Solution manual cost accounting by LauderbachDIVISIONAL PERFORMANCE MEASUREMENT

10-16 Transfer Prices and Decisions 25-30 minutes Preliminary Note to the Instructor: This is one of the few early exercises where students can prepare complete income statements for th

is greater It is also possible that the change could increase margins, if

it results in incremental sales at value menu prices, but preserves existing sales We think this unlikely

10-2 Alternative Accounting Methods

The effects of the cost flow assumptions are the same for a division of

a larger company as they are for an entire company as discussed in financial accounting In the context of rising prices, a division using LIFO would show lower profits and lower inventories and hence lower book investment than

if the division were using FIFO Use of weighted average would produce profits, inventories, and total investment somewhere between those resulting from LIFO and FIFO Return on book investment could appear to be lower if the division uses LIFO, though this would not necessarily be the case as the cumulative effects of LIFO on the inventory grow larger In fact, ROI would remain constant under LIFO if the division were able to price consistently atsome absolute amount over current cost, while ROI would fall under FIFO if the same pricing practice were followed (This answer assumes no change in the quantity of inventory on hand and a constant investment in other assets.)

If the company's practice is to set prices at a fixed percentage over

replacement cost, ROI should increase under LIFO and FIFO both, though, again, the return will be lower with LIFO

10-3 Product - Line Reporting

The major problem in preparing financial statements by product line, division, or principal lines of business is finding meaningful bases for allocating those balance sheet and income statement items that are not

directly associated with the segments being reported upon It is highly likely that any business of sufficient size to publish public annual reports has assets, liabilities, and costs that are joint to several operating

segments Segment reports could be prepared without allocations and showing unallocated balance sheet and income statement items separately, or possibly joint costs could be allocated on the basis of contribution margin minus separable costs

Whether or not segment reports incorporate allocations, there may be a drawback to publishing such reports if readers of the reports fail to

recognize that different types of divisions could, for reasons explained in the chapter, operate at different rates of return on sales or on investment Such understanding is, of course, a function of the sophistication of the

users On the other hand, readers of the reports would be better able to compare the performance of individual divisions with important competitors intheir industries, comparisons that are not now possible for multi-industry firms

As noted in Chapter 4, a company's activities can be segmented in many ways, and publishing reports on segments raises the question of what approach

to use in determining which segments to use for reporting Should the

reports be prepared by product line, by product, by division, by geographicalarea, by some common industry classification, or by some other scheme? The balance sheet and income statement items that require allocation will differ depending on the segmentation scheme

Note to the Instructor: Some instructors use this opportunity to tell students the current SEC and FASB requirements for segment reporting in published reports Others try to give students an idea of the diversity thatcan exist in large companies by referring to the annual reports of some well-known companies Our experience has been that undergraduate students atthe introductory level are seldom aware of the degree of diversification in the country's business enterprises

10-4 Performance measures and bonuses

Two important aspects of the new bonus plan are the explicit identification

of benchmarks and controllability Managers can now take action that will have an impact on the benchmarks and thus their bonus Under the old plan theconnection between the size of the bonus and actions taken was nebulous Managers now receive feedback on a quarterly basis rather than once at the end of the year

10-5 Whirlpool's Operating Results

The Sears sales should reduce margins, increase turnover, and increase ROI That answer assumes that Whirlpool does not have to add assets

proportionately to the increased sales The assumption is fine for fixed assets, and we suspect that receivables from Sears would not be as high as the average, nor will the extra business require inventories in the same relative amounts as ordinary operations require

A contrary answer, that turnover could remain the same or decrease, and ROI fall, might be made on grounds that 19% of sales is so large as to

require commensurate increases in all asset categories We acknowledge that 19% is significant, but doubt that it could generate so much in asset

increases

10-6 RI, ROI, and CVP Analysis (15-20 minutes)

1 50,000 ($600,000/$12)

Required income ($1,000,000 x 20%) $200,000 Fixed costs 400,000 Required contribution margin $600,000

2 32% ($320,000/$1,000,000)

Contribution margin (60,000 x $12) $720,000 Fixed costs 400,000

Income $320,000

3 $170,000

Income (requirement 2) $320,000 Required income ($1,000,000 x 15%) 150,000

RI $170,000

4 $21.00 $8 variable cost + $13 required contribution margin

Target income ($1,000,000 x 25%) $250,000 Plus fixed costs 400,000 Required contribution margin $650,000 Divided by 50,000 units equals required unit CM $13.00

