Solution manual accounting 25th edition warren chapter 24

When using the negotiated price approach to transfer pricing, the transfer price should be less than the market price but greater than the supplying division’s variable cost per unit..

PERFORMANCE EVALUATION FOR DECENTRALIZED OPERATIONS DISCUSSION QUESTIONS

1 In a centralized operation, all major planning and operating decisions are made by top management.

In a decentralized operation, managers of separate divisions or units are delegated operating responsibility The division (unit) managers are responsible for planning and controlling the operations of their divisions Divisions are often structured around products, customers, or

regions

2 The department manager of a profit center has responsibility for and authority over costs and

revenues, while the manager of an investment center has responsibility for and authority overcontrolling investments in assets as well as costs and revenues

3 Payroll: Number of checks issued Accounts payable: Number of invoices paid Accounts

receivable: Number of sales invoice payments collected Database administration: Number of reports generated

4 The major shortcoming of using income from operations as a measure of investment center

performance is that it ignores the amount of investment committed to each center Since

investment center managers also control the amount of assets invested in their centers, they should be held accountable for the use of invested assets

5 A division of a decentralized company could be considered the least profitable, even though

it earned the largest amount of income from operations, when its rate of return on investment

is the lowest In this situation, the division would be considered the least profitable per dollarinvested in the division because it generated less profit out of each dollar of assets invested

6 By dividing income from operations by the amount of invested assets, each division is placed

on a comparable basis of income from operations per dollar invested

7 The balanced scorecard attempts to identify the underlying nonfinancial drivers, or causes, of

financial performance related to innovation and learning, customer service, and internal processes

In this way, the financial performance may be improved For example, customer satisfaction is often measured by the number of repeat customers By increasing the number of repeat customers, sales and income from operations can be increased

8 The objective of transfer pricing is to encourage each division manager to work in the best

interests of the company Thus, transfer prices should encourage managers to transfer goods between divisions if the overall company income can be increased

9 When unused capacity exists in the supplying division, the negotiated price approach is

preferred over the market price approach

10 When using the negotiated price approach to transfer pricing, the transfer price should be less

than the market price but greater than the supplying division’s variable cost per unit

24-1

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Northeast Division Service Charge for Travel Departmen t :

$195,750 = 1,800 billed reservations × ($435,000 ÷ 4,000 reservations) Pacific Division Service Charge for Travel Departmen t :

$239,250 = 2,200 billed reservations × ($435,000 ÷ 4,000 reservations)

PE 24–2B

Retail Division Service Charge for Computer Technology Departmen t :

$118,800 = 1,125 billed hours × ($264,000 ÷ 2,500 hours billed)

Commercial Division Service Charge for Computer Technology Departmen t :

$145,200 = 1,375 billed hours × ($264,000 ÷ 2,500 hours billed)

PE 24–3A

Northeast Pacific Division Division

Cost of goods sold……… 590,800 658,000

Selling expenses……… 231,000 252,000 Income from operations before service

department charges……… $ 333,200 $ 294,000 Service department charges……… 195,750 239,250 Income from operations……… $ 137,450 $ 54,750

Service department charges……… 118,800 145,200

Less: Minimum acceptable income from operations as a

PE 24–5B

Less: Minimum acceptable income from operations as a

Increase in South (Supplying) (Transfer Price – Variable Cost per Unit) Division’s Income from Operations = × Units Transferred

Increase in South (Supplying)

Division’s Income from Operations =

($52 – $42) × 30,000 units = $300,000

Increase in North (Purchasing)

Division’s Income from Operations =

(Market Price – Transfer Price)

× Units Transferred

Increase in North (Purchasing)

Division’s Income from Operations = ($60 – $52) × 30,000 units = $240,000

PE 24–6B

Increase in Pembroke (Supplying)

Division’s Income from Operations =

(Transfer Price – Variable Cost per Unit)

× Units Transferred

Increase in Pembroke (Supplying)

Division’s Income from Operations =

($82 – $75) × 15,000 units = $105,000

Increase in Multinomah (Purchasing)

Division’s Income from Operations =

(Market Price – Transfer Price)

× Units Transferred Increase in Multinomah (Purchasing)

Division’s Income from Operations = ($90 – $82) × 15,000 units = $120,000

Schedules of supporting calculations (answers in italics; the solution requires

working from the department level, up to the plant level, then to the vice president

of production level):

MAQUIRE COMPANY Budget Performance Report—Vice President, Production

For the Month Ended May 31, 2014

Over Budget

Under Budget

For the Month Ended May 31, 2014

Over Budget

Under Budget Chip Fabrication $192,240 (a) $195,072 (b) $2,832 (c)

