1. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-1 RESPONSIBILITY ACCOUNTING AND TRANSFER PRICING Chapter 22

2. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-2 Responsibility Centers Large complex businesses are divided into responsibility centers enabling managers to have a smaller effective span of control.

3. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-3 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.

4. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-4 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.

5. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-5 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

6. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-6 Cost Centers, Profit Centers, and Investments Centers Investment Center A profit center where management also makes capital investment decisions. Corporate Headquarters

7. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-7 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

8. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-8 An accounting system that provides information... Responsibility Accounting Systems Relating to the responsibilities of individual managers. To evaluate managers on controllable items.

9. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-9  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

10. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-10 Successful implementation of responsibility accounting may use organization charts with clear lines of authority and clearly defined levels of responsibility.

11. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-11 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

12. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-12 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

13. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-13 Responsibility Accounting Systems To be of maximum benefit, responsibility reports should... Be timely. Be issued regularly. Be understandable. Compare budgeted and actual amounts.

14. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-14 Assigning Revenue and Costs to Business Centers Revenue is easily and automatically assigned to specific departments using point of sale entries from cash registers. Service Department

15. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-15 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.

16. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-16 Profit Center Reporting Webber, Inc. has two divisions. Let’s look more closely at the Television Division’s income statement.

17. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-17 Cost of goods sold consists of variable manufacturing costs. Cost of goods sold consists of variable manufacturing costs. Profit Center Reporting

18. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-18 Fixed and variable costs are listed in separate sections. Profit Center Reporting

19. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-19 Responsibility margin is the Television Division’s contribution to overall operations. Responsibility margin is the Television Division’s contribution to overall operations. Profit Center Reporting

20. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-20 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.

21. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-21 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. We still have a company president. Common Fixed Costs No computer division means...

22. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-22 Let’s see how the Television Division fits into Webber, Inc. Let’s see how the Television Division fits into Webber, Inc. Profit Center Reporting

23. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-23 Common costs arise because of overall operating activities and are not due to the existence of a particular division. Common costs arise because of overall operating activities and are not due to the existence of a particular division. Profit Center Reporting

24. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-24 Let’s 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.

25. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-25 Profit Center Reporting

26. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-26 $90,000 cost directly traced to the Television Division. Profit Center Reporting

27. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-27 Time Profits Responsibility Margin best gauge Responsibility margin is the best gauge of the long-run profitability of a business center.

28. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-28 The Dryer Division is unprofitable because the responsibility margin is negative. When is a Business Center Unprofitable?

29. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-29 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.

30. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-30 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.

31. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-31 The amount charged when one division sells goods or services to another division. Battery DivisionAuto Division Batteries Transfer Prices

32. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-32 A higher transfer price for batteries means...... greater profits for the Battery Division. Auto Division Transfer Prices The transfer price affects the profit measure for both buying and selling divisions. Battery Division

33. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-33... lower profits for the Auto Division. Auto Division A higher transfer price for batteries means... Transfer Prices The transfer price affects the profit measure for both buying and selling divisions. Battery Division

34. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-34 Many companies use the external market value of goods transferred as the transfer price. Transfer Prices Transfer prices have no direct effect upon the company’s overall net income.

35. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-35 Transfer prices have no direct effect upon the company’s overall net income. When the external market value of goods transferred is unavailable... Transfer Prices Negotiated transfer price Cost-plus transfer price

36. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-36 Nonfinancial Performance Measures

37. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-37 Overview of Traditional and Variable Costing Direct Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses Traditional Costing Variable Costing Product Costs Period Costs Product Costs Period Costs

38. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-38 Unit Cost Computations Dana, Inc. produces a single product with the following information available:

39. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-39 Unit Cost Computations Unit product cost is determined as follows: Selling and administrative expenses are always treated as period expenses and deducted from revenue.

40. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-40 Income Comparison of Traditional and Variable Costing Dana had no beginning inventory, produced 25,000 units and sold 20,000 units this year.

41. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-41 Income Comparison of Traditional and Variable Costing Dana had no beginning inventory, produced 25,000 units and sold 20,000 units this year.

42. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-42 Income Comparison of Traditional and Variable Costing Now let’s look at variable costing by Dana, Inc. Variable costs only. All fixed manufacturing overhead is expensed.

43. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-43 Income Comparison of Absorption and Variable Costing Let’s compare the methods.

44. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-44 Reconciliation Fixed mfg. overhead $150,000 Units produced 25,000 units = = $6.00 per unit We can reconcile the difference between absorption and variable income as follows:

45. © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 22-45 End of Chapter 22