5 55,000 units

RI $ 60,000 Minimum required income ($1,000,000 x 20%) 200,000 Income $260,000 Plus fixed costs 400,000 Contribution margin $660,000 Divided by contribution margin per unit $12 Equals required unit volume 55,000

10-7 Comparison of ROI and RI, Investment Decisions (15-20 minutes)

Note to the Instructor: It is important to point out with this early assignment that using ROI as the basic decision criterion does not mean that all projects yielding more than the current ROI would be selected For example, another project, F, yielding 25.1% would be rejected because overallROI after adding B and D exceeds 25.1% Thus, the process of accepting specific projects must be carried out one project at a time

2 (a) All except A and E, although A could be selected without reducing RI

Income* $2,720,000 Required return ($10,800,000** x 15%) 1,620,000

RI $1,100,000

* $2,000,000 + $200,000 + $230,000 + $290,000

**$8,000,000 + $700,000 + $1,000,000 + $1,100,000

(b) B and D

Income* $2,490,000 Required return ($9,800,000** x 25%) 2,450,000

(c) Increase $100,000 2,000 x ($175 - $125) or the sum of the

increases in the incomes of the divisions ($50,000 + $50,000)}

10-9 Product-Line Evaluation (15 minutes)

1 Dollar amounts in the following calculation are in millions

Cleaners Disinfectants Insect SpraysMargin 20% 18% 25%

Times turnover 2.5 2 1.8

Equals ROI 50% 36% 45%

Investment (sales/turnover) $12 ($30/2.5) $5 ($10/2) $10 ($18/1.8)Profit (margin x sales) $ 6 (.20 x $30) $1.8 (.18 x $10) $4.5 (.25 x

$18)

2 Dollar amounts in the following calculation are in millions

Cleaners Disinfectants Insect Sprays Profit $6.0 $1.8 $ 4.5

Required dollar profit:

$12 x 3 3.6

$ 5 x 3 1.5

$10 x 3 3.0

RI $2.4 $0.3 $ 1.5

Note to the Instructor: This exercise shows that the principles of evaluating divisions apply also to evaluating smaller segments The ROIs arehigh, as is the 30% required return You might wish to point out that the direct costs and investment associated with product lines are likely to be relatively lower than those of divisions Therefore, if the company does notallocate common costs to the lines, they should show much higher ROIs than divisions

10-10 Basic Transfer Pricing (30-35 minutes)

1 Games gains $100,000 and Power gains $150,000 Toys-and-Stuff gains

$250,000, which is also the sum of the net changes in the incomes of the individual divisions

Games saves [500,000 x ($1.20 - $1.00)] $100,000 Power gains the contribution margin from sales of

500,000 more units at $0.30 ($1.00 - $0.70) $150,000 Toys-and-Stuff saves ($1.20 - $0.70) x 500,000 $250,000

2 Power's manager might want to keep busy, so that he avoids losing skilledworkers who might leave the area because a temporary decline in demand

prompted a layoff Because the order is a break-even proposition, Power's manager might accept it in a spirit of cooperation The manager might also believe that accepting the order could lead to other, profitable orders in the future

3 Games gains $100,000 (see requirement 1); Power's income declines by

$150,000 [500,000 x ($1.30 - $1.00)] because it is simply trading sales at

$1.00 for sales at $1.30; and Toys-and-Stuff's income declines by $50,000 Toys-and-Stuff:

Saves the $0.50 noted in requirement 1 $250,000 Loses the contribution margin on outside sales

500,000 x ($1.30 - $0.70) 300,000 Net change in income (decrease) $(50,000)

In the absence of excess capacity, Power's manager is not likely to accept any price below the market price of $1.30

4 As in requirements 1 and 3, Games gains $100,000 Power's income

declines by $30,000 Income of Toys-and-Stuff increases by $70,000, which isalso the sum of the changes in the incomes of the individual divisions

Games:

Saves [500,000 x ($1.20 - $1.00)] $100,000 Power:

New contribution [500,000 x ($1.00 - $0.70)] $150,000

Lost contribution [300,000 x ($1.30 - $0.70)] 180,000

Net decrease in income $ 30,000 Toys-and-Stuff:

Saves the $0.50 noted in requirement 1 $250,000

Loses contribution margin on outside sales

300,000 x ($1.30 - $0.70) 180,000

Net increase in income $ 70,000

5 $1.06 The price has to bring contribution margin on 500,000 units to equal the contribution margin lost from 300,000 units sold at regular prices Contribution margin to be lost = Contribution margin needed on order 300,000 x ($1.30 - $0.70) = 500,000 x (P - $0.70)

10-11 Components of ROI (15-20 minutes)