$592,056 (d) $596,256 (e) $4,848 (f) $648

MAQUIRE COMPANY Budget Performance Report—Supervisor, Chip Fabrication

For the Month Ended May 31, 2014

Over Budget

Under Budget

To: Holly Keller, Vice President of Production

The South Region plant has experienced a budget overrun, while the Mid-Atlantic and West Region plants have experienced a budget surplus The budget of the South Region plant reveals that the Chip Fabrication Department causes the majority

of the budget overrun The budget for the Chip Fabrication Department indicates that the budget overrun was caused by a combination of budget overruns in

wages, power and light, and maintenance that exceeded a budget surplus in

materials The supervisor of the Chip Fabrication Department should investigate the reasons for the budget overruns in wages, power and light, and

maintenance It is possible that all three of these budget overruns have the

same cause, such as a need for unplanned overtime or weekend work to meet

schedules.

Ex 24–2

ENDLESS RIVER CONSTRUCTION COMPANY

Divisional Income Statements For the Year Ended June 30, 2014

Commercial Division

Residential Division

Expense Activity Bases

c Electronic data processing Central processing unit (CPU) time, number of

printed pages, amount of memory usage

d Central purchasing Number of requisitions, number of purchase orders e.

Number of payroll checks:

Number of purchase

Service department charge rates:

Service department charges:

1 13,600 checks × $4.00 per check

2 7,700 checks × $4.00 per check

2,750 requisitions × $6.00 per requisition

The service department charges are determined by multiplying the service

department charge rate by the activity base for each division.

c Residential’s service department charge is higher than the other two divisions

because Residential is a heavy user of service department services Residential has many employees on a weekly payroll, which translates into a larger number

of check-issuing transactions This may be because residential jobs are less

productive per labor hour, compared to larger commercial and government

contract jobs Additionally, Residential uses purchasing services more than the other two divisions This may be because the division has many different

smaller jobs requiring frequent purchase transactions.

Monthly payroll × 12……… 600 1,200 720

$735,000 9,800 devices

$100,000 10,000 accounts

$124,600 8,900 phone extensions

= $50 per call

= $75 per device monitored

= $10 per user or e-mail account

= $14 per phone extension

b October charges to the COMM sector:

Help desk charge:

VAN EMBURGH TECHNOLOGY Divisional Income Statements For the Year Ended December 31, 2014

Consumer Division Commercial Division

Supporting calculations for controllable service department charges:

Note 1: Consumer Division ($676,000 ÷ 400 computers) × 250 computers = $422,500

Commercial Division ($676,000 ÷ 400 computers) × 150 computers = $253,500 Note 2: Consumer Division ($256,000 ÷ 10,000 checks) × 3,400 checks = $87,040

Commercial Division ($256,000 ÷ 10,000 checks) × 6,600 checks = $168,960

a The reported income from operations does not accurately measure performance because the service department charges are based on revenues Revenues are not associated with the profit center manager’s use of the service department services For example, the Reservations Department serves only the Passenger Division Thus, by charging this cost on the basis of revenues, these costs are incorrectly charged to the Cargo Division Additionally, the Passenger Division requires additional personnel Since

these personnel must be trained, the training costs assigned to the Passenger Division should be greater than the Cargo Division.

b.

WILD SUN AIRLINES INC.

Divisional Income Statements For the Year Ended December 31, 2014

Passenger Division Cargo Division

Income from operations

before service department

Supporting calculations for controllable service department charges:

Training: Passenger Division, ($250,000 ÷ 500 personnel trained) × 350

personnel trained Cargo Division, ($250,000 ÷ 500 personnel trained) × 150 personnel trained

Flight Scheduling: Passenger Division, ($216,000 ÷ 2,000 flights) × 800 flights

Cargo Division, ($216,000 ÷ 2,000 flights) × 1,200 flights Reservations: Passenger Division, ($302,400 ÷ 20,000 reservations) × 20,000

reservations Cargo Division, ($302,400 ÷ 20,000 reservations) × 0 reservations

FULL THROTTLE SPORTING GOODS CO.

