpoint of top management, which is the most profitable of the three stores? Why?
c. Which store manager seems to be pursuing the most effective strategy in managing his or her store? Why?
Top management of Drexel-Hall is considering closing Store 3. The three stores are close enough together that management estimates closing Store 3 would cause sales at Store 1 to increase by
$60,000, and sales at Store 2 to increase by $120,000. Closing Store 3 is not expected to cause any change in common fixed costs.
Compute the increase or decrease that closing Store 3 should cause in:
a. Total monthly sales for Drexel-Hall stores.
b. The monthly responsibility margin of Stores 1 and 2.
c. The company’s monthly income from operations.
The marketing manager of Drexel-Hall is considering two alternative advertising strategies, each of which would cost $15,000 per month. One strategy is to advertise the name Drexel-Hall, which is expected to increase the monthly sales at all stores by 5 percent. The other strategy is to empha- size the low prices available at Store 2, which is expected to increase monthly sales at Store 2 by
$150,000, but to reduce sales by $30,000 per month at Stores 1 and 3.
Determine the expected effect of each strategy on the company’s overall income from operations.
Delmar Foods has two divisions: (1) a Processed Meat Division and (2) a Frozen Pizza Division.
Delmar’s frozen pizzas use processed meat as a topping. The company’s Processed Meat Division supplies the Frozen Pizza Division with all of its meat toppings. Delmar managers are paid bonuses based on their division’s profitability.
The manager of the Processed Meat Division argues for a transfer price based on a market value approach. The manager of the Frozen Pizza Division favors a transfer price based on a cost approach. Explain how Delmar’s bonus system may influence each manager’s opinion regarding which approach to use in establishing a transfer price.
Listed below are parts of various well-known businesses:
1. The bookstore of Northern Jersey University.
2. The billing department of Rhode Island Life Insurance Co.
3. The Norwalk Factory of Melvin’s Chocolates.
EXERCISE 22.6 Evaluation of
Responsibility Centers and Center Managers R
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EXERCISE 22.7 Closing an
Unprofitable Business Unit
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EXERCISE 22.8 Cost-Volume-Profit Analysis
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EXERCISE 22.9 Transfer Pricing E
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EXERCISE 22.10 Types of
Responsibility Centers and Basis for Evaluation
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Profit Centers
Drexel-Hall Store 1 Store 2 Store 3 Dollars % Dollars % Dollars % Dollars % Sales. . . $1,800,000 100% $600,000 100% $600,000 100% $600,000 100%
Variable costs . . . 1,080,000 60 372,000 62 378,000 63 330,000 55 Contribution margin . . . $ 720,000 40% $228,000 38% $222,000 37% $270,000 45%
Traceable fixed costs: controllable . . . 432,000 24 120,000 20 102,000 17 210,000 35 Performance margin . . . $ 288,000 16% $108,000 18% $120,000 20% $ 60,000 10%
Traceable fixed costs: committed . . . 180,000 10 48,000 8 66,000 11 66,000 11 Store responsibility margin . . . $ 108,000 6% $ 60,000 10% $ 54,000 9% $ (6,000) (1)%
Common fixed costs . . . 36,000 2 Income from operations . . . $ 72,000 4%
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4. The jewelry department of Bloomingdale’s.
5. The gift shop at the Museum of Natural History.
6. The legal department of Sears.
Indicate whether each part represents an investment center, a profit center (other than an invest- ment center), or a cost center. Why are business organizations divided into responsibility centers?
Explain how revenue and costs are assigned to a responsibility center using a responsibility center income statement.
The following discussion occurred between two division managers, Bob and Jalenne, and the chief operating officer, Harry.
Bob: “Jalenne’s division has twice as many employees as my division, yet corporate head- quarters costs, which include human resource costs, are allocated to our two divisions equally, hurting my bottom line.”
Jalenne: “You know Bob is right to be upset about the human resource cost allocation. How- ever, the CEO and the CFO devote much more time and attention to Bob’s division because it is in financial difficulty. Perhaps we should track consumption of corporate time and allocate the corporate headquarters costs to divisions on the basis of corpo- rate time devoted to each division.”
Harry: “In my 25 years working at corporate, I have heard these arguments year after year.
Tracking time spent on activities related to divisions would be expensive and nearly impossible for central management. Furthermore, there are many corporate costs that are not related to human time spent on divisional issues. Allocating an equal portion of these costs to each division is the only practical method.”
Use your understanding of common and traceable costs to discuss the appropriateness of Harry’s response. Is there a method that could be used so that Jalenne and Bob would be less concerned about the allocation of corporate headquarters costs?