1 Fabric and Food and Health

Home Care Beverages Care Paper Return on Sales 19.1% 12.2% 13.8% 15.1% Investment Turnover 2.22 1.77 1.75 1.43 ROI 42.3% 21.7% 24.2% 21.6%

2 Fabric and Food and Health

Home Care Beverages Care Paper Return on Sales 20.1% 13.2% 14.8% 16.1% Investment Turnover 2.22 1.77 1.75 1.43 ROI 44.6% 23.4% 25.9% 23.0% Note to the Instructor: Some instructors might want to spend time

discussing how ROI is affected by changes in its components As shown in theproblem, the higher the turnover the greater increase in ROI that accompanies

an increase in ROS, and vice versa (The increases in ROI are all 1% x the investment turnover; the advance in ROI was greatest for Fabric and Home Care, which had the highest turnover.) It should be pointed out that the increases here, one percentage point, are not equal percentage changes For example, the percentage increase for Fabric and Home Care is 5.2% (1%/19.1%) and for Food and Beverages is 8.2% (1%/12.2%)

10-12 ROI, RI, and CVP Analysis (15-20 minutes)

1 43,750 units

Required profit ($900,000 x 25%) $225,000 Fixed costs 300,000 Contribution margin required $525,000Divided by per-unit contribution margin ($30 - $18) $12 Equals required unit volume 43,750

2 (a) 24%

Total contribution margin ($12 x 43,000) $516,000 Fixed costs 300,000 Profit $216,000 Divided by divisional investment $900,000 Equals ROI 24%

(b) $22.92

Required return on additional investment (24% x $80,000) $ 19,200 Increase in fixed costs 30,000 Additional contribution margin required $ 49,200 Additional variable costs (10,000 x $18) 180,000 Additional revenues needed $229,200 Divided by units in special order 10,000 Equals required price for order $ 22.92 Existing Special Order Total Sales $1,290,000 $229,200 $1,519,200 Variable costs 774,000 180,000 954,000 Contribution margin $ 516,000 $ 49,200 $ 565,200 Fixed costs 300,000 30,000 330,000 Profit $ 216,000 $ 19,200 $ 235,200 Divided by investment $ 900,000 $ 80,000 $ 980,000 Equals ROI 24% 24% 24%

3 (a) RI will increase $3,200

(b) $22.80

Additional required profit, 20% x $80,000 $16,000

Additional fixed costs 30,000

Required contribution margin $48,000

Divided by units in special order 10,000

Equals required contribution margin per unit $ 4.80

Plus variable cost 18.00

Equals required price $ 22.80

Note to the Instructor: This exercise shows that it is possible to compute the ROI on incremental investment ($80,000 in this case), compare the

result with ROI on existing business, and thus determine whether the overall ROI will rise or fall as a result of a decision to increase (or decrease) investment

10-13 ROI, RI, and EVA for Pfizer (10 minutes)

After-tax operating income $528.4

Minimum required return, $3,796 x 13% 493.5

EVA $ 34.9

10-14 Basic RI Relationships (10-15 minutes)

1 Sales = $60 million ($40 investment x 1.5 turnovers)

10-15 Transfer Pricing - - Increased Costs and Sacrificed Sales (10 minutes)Division A

Gain on inside sale:

Additional contribution margin, 30,000 x ($7 - $4 - $1) $60,000 Less additional fixed costs 12,000 Additional profit $48,000Loss on regular sales:

Contribution margin on 10,000 units, 10,000 x ($9 - $4) 50,000Net loss on sale $( 2,000)Division B

Savings from lower price [30,000 x ($8 - $7)] $ 30,000ABC

Savings on lower price, 30,000 x ($8 - $4 - $1) $ 90,000Less lost contriubtiion margin on outside sales, 10,000 x ($9 - $4) (50,000)Less increased fixed costs (12,000)Net gain $ 28,000The gain to the company equals the gain and loss to the divisions, ($-2,000 +

$30,000)

The situation is ripe for a solution The company stands to gain

$28,000, so the divisions can in effect split that amount between themselves through the transfer price Division B will certainly not pay more than $8 per unit, the price it now pays outsiders, while division A will accept no less than $7.07 (rounded), which is only $0.07 above the offer

Contribution margin on lost sales $50,000Additional fixed costs 12,000Total required contribution margin on inside order $62,000Divided by units in order 30,000Equals required unit contribution margin $2.07Plus variable cost 5.00Required price $7.07Alternatively, division A faces a $2,000 loss at a $7 price, so $2,000/30,000

