RESPONSIBILITY ACCOUNTING AND TRANSFER PRICING LO1. The Need for Information About. Large complex. divided into responsibility.

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1 Chapter RESPONSIBILITY 15 ACCOUNTING AND TRANSFER PRICING Learning Objective To distinguish among cost centers, profit centers, and investment centers. LO1 Responsibility Centers 15-3 The Need for Information About Responsibility Center Performance 15-4 Large complex businesses are divided into responsibility centers enabling managers to have a smaller effective span of control. The accounting system provides information about resources used and outputs achieved. This information is used to: Plan and allocate resources. Control operations. Evaluate the performance of center managers.

2 Cost Centers, Profit Centers, and Investments Centers 15-5 Cost Centers, Profit Centers, and Investments Centers 15-6 Cost Center A business section that has control over the incurrence of costs, but no control over revenues or investment funds. 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 Cost Centers, Profit Centers, and Investments Centers 15-7 Cost Centers, Profit Centers, and Investments Centers 15-8 Investment Center A profit center where management also makes capital investment t decisions. Corporate Headquarters Cost Center Profit Center Investment Center Evaluation Measures Cost control Quantity and quality of services Profitability Return on assets (ROA) Residual income (RI)

3 Learning Objective Responsibility Accounting Systems To explain the need for responsibility center information and describe a responsibility accounting system. Relating to the responsibilities of individual id managers. An accounting system that provides information... To evaluate managers on controllable items. LO Responsibility Accounting Systems Successful implementation of responsibility accounting may use organization charts with clear lines of authority and clearly defined levels of responsibility. Prepare budgets for each responsibility center. Measure performance of each responsibility center. Board of Directors President Vice President of Finance Vice President of Operations Vice President of Marketing Prepare timely performance reports comparing actual amounts with budgeted amounts. Store Manager Department Manager

4 Responsibility Accounting Systems Amount of detail varies according to level in organization. Responsibility Accounting Systems Amount of detail varies according to level in organization. Management by exception: Upper-level l management does not receive operating detail unless problems arise. A department manager receives detailed reports. A store manager receives summarized information from each department. The vice president of operations receives summarized information from each store Responsibility Accounting Systems To be of maximum benefit, responsibility reports should... Be timely. Be issued regularly. Be understandable. Compare budgeted and actual amounts. Learning Objective To prepare an income statement showing contribution margin and responsibility margin. LO3

5 Assigning Revenue and Costs to Business Centers Assigning Revenue and Costs to Business Centers Revenueen e is easily and automatically at assigned to specific departments using point of sale entries from cash registers. Service Department 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 Webber, Inc. has two divisions. Computer Division Webber, Inc. Let s look more closely at the Television Division s income statement. Television Division Contribution Margin Format Television Division Sales $ 300,000 Variable COGS $ 120,000 Other variable costs 30,000 Total variable costs $ 150,000 Contribution margin $ 150,000 Traceable fixed costs 90, Responsibility margin $ 60,000 Cost of goods sold consists of variable manufacturing costs.

6 Contribution Margin Format Television Division Sales $ 300,000 Variable COGS $ 120,000 Other variable costs 30,000 Total variable costs $ 150,000 Contribution margin $ 150,000 Traceable fixed costs 90, Responsibility margin $ 60,000 Fixed and variable costs are listed in separate sections. Contribution Margin Format Television Division Sales $ 300,000 Variable COGS $ 120,000 Other variable costs 30,000 Total variable costs $ 150,000 Contribution margin $ 150,000 Traceable fixed costs 90, Responsibility margin $ 60,000 Responsibility margin is the Television Division s s contribution to overall operations Learning Objective To distinguish between traceable and common fixed costs. Traceable Fixed Costs Traceable fixed costs would disappear over time if the center itself disappeared. No computer division means... No computer division manager. LO4

7 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 We still have a division means... company president. Let s see how the Television Division fits into Webber, Inc Traceable Costs Can Become Common Costs Company 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) 000) (90,000) 000) (80,000) 000) Responsibility margin $ 100,000 $ 60,000 $ 40,000 Common costs (25,000) Net income $ 75,000 Fixed costs that are traceable on one level can become common if the business is divided into smaller parts. Let s see how this works! Common costs arise because of overall operating activities and are not due to the existence of a particular division.

8 Television Division Color HDTV Sales $ 300,000 $ 200,000 $ 100,000 Variable costs (150,000) (95,000) (55,000) CM $ 150, $ 105, $ 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 Television Division Color HDTV Sales $ 300,000 $ 200,000 $ 100,000 Variable costs (150,000) (95,000) (55,000) CM $ 150, $ 105, $ 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 $90,000 cost directly traced to the Television Division. $ 45,000 To Color 35,000 To HDTV 10,000 Common $ 90,000 TV Division Learning Objective Responsibility Margin To explain the usefulness of the contribution margin and responsibility margin in making short-term and long-term decisions. Responsibility margin is the best gauge of the long-run profitability of a business center. Profits LO5 Time

9 When is a Business Center Unprofitable? When is a Business Center Unprofitable? Home Appliance Company 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 Home Appliance Company 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 because the responsibility margin is negative. While contribution margin is used for short-run decisions, responsibility margin is used for long-run decisions? i Should the Dryer Division be discontinued because the responsibility margin is negative? Evaluating Business Center Managers Arguments Against Allocating Common Fixed Costs 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. 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. The key issue is controllability.

10 Nonfinancial Objectives and Information End of Chapter Product Quality Number of defective parts Number of customer returns Number of customer complaints Personnel Number of sick days taken Employee turnover Number of grievances filed Marketing Number of new customers Number of sales calls initiated Market share Number of product stockouts Efficiency and Capacity Cycle time (manufacturing) Occupancy rates (hotels) Passenger miles (airlines) Patient days (hospitals) Transactions processed (banks)