Divisional Income Statements For the Year Ended December 31, 2014

Winter Sports Division

Summer Sports Division

$ 8,190,000 $ 8,335,600 Income from operations before service

Less service department charges:

Supporting Schedule:

Note (1) Winter Sports Division: $611,000

Summer Sports Division: $746,900

Note (2) Winter Sports Division:

Summer Sports Division:

(20,400 bills of lading × $14.00 per bill of lading) (22,100 bills of lading × $14.00 per bill of lading) Note (3) Winter Sports Division:

Summer Sports Division:

(13,120 invoices × $7.50 per invoice) (18,880 invoices × $7.50 per invoice) Note (4) Winter Sports Division:

Summer Sports Division:

($2,650,000/265,000 sq ft.) × 124,550 sq ft ($2,650,000/265,000 sq ft.) × 140,450 sq ft.

Internet Division

Minimum amount of income from

a Rate of Return

on Investment = Profit Margin × Investment Turnover

Rate of Return

ROI = $1,750,000 × $7,000,000

$7,000,000 $5,000,000 ROI = 25% × 1.40

ROI = 35%

b The profit margin would increase from 25% to 30%, the investment turnover would remain unchanged, and the rate of return on investment would increase from 35% to 42%, as shown below.

ROI = 42%

* $1,750,000 + $350,000

a Rate of Return

on Investment =

Income from Operations

Revenues × Invested Assets Revenues

investment turnover The combination produces a respectable ROI of 7.9% Studio Entertainment has a weak profit margin and a weak investment turnover generating only

a 5% return on investment The Consumer Products division combines a good profit margin with a good investment turnover The combination produces a sound ROI of 16.3%.

c (1) The South Division has the highest return on investment (21.6%).

(2) The West Division has the largest residual income.

a Rate of Return

on Investment =

Income from Operations

Revenues × Invested Assets Revenues

Income from operations………

Less: Minimum return (5% of assets)………

Residual income (loss)………

c The Vacation Ownership (VO) segment has the weakest return on investment, which is mainly the result of a weak investment turnover The VO segment earns profit margins that are higher than the profit margins in the Hotel Ownership (HO) segment (15.3% vs 13.0%) However, weak investment turnover is causing the ROI for the VO segment to be less than the assumed minimum acceptable return.

The residual income is negative for VO, which is consistent with a ROI less than the acceptable 5% minimum return This weak performance is due primarily to the deterioration in the real estate market that has occurred in recent years The

profit margin and investment turnover in the VO segment are closely tied to the strength of the real estate market and the overall economy, both of which

deteriorated significantly in the preceding years.

The HO segment ROI is also affected by the global economy, but is still generating

a solid ROI Stable profit margins and investment turnover generate a ROI that is above the minimum acceptable return The residual income is positive, which is consistent with a ROI that is greater than the 5% minimum return.

Although there is some judgment in classifying each of these measures, the following represents the author’s assessment with explanations:

Average card member spending Customer—demonstrates the usefulness of

the card to the customer.

card, they would not have one.

Hours of credit consultant training Internal process—advisors will do their job

better if they are trained.

Investment in information technology Internal process (or innovation)—shows the

investment in improving processes.

Number of Internet features Internal process (or innovation)—shows new

process investments in a new channel Number of merchant signings Customer—the larger the number of

merchants that honor the card, the more valuable it is to cardholders.

to customers.

Number of new card launches Innovation—measures the new cards

(affinity, regional, etc.) being developed and marketed.

a UPS wanted a performance measurement system that would focus more on

the underlying drivers, or levers, of financial success It believed that focusing on

the financial numbers by themselves would not reveal how financial objectives

were to be achieved, especially with new demands coming from customers in the Internet age The balanced scorecard provides information on how the financial

targets are to be achieved Using common measures throughout the organization also aligns the organization, while simultaneously communicating priorities

Apparently, UPS determined that its future success as an organization depended

on “point of arrival” measures These measures emphasized customer

performance to a much higher degree than would straight financial numbers.

b The employee sentiment number is common in service businesses The

employees are the face of the company to the customer If employees feel poorly about the organization, or if they feel that they don’t make a difference, then they are not likely to deliver premium service experiences to their customers Just

think of the variety of fast food experiences you may have had in the past month Sometimes, the service is excellent with a smile; at other times, it’s poor with a

scowl Measuring the improving employee morale is critical to organizations

relying on front-line employees that deliver the customer experience.