Consider Exhibit 22–5 , which shows the responsibility margins for the Sales Department and Repairs Department profit centers at the 42nd Street store of NuTech Electronics. Assume that 25 percent of the Repairs Department repair work is done for the Sales Department and that the Repairs Depart- ment has been transferring its services to Sales at variable cost as the transfer price. Because the Repairs Department has a negative responsibility profit, assume the Repairs Department has asked the manager of the 42nd Street store to allow a transfer price that will earn the normal contribu- tion margin that is earned on repair services to external customers. Compute the new responsibility margins for the Sales and Repairs Departments if the store manager allows the new transfer price.
Cristina’s Crafts has two operating divisions: one in the U.S. and one in Mexico. The Mexican Division produces product X, which is a component used in the production process of the U.S.
Division. If the U.S. Division purchases product X from the Mexican Division, a transfer price of $650,000 is charged. However, if the U.S. Division were to purchase product X from an outside supplier, the cost would be $750,000. The operating expenses for the Mexican and U.S.
Divisions are, respectively, $200,000 and $350,000 (not including the cost of goods transferred from the Mexican Division). The U.S. Division has revenue amounting to $1,500,000. Cristina, the CEO of the company, is trying to decide which amount should be used for the transfer price ($650,000 or $750,000).
a. Assume that the marginal tax rates for Mexico and the U.S. are 30 percent and 40 percent, respectively. What is the tax liability of each division for each of the transfer pricing alternatives?
b. Which transfer pricing alternative will produce the lowest tax liability for the company as a whole? Show your computations.
Jasper Golf Resort has a full-service hotel and three golf courses. The hotel, in addition to having over 100 hotel rooms, has two dining areas and a catering service for weddings and meetings. The hotel has a housekeeping staff and a repairs and maintenance group. In addition, there is a meetings coordinator with a technical staff to support meetings.
The golf courses have a superintendent that oversees a grounds and maintenance staff. Each course has a pro shop that includes apparel and golf supplies and a lunch counter. In addition, there is a golf cart center that provides carts to each course. Design a responsibility center chart like Exhibit 22–1 for Jasper Golf Resort.
EXERCISE 22.11 Corporate Costs:
Traceable or Common?
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EXERCISE 22.12 Transfer Prices and Responsibility Margins E
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EXERCISE 22.13 Transfer Price and International Taxes E
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EXERCISE 22.14 Responsibility Centers in a Golf Resort E
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Confirming Pages
Problem Set A 979
Use the first paragraph in note 1 in Appendix A to create a responsibility center design for Home Depot. Your design should be similar to Exhibit 22–1 and show investment, profit, and cost centers for Home Depot.
Problem Set A
Mixers, Inc., produces two products: soda water and seltzer juice. Cost and revenue data for each product line for the current month are as follows:
EXERCISE 22.15 Home Depot’s Responsibility Centers
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Prob bl lem Set A accounting
PROBLEM 22.1A Preparing and Using Responsibility Income Statements
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In addition, fixed costs that are common to both product lines amount to $75,000.
Instructions
a. Prepare Mixers, Inc.’s responsibility income statement for the current month. Report the responsibility margin for each product line and income from operations for the company as a whole. Also include columns showing all dollar amounts as percentages of sales.
b. According to the analysis performed in part a, which product line is more profitable? Should the common fixed costs be considered when determining the profitability of individual product lines? Why or why not?
c. Mixers, Inc., has $15,000 to be used in advertising for one of the two product lines and expects that this expenditure will result in additional sales of $50,000. How should the company decide which product line to advertise?
Regal Flair Enterprises has two product lines: jewelry and women’s apparel. Cost and revenue data for each product line for the current month are as follows:
PROBLEM 22.2A Preparing and Using Responsibility Income Statements
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In addition to the costs shown above, the company incurs monthly fixed costs of $100,000 com- mon to both product lines.
Instructions
a. Prepare Regal Flair Enterprises’s responsibility income statement for the current month. Report the responsibility margin for each product line and income from operations for the company as a whole. Also include columns showing all dollar amounts as percentages of sales.
b. Assume that a marketing survey shows that a $75,000 monthly advertising campaign focused on either product line should increase that product line’s monthly sales by approximately
$150,000. Do you recommend this additional advertising for either or both product lines?
Show computations to support your conclusions.
c. Management is considering expanding one of the company’s two product lines. An invest- ment of a given dollar amount is expected to increase the sales of the expanded product line by $300,000. It is also expected to increase the traceable fixed costs of the expanded product line by 75 percent. On the basis of this information, which product line do you recommend expanding? Explain the basis for your conclusion.