= $0.07 required increase in price

10-16 Transfer Prices and Decisions (25-30 minutes)

Preliminary Note to the Instructor: This is one of the few early

exercises where students can prepare complete income statements for the divisions and for the company as a whole By asking only for the changes in income, we tried to discourage students from preparing such statements, but many are likely to do so nevertheless Solving the problem by concentrating

on differences reinforces the principle, introduced in Chapter 5, that

differences should be the basis for making decisions Using only the

differential approach in requirements 1 and 2 encounters little student resistance But invariably some students insist on seeing complete income statements to clarify their understanding for requirement 3, and we believe

it worthwhile to show both approaches for that requirement

1 Carter's income falls $30,000, Devon's income increases $30,000, and Montauk's income doesn't change.

Carter: Reduced contribution margin on sales to Devon

because of drop in selling price

60,000 x ($4.00 - $3.50) $30,000 Devon: Increased contribution margin because of lower

purchase cost [60,000 x ($4.00 - $3.50)] $30,000 Montauk: No change; the company as a whole is still paying

$3.50 to make the compound $ 0

2 Carter's income falls by $90,000, Devon's income increases by $30,000, and Montauk's income falls by $60,000

Carter: Loses the contribution on sales previously

made to Devon [60,000 x ($4.00 - $2.50)] $(90,000) Devon: Increased contribution margin, as in requirement 1 $ 30,000 Montauk: Loses because outsiders must be paid $3.50

for 60,000 units previously made inside for $2.50

60,000 x ($3.50 - $2.50) $(60,000)

3 Carter should not reduce its price Refusing to reduce its price yields

a $22,500 increase in income for Carter Devon's income increases $30,000 and

Montauk's income rises $52,500

New revenue from outside sales by Carter

Net cost increase 172,500

Net increase in income $52,500 Comparing income under current conditions with revised income statements for the individual divisions and the company as a whole produces the same answer

Carter Devon Total Sales to outsiders:

245,000 x $5 $1,225,000

$1,225,000

60,000 x $9 $540,000

10-17 Range of Transfer Price (15 minutes)

1 $13 ($22 outside price - $9 variable cost)

2 $9 variable cost

3 $22, the price it would have to pay on the outside

4 The company will lose $6 for each chip transferred Albacor will lose

$28 in revenue while the company saves the $22 outside price There should

be no transfer because Albacor's minimum is $28, while the Consumer Products Division is willing to pay only $22 The $6 difference is also the loss to the company

Note to the Instructor: Some students might wonder why Albacor can sellits chip for $28 while an outside company sells one for $22 The text says that the outside company makes a "suitable chip," so that it might be of lower quality than Albacor's

After completing requirement 3, you might also wish to point out that the range of acceptable prices, from $9 to $22, is $13, which is also the benefit to the company of making the chip It is always true that if there

is a benefit to the company in making a transfer, there is potential benefit

to the divisions, as reflected in the range of acceptability of the transfer price In this case, the divisional managers should be able to get together because the range is wide

10-18 Basic ROI Relationships (10 minutes)

1 (a) $30 million ($60 million sales divided by 2 turnovers)

(b) $6 million (20% x $30 million investment)

(c) 10% ($6 million divided by $60 million, or 20% ROI divided by 2 turnovers)

2 30% [10% ROS times 3, or $6 million income divided by new investment of $20 million ($60 million sales divided by 3 turnovers)]

10-19 ROI and RI Relationships (20 minutes)

In many cases several relationships allow you to fill in blanks

A Income = $60 $400 sales x 15% margin

Investment = $200 $60 income/30% ROI

Turnover = 2 times $400 sales/$200 investment, or 30% ROI/15% margin

RI = $20 $60 income - (20% x $200 investment)

B Sales = $900 $300 investment x 3 turnovers

Income = $72 $900 sales x 8% margin

ROI = 24% $72 income/$300 investment, or 8% margin x 3

turnovers

RI = $12 $72 income - (20% x $300 investment)

C Margin = 6% $42 income/$700 sales

Investment = $100 $42 income - $22 RI = $20 income needed for 20% ROI; dividing $20 by 20% gives $100

Turnover = 7 $700 sales/$100 investment

ROI = 42% $42 income/$100 investment, or 6% margin x 7

turnovers

D Margin = 10% 40% ROI/4 times turnover

Sales = $1,000 $100 income/10% margin

Investment = $250 $1,000 sales/4 times turnover

RI = $50 $100 income - (20% minimum ROI x $250 investment)

5 (b) $30,000 RI of $3,000 is 10% of investment (30% ROI less 20%

minimum desired ROI)