Ex 24–20

Income from Operations = Price – per Unit × Transferred

b Increase in the Instrument Division’s

Income from Operations =

c Increase in the Components Division’s

Income from Operations =

Transfer

Variable Cost per Unit ×

Unit Transferred

a Increase in Dart Industries’

Market

Variable Cost per Unit ×

Units Transferred

This amount is the same amount by which Dart Industries’ income from

operations increased in Ex 24–20, when a transfer price of $145 was used.

b Increase in the Instrument Division’s Market Transfer Units

This is the amount the Instrument Division saves by purchasing from the

Components Division at an internal price that is lower than the market price.

c Increase in the Components Division’s Transfer Variable Cost Units

This is the amount the Components Division earns by using available excess capacity

to produce and sell products above variable cost to the Instrument Division.

d Any transfer price will cause the total income of the company to increase,

as long as the supplier division capacity is used toward making materials for

products that are ultimately sold to the outside However, transfer prices should

be set between variable cost and selling price in order to give the division

managers proper incentives A transfer price set below variable cost would

cause the supplier division to incur a loss, while a transfer price set above

market price would cause the purchasing division to incur opportunity costs

Neither situation is an attractive alternative for an investment center manager

Thus, the general rule is to negotiate transfer prices between variable cost and

market price when the supplier division has excess capacity The range of

acceptable transfer prices for Dart Industries would be between $180 and $125.

Prob 24–1A

1.

2 The customer service and marketing salaries are significantly over budget The director should investigate the cause of these results One possibility is that the company is having an increase in sales, requiring greater marketing effort and

customer service However, the warehouse and distribution costs have not

shown similar increases Thus, it’s also possible that marketing and customer

service salaries are increasing because of service problems and unplanned

efforts to market the company’s service.

E-NET COMPANY Budget Performance Report—Director, Consumer Products Division

For the Month Ended January 31, 2014

Over Budget

Under Budget Customer service salaries $ 390,600 $ 500,040 $109,440

TRAXONIA RAILROAD INC.

Divisional Income Statements For the Quarter Ended December 31, 2014

Income from operations before service

Less service department charges:

$167,500 $ 228,000 $ 274,500

Supporting Schedule:

Service department charge rates for the two service departments, Customer

Support and Legal, are determined as follows:

Note (A) East Division:

West Division:

Central Division:

($400,000/20,000 contacts) × 5,000 contacts ($400,000/20,000 contacts) × 6,000 contacts ($400,000/20,000 contacts) × 9,000 contacts Note (B) East Division:

West Division:

Central Division:

($270,000/5,400 hours) × 1,350 contacts ($270,000/5,400 hours) × 2,160 contacts ($270,000/5,400 hours) × 1,890 contacts

Note: The Shareholder Relations Department and general corporate officers’

salaries are not controllable by division management and thus are not included

in determining division income from operations.

2 The CEO evaluates the three divisions using income from operations as a

percent of revenues (profit margin) This measure is calculated for the three

The method used to evaluate the performance of the divisions should be

reevaluated The present method identifies the amount of income from

operations per dollar of earned revenue However, this company requires a

significant investment in fixed assets, for production and distribution facilities The amount of assets may not be related to the revenue earned The present

measure fails to incorporate these differences in asset utilization into the measure Naturally, the amount of assets used by a division in earning a return is a very important consideration in evaluating divisional performance Therefore, a better divisional performance measure would be either (a) rate of return on investment (income from operations divided by divisional assets) or (b) residual income (income from operations less a minimal return on divisional assets) Both measures

incorporate the assets used by the divisions.

on Investment = Profit Margin × Investment Turnover Rate of Return

Mutual Fund Division:

Electronic Brokerage Division:

ROI =

ROI = 8.0% × 3.00 ROI = 24.0%

Investment Banking Division:

ROI =

ROI = 18.0% × 1.20 ROI = 21.6%

E.F LYNCH COMPANY Divisional Income Statements For the Year Ended June 30, 2014

Mutual Fund Division

Electronic Brokerage Division

Investment Banking Division

3 Per dollar of invested assets, the Electronic Brokerage Division is the most

profitable of the three divisions Assuming that the rates of return on

investments do not change in the future, an expansion of the Electronic

Brokerage Division will return 24 cents (24%) on each dollar of invested assets, while the Mutual Fund and Investment Banking divisions will return only 22.4 cents (22.4%) and 21.6 cents (21.6%), respectively Thus, when faced with limited funds for expansion, management should consider an expansion of the

Electronic Brokerage Division first.

Note to Instructors: The Mutual Fund Division has excellent profit margins, but the

investment turnover is very low The investment in the “bricks and mortar” of the Mutual Fund Division offices causes the rate of return on investment to be depressed However, the Electronic Brokerage Division has very thin margins because the fees earned per trade are very small However the assets required

to execute trades are much less than the Mutual Fund Division because there is no need for offices (trades are executed over the Internet) As a result of the high investment turnover in the Electronic Brokerage Division, the rate of return on investment is much better.