Product Lines
Jewelry Apparel
Sales. . . $800,000 $450,000 Variable costs as a percentage of sales . . . 55% 28%
Fixed costs traceable to product lines . . . $200,000 $250,000
Product Lines
Soda Water Seltzer Juice
Sales . . . $750,000 $970,000 Contribution margin as a percentage of sales . . . 35% 60%
Fixed costs traceable to product lines . . . $175,000 $150,000
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Giant Chef Equipment Company is organized into two divisions: Commercial Sales and Home Products. During June, sales for the Commercial Sales Division totaled $1,500,000, and its contri- bution margin ratio averaged 34 percent. Sales generated by the Home Products Division totaled
$900,000, and its contribution margin ratio averaged 50 percent. Monthly fixed costs traceable to each division are $180,000. Common fixed costs for the month amount to $120,000.
Instructions
a. Prepare Giant Chef Equipment’s responsibility income statement for the current month. Be certain to report responsibility margin for each division and income from operations for the company as a whole. Also include columns showing all dollar amounts as percentages of sales.
b. Compute the dollar sales volume required for the Home Products Division to earn a monthly responsibility margin of $500,000.
c. A marketing study indicates that sales in the Home Products Division would increase by 5 percent if advertising expenditures for the division were increased by $15,000 per month. Would you recommend this increase in advertising? Show computations to support your decision.
Muscle Bound Co. sells home exercise equipment. The company has two sales territories, East- ern and Western. Two products are sold in each territory: FasTrak (a Nordic ski simulator) and RowMaster (a stationary rowing machine).
During January, the following data are reported for the Eastern territory:
PROBLEM 22.3A Preparing and Using a Responsibility Income Statement
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PROBLEM 22.4A Preparing
Responsibility Income Statements in a Responsibility Accounting System
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Common fixed costs in the Eastern territory amounted to $120,000 during the month.
During January, the Western territory reported total sales of $600,000, variable costs of
$270,000, and a responsibility margin of $200,000. Muscle Bound also incurred $180,000 of com- mon fixed costs that were not traceable to either sales territory.
In addition to being profit centers, each territory is also evaluated as an investment center. Aver- age assets utilized by the Eastern and Western territories amount to $14,000,000 and $12,000,000, respectively.
Instructions
a. Prepare the January income statement for the Eastern territory by product line. Include col- umns showing percentages as well as dollar amounts.
b. Prepare the January income statement for the company showing profits by sales territories.
Conclude your statement with income from operations for the company and with responsibil- ity margins for the two territories. Show percentages as well as dollar amounts.
c. Compute the rate of return on average assets earned in each sales territory during the month of January.
d. In part a, your income statement for the Eastern territory included $120,000 in common fixed costs. What happened to these common fixed costs in the responsibility income statement shown in part b ?
e. The manager of the Eastern territory is authorized to spend an additional $50,000 per month to advertise one of the products. On the basis of past experience, the manager estimates that additional advertising will increase the sales of either product by $120,000. On which product should the manager focus this advertising campaign? Explain.
f. Top management is considering investing several million dollars to expand operations in one of its two sales territories. The expansion would increase the traceable fixed costs to the expanded territory in proportion to its increase in sales. Which territory would be the best candidate for this investment? Explain.
Shown on the following page are responsibility income statements for Butterfield, Inc., for the month of March.
PROBLEM 22.5A Analysis of
Responsibility Income Statements
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FasTrak RowMaster
Sales . . . $600,000 $750,000 Contribution margin ratios . . . 55% 40%
Traceable fixed costs . . . $ 80,000 $150,000
Confirming Pages
Problem Set A 981
Instructions
a. The company plans to initiate an advertising campaign for one of the two products in Divi- sion 1. The campaign would cost $10,000 per month and is expected to increase the sales of whichever product is advertised by $30,000 per month. Compute the expected increase in the responsibility margin of Division 1 assuming that ( 1 ) product A is advertised and ( 2 ) product B is advertised.
b. Assume that the sales of both products by Division 1 are equal to total manufacturing capac- ity. To increase sales of either product, the company must increase manufacturing facilities, which means an increase in traceable fixed costs in approximate proportion to the expected increase in sales. In this case, which product line would you recommend expanding? Explain.
c. The income statement for Division 1 includes $21,000 in common fixed costs. What happens to these fixed costs in the income statement for Butterfield, Inc.?
d. Assume that in April the monthly sales in Division 2 increase to $200,000. Compute the expected effect of this change on the operating income of the company (assume no other changes in revenue or cost behavior).
e. Prepare an income statement for Butterfield, Inc., by division, under the assumption stated in part d. Organize this income statement in the format illustrated above, including columns for percentages.
