© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Responsibility Accounting and Transfer Pricing Chapter 21

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Responsibility Centers Large complex businesses are divided into responsibility centers enabling managers to have a smaller effective span of control.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The accounting system provides information about resources used and outputs achieved. The Need for Information About Responsibility Center Performance This information is used to : Plan and allocate resources. Control operations. Evaluate the performance of center managers.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Cost 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.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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. Revenues Sales Interest Other Costs Mfg. costs Commissions Salaries Other

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Corporate Headquarters Cost Centers, Profit Centers, and Investments Centers Investment Center A profit center where management also makes capital investment decisions.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Cost Center Cost control Quantity and quality of services Profit Center Investment Center Return on assets (ROA) Residual income (RI) Evaluation Measures Profitability Cost Centers, Profit Centers, and Investments Centers

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin An accounting system that provides information... Responsibility Accounting Systems Relating to the responsibilities of individual managers. To evaluate managers on controllable items.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Prepare budgets for each responsibility center. Prepare timely performance reports comparing actual amounts with budgeted amounts. Measure performance of each responsibility center. Responsibility Accounting Systems

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Successful implementation of responsibility accounting may use organization charts with clear lines of authority and clearly defined levels of responsibility.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 Systems

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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 Systems

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Responsibility Accounting Systems To be of maximum benefit, responsibility reports should... Be timely. Be issued regularly. Be understandable. Compare budgeted and actual amounts.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin $$$$$$ Service Department Assigning Revenue and Costs to Business Centers Revenue is easily and automatically assigned to specific departments using point of sale entries from cash registers.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Profit Center Reporting Webber, Inc. has two divisions. Lets look more closely at the Television Divisions income statement.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Cost of goods sold consists of variable manu- facturing costs. Profit Center Reporting

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Fixed and variable costs are listed in separate sections. Profit Center Reporting

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Responsibility margin is the Television Divisions contribution to overall operations. Profit Center Reporting

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin No computer division means... No computer division manager. Traceable Fixed Costs Traceable fixed costs Traceable fixed costs would disappear over time if the center itself disappeared.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Common fixed costs arise because of overall operation of the company and are not due to the existence of a particular center. 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. Common Fixed Costs

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Lets see how the Television Division fits into Webber, Inc. Profit Center Reporting

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Common costs arise because of overall operating activities and are not due to the existence of a particular division. Profit Center Reporting

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Lets see how this works! Traceable Costs Can Become Common Costs smaller Fixed costs that are traceable on one level can become common if the business is divided into smaller parts.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Profit Center Reporting

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin $90,000 cost directly traced to the Television Division. Profit Center Reporting

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Time Profits Responsibility Margin best gauge Responsibility margin is the best gauge of the long-run profitability of a business center.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Dryer Division is unprofitable because the responsibility margin is negative. When is a Business Center Unprofitable?

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The key issue is controllability. Evaluating Business Center Managers Managers should be evaluated on the portion of responsibility margin they control. Common fixed costs can not be traced to the Dryer Division or the Washer Division, so they are excluded from the responsibility margin.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Lets change topics! Transfer Prices

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The amount charged when one division sells goods or services to another division. Battery DivisionAuto Division Batteries Transfer Prices

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin A higher transfer price for batteries means greater profits for the Battery Division. Auto DivisionBattery Division Transfer Prices The transfer price affects the profit measure for both buying and selling divisions.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin... lower profits for the Auto Division. Auto DivisionBattery Division A higher transfer price for batteries means... Transfer Prices The transfer price affects the profit measure for both buying and selling divisions.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Many companies use the external market value of goods transferred as the transfer price. Transfer Prices Transfer prices have no direct effect upon the companys overall net income.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Transfer prices have no direct effect upon the companys overall net income. When the external market value of goods transferred is unavailable... Transfer Prices Negotiated transfer price Cost-plus transfer price

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Nonfinancial Performance Measures

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin This information is far less detailed than the responsibility center information developed for management. This information is far less detailed than the responsibility center information developed for management. Segment Reporting in Financial 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.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin End of Chapter 21