RI = income - (minimum desired ROI x investment)

ROI = income/investment

From the second equation we get

Income = ROI x investment

Substituting in the first equation,

RI = (ROI x investment) - (minimum desired ROI x investment),which can be restated as

RI = (ROI - minimum desired ROI) x investment

10-21 Transfer Prices - - Cost Savings (20-30 minutes)

1 (a) $24,000 decrease ABC loses the contribution margin of $3 ($5 - $2)

on sales of 8,000 units

(b) $20,000 decrease The $24,000 decrease for ABC, (requirement a) is partially offset by a $4,000 increase for XYZ (8,000 x a $0.50 per unit saving)

Note to the Instructor: Some students will prepare revised income

statements, such as the following

ABC XYZ Totals ABC sales (80,000 x $6) $480,000 $ 480,000XYZ sales (8,000 x $70) $560,000 560,000 Total sales $480,000 $560,000 $1,040,000Variable costs:

ABC - 80,000 x $2 $160,000 $ 160,000 XYZ - 8,000 x $4.50 $ 36,000 36,000

- 8,000 x $35 280,000 280,000 Total variable costs $160,000 $316,000 $ 476,000Contribution margin $320,000 $244,000 $ 564,000Fixed costs 250,000 95,000 345,000Income $ 70,000 $149,000 $ 219,000Less prior incomes 94,000 145,000 239,000Change in incomes $(24,000) $ 4,000 $ (20,000)

2 $10,000 increase The shortest way to the answer is to compare the gainsand losses for the company as a whole, as follows

Savings in variable costs for units produced and sold to

outsiders (80,000 x $0.15 per unit saving) $ 12,000

Savings because some units don't have to be produced

at all (8,000 x $2 variable cost) 16,000

Savings in fixed costs 18,000

Total gains from accepting outside offer $ 46,000

Cost - cash to outside supplier (8,000 x $4.50) 36,000

Net gain from accepting offer of outside supplier $ 10,000

Another approach is to look at the effects of the switch on the

individual divisions

Gains from lower cost for outside purchase (8,000 x $0.50) 4,000 Effect on the company (gain) $ 10,000 Note to the Instructor: For students who choose to prepare revised income statements,

ABC XYZ Totals ABC sales (80,000 x $6) $480,000 $ 480,000 XYZ sales (8,000 x $70) $560,000 560,000 Total sales $480,000 $560,000 $1,040,000 Variable costs:

ABC - 80,000 x $1.85 $148,000 $ 148,000 XYZ - 8,000 x $4.50 $ 36,000 36,000

- 8,000 x $35 280,000 280,000 Total variable costs $148,000 $316,000 $ 464,000 Contribution margin $332,000 $244,000 $ 576,000 Fixed costs 232,000 95,000 327,000 Income $100,000 $149,000 $ 249,000 Less prior incomes 94,000 145,000 239,000 Change in incomes $ 6,000 $ 4,000 $ 10,000

10-22 Transfer Prices for Service Work (15-20 minutes)

1 Various possible transfer prices are discussed in the chapter The following seem most likely to be considered in the situation given

(a) Use the normal prices charged to customers, which is what the service manager would want These prices could be justified on the basis that they are market prices, assuming that the used-car manager is free to take the reconditioning work outside These prices are probably not as reliable as most market prices that could be obtained in other circumstances and are lessjustifiable for that reason Additionally, if the used-car manager is a captive customer (unable to take the work outside), the service manager has aguaranteed volume A used-car manager who thought reconditioning prices weretoo high might try to sell more cars "as is," which could hurt the sales and reputation of the firm

(b) Full cost with no markup is a possibility but would require careful budgeting if the charges are to be set in advance, rather than calculated at the end of a period There is also no opportunity to evaluate the service manager's performance unless there are standards (norms) available to check-for example, labor time on a particular type of job There are schedules available showing approximate times required for automobile work and these might be used to set standard times

(c) Budgeted variable cost determined, if possible, by reference to the standards mentioned above This price would not please the service manager but would be most acceptable to the used-car manager The service manager would be likely to postpone reconditioning work if there were more profitablework to do, and that decision could hurt the firm The used-car manager is

likely to complain if service is slow

(d) Variable cost, actual or budgeted, plus a markup A standard variable cost plus a markup is reasonable, especially if the price charged to outside customers is not an acceptable market price This price would keep the (in)efficiencies of the service department where they belong and would also yield a contribution margin on the work