FlyWiz, Inc., is a small manufacturer of professional fishing equipment. The company has two divisions: the Rod Division and the Reel Division. Data for the month of January are shown on the following page.
PROBLEM 22.6A Evaluating an
Unprofitable Business Center
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Investment Centers
Butterfield,
Inc. Division 1 Division 2 Dollars % Dollars % Dollars % Sales. . . $450,000 100% $300,000 100% $150,000 100%
Variable costs . . . 225,000 50 180,000 60 45,000 30 Contribution margin . . . $225,000 50% $120,000 40% $105,000 70%
Fixed costs traceable to
divisions . . . 135,000 30 63,000 21 72,000 48 Division responsibility
margin . . . $ 90,000 20% $ 57,000 19% $ 33,000 22%
Common fixed costs . . . 45,000 10 Income from operations . . . . $ 45,000 10%
Profit Centers
Division 1 Product A Product B Dollars % Dollars % Dollars % Sales. . . $300,000 100% $100,000 100% $200,000 100%
Variable costs . . . 180,000 60 52,000 52 128,000 64 Contribution margin . . . $120,000 40% $ 48,000 48% $ 72,000 36%
Fixed costs traceable to
products . . . 42,000 14 26,000 26 16,000 8 Product responsibility
margin . . . $ 78,000 26% $ 22,000 22% $ 56,000 28%
Common fixed costs . . . 21,000 7 Responsibility margin for
division . . . $ 57,000 19%
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Nick Fulbright, the company’s chief financial officer since January 1 of the current year, wants to close the unprofitable Rod Division. He believes that doing so will benefit FlyWiz and benefit him, given that his end-of-year bonus is to be based on the company’s overall operating income. In a recent interview, Fulbright summarized his business philosophy as follows: “A company is only as strong as its least profitable segment. As long as I’m at the financial helm, only the strongest shall survive at FlyWiz.”
Instructions
a. Had the Rod Division been closed on January 1, what would the company’s operating income for the month have been?
b. After learning about Fulbright’s business philosophy, the Rod Division’s director of market- ing made the following statement: “Nick Fulbright may understand numbers, but he doesn’t understand the complementary relationship between rods and reels, nor the seasonal nature of our business.” What did the director of marketing mean by this statement? How might such information influence Fulbright’s assessment of the company’s Rod Division?
c. By how much would the Rod Division’s monthly sales have to increase for it to generate a positive responsibility margin of $4,000 in any given month? Show all of your computations.
Rhinesch Corporation has two divisions: the Motor Division and the Pump Division. The Motor Division supplies the motors used by the Pump Division. The Pump Division produces approxi- mately 10,000 pumps annually. Thus, it receives 10,000 motors from the Motor Division each year. The market price of these motors is $320. The total variable cost of the motor is $195 per unit. The market price of the pumps is $500. The unit variable cost of each pump, excluding the cost of the motor, is $75.
The Motor Division is currently operating at full capacity, producing 20,000 motors per year (10,000 of which are transferred to the Pump Division). The demand for the motors is so great that all 20,000 units could be sold to outside customers if the Pump Division acquired its motors elsewhere. The Motor Division uses the full market price of $320 as the transfer price charged to the Pump Division.
The manager of the Pump Division asserts that the Motor Division benefits from the intercom- pany transfers because of reduced shipping costs. As a result, he wants to negotiate a lower transfer price of $310 per unit.
Instructions
a. Compute the contribution margin earned annually by each division and by the company as a whole using the current transfer price.
b. Compute the contribution margin that would be earned annually by each division and by the company as a whole if the discounted transfer price were used.
c. What issues and concerns should be considered in setting a transfer price for intercompany transfers of motors?
Sparta and Associates produces trophies and has two divisions: the Green Division and the White Division. The Green Division produces the trophy base, which it can sell to outside markets for
$150. A trophy base has variable costs per unit of $65 and fixed costs of $100,000, based on monthly production of 2,000 bases. Each trophy base could be sold to outside customers by the Green Division, as bases are in high demand. The Green Division has no idle capacity.
PROBLEM 22.7A Transfer Pricing Decisions P T LO1
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PROBLEM 22.8A Transfer Pricing Decisions P T LO1
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Profit Centers
Entire Rod Reel
Company Division Division Sales . . . $64,000 $26,000 $38,000
Variable costs . . . 29,000 13,000 16,000 Contribution margin . . . $35,000 $13,000 $22,000 Traceable fixed costs . . . 27,000 17,000 10,000 Division responsibility margin . . . $ 8,000 $ (4,000) $12,000 Common fixed costs . . . 3,000
Monthly operating income . . . $ 5,000