Responsibility Accounting and Transfer Pricing

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Chapter21
Responsibility Accounting and Transfer Pricing
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Responsibility Centers

• Large complex businesses are divided into
  responsibility centers enabling managers to have
  a smaller effective span of control.

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The Need for Information About Responsibility
Center Performance

• This information is used to
• Plan and allocate resources.
• Control operations.
• Evaluate the performanceof center managers.

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

Cost
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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.

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Cost Centers, Profit Centers, and Investments
Centers

• Investment Center
• A profit center where management also makes
  capital investment decisions.

Corporate Headquarters
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Cost Centers, Profit Centers, and Investments
Centers
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Responsibility Accounting Systems
An accounting system thatprovides information .
. .
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Responsibility Accounting Systems

• Prepare budgets for each responsibility center.

• Measure performance ofeach responsibility
  center.

• Prepare timely performance reportscomparing
  actual amounts with budgeted amounts.

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Successful implementation of responsibility
accounting may use organization charts with clear
lines of authority and clearly defined levels of
responsibility.
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Responsibility Accounting Systems
Amount of detail varies according to level in
organization.
A store manager receives summarized information
from each department.
A department manager receives detailed reports.
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Responsibility Accounting Systems
Amount of detail varies according to level in
organization.
Management by exception Upper-level management
does not receive operating detail unless problems
arise.
The vice president of operations receives
summarized information from each store.
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Responsibility Accounting Systems

• To be of maximum benefit, responsibility
  reports should . . .
• Be timely.
• Be issued regularly.
• Be understandable.
• Compare budgetedand actual amounts.

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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

• 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 Reporting
Webber, Inc. has two divisions.
Lets look more closely at the Television
Divisions income statement.
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Profit Center Reporting
Cost of goods sold consists of variable
manu- facturing costs.
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Profit Center Reporting
Fixed and variable costs are listed
in separate sections.
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Profit Center Reporting
Responsibility marginis the TelevisionDivisions
contribution to overall operations.
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Traceable Fixed Costs

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

No computer division means . . .
No computer division manager.
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Common Fixed Costs
Common fixed costs arise because of overall
operation of the company and are not due to the
existence of a particular center.
No computer division but . . .
We still have a company president.
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Profit Center Reporting
Lets see how the Television Division fits into
Webber, Inc.
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Profit Center Reporting
Common costs arise because of overall operating
activities and are not due to the existence of a
particular division.
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Traceable Costs Can Become Common Costs

• Fixed costs that are traceable on one level
  can become common if the business is divided into
  smaller parts.

Lets see how this works!
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Profit Center Reporting
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Profit Center Reporting
90,000 cost directly tracedto the Television
Division.
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Responsibility Margin

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

Profits
Time
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When is a BusinessCenter Unprofitable?
The Dryer Division is unprofitable becausethe
responsibility margin is negative.
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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

• Common fixed costs would not change even if a
  business center were eliminated.
• Common fixed costs are not under the direct
  control of the centers managers.
• Allocation of common fixed costs may imply
  changes in profitability that are unrelated to
  the centers performance.

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Transfer Prices
Lets change topics!
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Transfer Prices
The amount charged when one division sells goods
or services to another division.
Batteries
Battery Division
Auto Division
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Transfer Prices

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

A higher transferprice for batteriesmeans . . .
. . . greater profits for the Battery Division.
Auto Division
Battery Division
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Transfer Prices

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

A higher transferprice for batteriesmeans . . .
. . . lowerprofits for the Auto Division.
Auto Division
Battery Division
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Transfer Prices
Many companies use the externalmarket value of
goods transferredas the transfer price.
Transfer prices have no direct effect uponthe
companys overall net income.
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Transfer Prices
When the external market value of
goodstransferred is unavailable . . .
Transfer prices have no direct effect uponthe
companys overall net income.
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Nonfinancial Performance Measures
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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.

This information isfar less detailed thanthe
responsibility center information developed for
management.
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End of Chapter 21