(e) Full cost plus a markup that is lower than the one used for ordinary customers is also a reasonable choice if the managers can agree on the

markup It seems reasonable that the service manager make some contribution margin on work for the used-car manager A margin lower than that on outsidework makes sense if the service department is not operating at full capacity.But if the service department is operating at full capacity, a conflict between the managers will continue if work for the used-car manager carries alower margin

2 Any recommendation should take into account the factors discussed in requirement 1 No single recommendation can be considered best with the limited data available However, the use of prices charged to outside

customers should not be recommended unless the used-car manager has the freedom to take his work outside The service manager should be entitled to recovery of at least the standard variable cost and probably should get some contribution margin, particularly if reconditioning work for the used-car manager strains the capacity of the service department and lengthens the timerequired to complete work on customers' cars He would suffer if the servicetimes were stretched and customers sought other places to obtain the desired repair work

Note to the Instructor: You can extend the discussion by exploring withstudents the idea of establishing some type of priorities for jobs to be done

in the service department The importance of incorporating priorities into the transfer-pricing system would be determined by the extent to which the service department is operating at capacity If the used-car manager wants

to displace or delay regular service work and have his own work done quickly,

he should pay more than he would if the work could be done at slack times The used-car manager will want to have his cars ready for sale soon after they come in, especially if he is charged imputed interest on the value of the user-car inventory The service manager will want to keep his mechanics busy The managers in conflict here might be made to see that it is in their interests to cooperate in scheduling reconditioning work so that it falls in slack period as much as possible, and to agree on a pricing system that recognizes the factors discussed in requirement 1

Reconciling the conflicts in this case is easier said than done A student of the authors described similar problems in a dealership in which heworked The problems extended beyond the current assignment and into the conflict between the used-car and new-car managers, an issue covered in a late assignment in Chapter 9, which deals with the prices to be set for used cars taken in trade The student told us that the bickering among the

new-car, used-car, and service managers became so bad that the performance measurement system was dropped and all of the managers were evaluated as a group

10-23 Review of Chapters 9 and 10 (20-30 minutes)

5 $256,000 [$640,000 - (12% x $3,200,000)]

6 (a) 12.5% ($400,000 income/$3,200,000 investment)

Seneca's current income $640,000 Seneca's portion of allocated joint operating costs:

Seneca's sales $ 9,600,000

Divided by total sales ($9,600,000 + $6,400,000) $16,000,000

Equals percentage allocated to Bert 60%

Times total cost to be allocated $400,000

Equals portion allocated to Seneca 240,000 Seneca's revised divisional income $400,000 (b) 14.3%, as in requirement 4 Allocating previously unallocated costswill not change the company's ROI, because these costs were considered in theprevious calculation of the company's total income

7 14.3%, as in requirements 4 and 6(b)

10-24 Performance Evaluation Criteria (20 minutes)

1 The manager of Superior Division would reject the project while the manager of Poplar Division would accept it The ROI on the project is 20% ($8/$40) which is less than the 25% that Superior earns ($60.0/$240.0) and more than the 10% that Poplar earns ($20.0/$200.0)

2 Both would accept the project Current residual incomes are as follows Superior Poplar

* Previous required returns plus $7.2 ($40 x 18%)

The project yields more than 18%, so it will increase RI for both

divisions The $8 million return is $800 thousand more than the required return of $7.2 million, increasing both divisions' RIs by $800 thousand

3 Yes, because it promises a return greater than the minimum required Theproblem illustrates the behavioral difficulty in the use of ROI The projectwould be rejected if it were available only to the manager of Poplar

Division

10-25 Components of ROI (15-20 minutes)

1 Margin, 15% (30% margin x 0.5 turnovers)

Turns, 15% (3.75% margin x 4 turnovers)

2 (a) 0.67 (20% target ROI/30% margin)

(b) 5% (20% target ROI/4 turnovers)

Note to the Instructor: This assignment reinforces the point that divisions can show equal ROIs with quite different margin-turnover

relationships Note also that the required increases in each factor are 33.3% of the factor's current value, which is the desired percentage

increase That is, increasing ROI from 15% to 20% is a 33.3% increase

(5%/15%) The increase in turnovers is from 0.5 to 0.67, a 33.3% increase (0.17/0.5) With margin, it is from 3.75% to 5%, also a 33.3% increase

10-26 Appropriate Transfer Price (15-20 minutes)

Preliminary Note to the Instructor: Students have trouble with this problem because no transfer price is given Requirement 1 emphasizes that the transfer price is irrelevant in determining the effects of a transfer on the profit of the company as a whole Requirements 2 and 3 provide the $0.67($6 - $5.33) range for negotiation of a transfer price that will benefit bothparties Expressed in total, the $200,000 range [300,000 units x ($6 -

$5.33)] equals the additional profit to the company if the transfer takes place, as shown in requirement 1 (In effect, the negotiated price allocatesthat additional profit between the two parties.) The point made in

requirement 4 is the same as in requirement 1 but within the context of excess capacity at the selling division

1 An increase of $200,000

Increase from sales of Wood's product, ($11 - $5 - $4) x 300,000 $600,000 Decrease from sales of Crandon's product, ($8 - $4) x 100,000 400,000 Net increase $200,000

2 $5.33 ($1.33 contribution margin + $4 variable cost)

Crandon must get enough contribution margin from the units sold to Wood to make up for the contribution margin on lost sales

Contribution margin lost by Crandon (100,000 x $4, above) $400,000 Divided by the number of units to be transferred 300,000 Equals contribution margin required per unit $1.33Alternatively,

Total price for units below capacity, 200,000 x $4 variable cost) $

3 $6 (the $11 selling price - the $5 variable cost that Wood incurs)

4 An increase of $600,000, the profit from sales of Wood's product

Crandon does not lose outside sales We do not ask for the minimum transfer price that Crandon would accept, but it is the $5 variable cost

Note to the Instructor: Incremental cost is the best transfer price from the company's standpoint when the selling division is below capacity You can use this assignment to show why by asking whether the transfer shouldtake place if the selling price of Wood's product is $9 The product would break even, as shown below

10-27 ROI and RI on a Special Order (20-25 minutes)

1 No ROI will decline because the ROI on the order is less than the 29.6%currently expected

Current ROI:

Unit contribution margin ($40 - $18) $22 Times annual unit volume 1,700,000 Total contribution margin $37,400,000 Less fixed costs 30,000,000 Divisional profit $ 7,400,000 Divided by divisional investment $25,000,000 Equals ROI 29.6%ROI with order: Unit contribution margin ($24 - $18) $6 Times volume 250,000 Total contribution margin $ 1,500,000 Less: Fixed costs $ 100,000 Lost contribution margin (50,000 x $22) 1,100,000 1,200,000 Profit on order $ 300,000 Divided by increased investment $ 1,200,000 Equals ROI on order 25%

Note to the Instructor: Some students will redo the income statement todetermine the new ROI We encourage instructors to point out the ROI on the incremental business is 25%, even considering the effects on existing sales,

so overall ROI after accepting the order must drop

2 Yes RI will increase by $60,000.

Profit on order (requirement 1) $300,000

Less minimum return ($1,200,000 x 20%) 240,000

(b) $40,000

Income (a) $360,000 Required minimum ROI ($1,600,000 x 20%) 320,000

RI $ 40,000

2 85,000 units

Target RI $100,000 Required minimum ROI ($1,600,000 x 20%) 320,000 Required divisional income $420,000 Fixed costs 600,000 Required divisional contribution margin $1,020,000 Divided by contribution margin per unit $12 Equals required sales, in units 85,000

3 (a) $26, the price Rogers now pays to the outside supplier

(b) $22.40

Variable costs on units supplied to Rogers, 25,000 x $20 $500,000Lost contribution margin on lost sales, 5,000 x $12 60,000Amount to be recovered in price to Rogers $560,000Divided by number of units to be sold to Rogers 25,000Required price for units to be sold to Rogers $ 22.40 (c) Income will increase by $90,000

Lost contribution on outside sales, 5,000 x $12 60,000

Net gain to Lerner 40,000 Increase in company income $90,000 Note to the Instructor: Students usually find it more difficult to determine the change in the company's income directly when the situation involves losing regular sales Accordingly, our solutions to many of the early problems showed both alternatives and suggested that both be presented.Our experience has been that students are more willing to try using an

approach they find more difficult if they can check their answer against one developed using an approach that they understand better but that is more cumbersome

10-29 Transfer Prices and Required Profit Margins (10-15 minutes)

The direction of discussion can be selected after finding the viewpoint from which students answered the question about whether Roberts should go outside for the work It is in Roberts' interest to use the outside service provided that the quality of work is at least equal to that done internally, that the four-day delay is not critical, and that the amount charged by Sharp

is less than what would be charged internally (it is quite possible that 20% over Sharp's cost would be more than one-third over the internal cost) Whether going to Sharp is best for the company cannot be determined fromthe available data If costs are the same internally as they are at Sharp's,

it would be cheaper for the company for Roberts to keep the business inside However, if Black could use the available resources to do customer work instead of working on cars brought in for reconditioning, total profits for the company could well be higher than they are currently Thus, the

information that needs to be obtained includes the demand for service work from outsiders and the incremental revenues and costs associated with such business if Roberts goes outside

Other information that would be desirable is the quality of the work that would be done by Sharp vis-a-vis that done internally The company could well suffer if Sharp's work is poor and used-car sales begin to drop There is also the question of whether the capacity of the dealership's

service department could be increased Increased capacity might be desirable

if a good deal of outside demand is currently not satisfied because of the amount of reconditioning being done internally

10-30 Make - or Buy and Transfer Pricing (20-25 minutes)

1 Partial income statements

A B C Totals Sales $440,000 $280,000 $1,100,000 $1,820,000 Variable costs 360,000 200,000 880,000* 1,440,000 Contribution margin $ 80,000 $ 80,000 $ 220,000 $ 380,000

* Sales of A and B plus $160,000 ($16 x 10,000) variable cost incurred in C

2 A would lose $40,000 if it failed to meet the price and the company wouldlose $40,000 as well The offer should not be accepted

Division A

Sell at $40 Do Not Sell

Sales $400,000 0

Variable costs 360,000 0

$40 cost whether it buys from Division A or from the outside supplier The difference in incomes for Division A is therefore the difference for the company as a whole because none of the other division's incomes are affected Note to the Instructor: You might wish to ask students what would happen if the constraint on A's capacity were loosened so that A could make, say, 15,000 units per year The general answer is that A should sell as manyunits outside as it can at $48 and devote any leftover capacity to supplying division C

10-31 Goal Congruence and Motivation (15-20 minutes)

1 The manager would probably select Thomas Company because its price is $10per chair less than Wisner's Since Bills is evaluated based on ROI, the higher the income, the better the showing (investment is presumably

unaffected by which bid she accepts)

2 Roth's president prefers that the bid go to Wisner The $10 price

difference is more than made up by the additional contribution margin

provided by the sale of materials from Ronson to Wisner ($56 selling price -

$35 variable cost = $21 contribution margin per chair) The company's net outlay per unit if the Wisner bid is accepted is $119 ($140 - $21); if the Thomas bid is accepted, the outlay is $130 per unit

3 The memo should suggest that some incentive be given to the manager of the Redfern Division to buy from Wisner Perhaps Ronson's manager would

"pay" Redfern $10 (or more) per chair to accept the Wisner bid A $10 chargewould equalize Redfern's costs and still yield $11 more contribution margin per chair to Ronson ($56 - $35 - $10) The manager of the Ronson Division could afford to pay up to $21 to Redfern and still increase his division's contribution margin and income

10-32 Performance of International Division (10 minutes)

1 and 2 Budgeted Income Statements (000's)

(1) (2)*

In Forints In Dollars

Sales F2,200,000 $7,333

Cost of sales at 40% 880,000 2,933

2 Assessing performance requires a basis for comparison The normal

approach is to compare actual results with budgeted results, and the

performance report should, to the extent possible, reflect only those things that can be controlled by the manager being evaluated The manager of the Hungarian Division of a single company has no control over forint-to-dollar exchange rates, so a reasonable comparison would state results in forints

* From previous assignment requirement 1

Performance was good A different, and misleading, picture appears if actualresults in dollars (requirement 1) are compared with the budgeted dollar results computed at the beginning of the quarter for requirement 2 of

assignment 10-32

performance by the division's managers

Note to the Instructor: You might want to point out that the company's financial statements will be reported in dollars and use actual results translated at current exchange rates (requirement 1) If the company prefers

to compare those results with budgeted amounts, the budget in forints must betranslated using the exchange rate (conversion ratio) at the same point in time

One reservation applies to virtually all aspects of the solution we presented as well as to budget/actual comparisons in general Preparing a realistic budget requires that managers forecast price and cost changes likely to occur because of expected inflation (or deflation) When assertingthe usefulness of a budget/actual comparison in forints, we assumed that the budget for the Hungarian Division reflected such expectations

Instructors who want to devote more time to the topic of exchange rates could discuss the factors influencing changes in such rates and point out that none of those factors is controllable by the company's topmost managers

or by the managers of foreign or domestic divisions

10-34 Divisional Performance - - Interactions (25-30 minutes)

1 RI for the Camera Division would decline by $100,000

Additional contribution margin for X-40's (200,000 x $6) $1,200,000

Additional fixed costs 500,000

of the Camera Division will not increase production It is profitable for the manager of the Film Division to make the $600,000 investment to produce the new film, even selling 2.5 million rolls