Solution manual managerial accounting concept and applications by cabrera chapter 14 answer

Negotiated transfer prices should be used 1 when the volume involvedis large enough to justify quantity discounts, 2 when selling and/oradministrative expenses are less on intracompany s

2 Overall profitability can be improved (1) by increasing sales, (2) byreducing expenses, or (3) by reducing assets.

3 ROI may lead to dysfunctional decisions in that divisional managersmay reject otherwise profitable investment opportunities simplybecause they would reduce the division’s overall ROI figure Theresidual income approach overcomes this problem by establishing aminimum rate of return which the company wants to earn on itsoperating assets, thereby motivating the manager to accept allinvestment opportunities promising a return in excess of this minimumfigure

4 A cost center manager has control over cost, but not revenue orinvestment funds A profit center manager, by contrast, has controlover both cost and revenue An investment center manager has controlover cost and revenue and investment funds

5 The term transfer price means the price charged for a transfer of goods

or services between units of the same organization, such as twodepartments or divisions Transfer prices are needed for performanceevaluation purposes

6 The use of market price for transfer purposes will create the actualconditions under which the transferring and receiving units would beoperating if they were completely separate, autonomous companies It

is generally felt that the creation of such conditions providesmanagerial incentive, and leads to greater overall efficiency inoperations

7 Negotiated transfer prices should be used (1) when the volume involved

is large enough to justify quantity discounts, (2) when selling and/oradministrative expenses are less on intracompany sales, (3) when idlecapacity exists, and (4) when no clear-cut market price exists (such as

a sister division being the only supplier of a good or service)

8 Suboptimization can result if transfer prices are set in a way thatbenefits a particular division, but works to the disadvantage of thecompany as a whole An example would be a transfer betweendivisions when no transfers should be made (e.g., where a better overallcontribution margin could be generated by selling at an intermediatestage, rather than transferring to the next division) Suboptimizationcan also result if transfer pricing is so inflexible that one division buysfrom the outside when there is substantial idle capacity to produce theitem internally If divisional managers are given full autonomy insetting, accepting, and rejecting transfer prices, then either of thesesituations can be created, through selfishness, desire to “look good”,pettiness, or bickering

II Exercises

Exercise 1 (Evaluation of a Profit Center)

No Although Department 3 does not cover all of the cost allocated to it Itcontributes P21,000 to the total operations over and above its direct costs.Without Department 3, the company would earn P21,000 less as comparedwith the original over-all income of P47,000

Exercise 2 (Evaluation of an Investment Center)

Present New Project Overall

Present New Project Overall

Division X Division Y Division Z

Exercise 4 (ROI, RI, Comparisons of Two Divisions)

operating assets - 16% x (a) 480,000 1,600,000Residual income P 150,000 P 200,000

Requirement 3

No, Division B is simply larger than Division A and for this reason onewould expect that it would have a greater amount of residual income Asstated in the text, residual income can’t be used to compare the

Net Operating income

Sales X SalesAverage Operating Assets = ROI

P630,000P9,000,000 X P9,000,000P3,000,000 = ROI

P1,800,000P20,000,000

P20,000,000P10,000,000 = ROI X

performance of divisions of different sizes Larger divisions will almostalways look better, not necessarily because of better management butbecause of the larger peso figures involved In fact, in the case above,Division B does not appear to be as well managed as Division A Notefrom Part (2) that Division B has only an 18 percent ROI as compared to 21percent for Division A.

Exercise 5 (Evaluation of a Cost Center)

(1) Controllable Costs by supervisor of Department 10 are as follows:

a Supplies, Department 10

b Repairs and Maintenance, Department 10

c Labor Cost, Department 10

(2) Direct Costs of Department 10 are

a Salary, supervisor of Department 10

b Supplies, Department 10

c Repairs and Maintenance, Department 10

d Labor Cost, Department 10

(3) Costs allocated to Factory Department are:

a Factory, heat and light

b Depreciation, factory

c Factory insurance

d Salary of factory superintendent

(4) Costs which do not pertain to factory operations are:

a Sales salaries and commissions

b General office salaries

Exercise 6 (Evaluating New Investments Using Return on Investment (ROI) and Residual Income)

Requirement 1

Computation of ROI

Division A:

Division B:

Division C:

Requirement 2

Division A Division B Division C

Average operating assets P1,500,000 P5,000,000 P2,000,000 Required rate of return × 15% 18%× × 12% Required operating income P 225,000 P 900,000 P 240,000 Actual operating income P 300,000 P 900,000 P 180,000 Required operating income (above)

225,000 900,000 240,000 Residual income 75,000P P 0 P (60,000)

Requirement 3

Therefore, if the division is

presented with an investment

opportunity yielding 17%, it

Minimum required return for

Therefore, if the division is

presented with an investment

opportunity yielding 17%, it

If performance is being measured by ROI, both Division A and Division Bprobably would reject the 17% investment opportunity The reason is thatthese companies are presently earning a return greater than 17%; thus, thenew investment would reduce the overall rate of return and place the

P10,000,000 x

P10,000,000P5,000,000 = 9% x 2 = 18%

ROI = P8,000,000P180,000 x P8,000,000P2,000,000 = 2.25% x 4 = 9%

divisional managers in a less favorable light Division C probably wouldaccept the 17% investment opportunity, since its acceptance wouldincrease the Division’s overall rate of return.

If performance is being measured by residual income, both Division A andDivision C probably would accept the 17% investment opportunity The17% rate of return promised by the new investment is greater than theirrequired rates of return of 15% and 12%, respectively, and would thereforeadd to the total amount of their residual income Division B would rejectthe opportunity, since the 17% return on the new investment is less thanB’s 18% required rate of return

Exercise 7 (Transfer Pricing from Viewpoint of the Entire Company)

Requirement 1

Division A Division B Total Company

Less expenses:

Added by the division 2,600,000 1,200,000 3,800,000

Transfer price paid — 700,000 —

Total expenses 2,600,000 1,900,000 3,800,000

Net operating income P 900,000 P 500,000 P1,400,000

1 20,000 units × P175 per unit = P3,500,000

2 4,000 units × P600 per unit = P2,400,000

3 Division A outside sales (16,000 units × P175 per unit) P2,800,000Division B outside sales (4,000 units × P600 per unit) 2,400,000Total outside sales P5,200,000Observe that the P700,000 in intracompany sales has been eliminated

Requirement 2

Division A should transfer the 1,000 additional units to Division B Notethat Division B’s processing adds P425 to each unit’s selling price (B’sP600 selling price, less A’s P175 selling price = P425 increase), but it addsonly P300 in cost Therefore, each tube transferred to Division Bultimately yields P125 more in contribution margin (P425 – P300 = P125)

to the company than can be obtained from selling to outside customers.Thus, the company as a whole will be better off if Division A transfers the1,000 additional tubes to Division B

Exercise 8 (Transfer Pricing Situations)

Requirement 1

The lowest acceptable transfer price from the perspective of the sellingdivision is given by the following formula:

There is no idle capacity, so each of the 20,000 units transferred fromDivision X to Division Y reduces sales to outsiders by one unit Thecontribution margin per unit on outside sales is P20 (= P50 – P30)

The buying division, Division Y, can purchase a similar unit from anoutside supplier for P47 Therefore, Division Y would be unwilling to paymore than P47 per unit

Transfer price  Cost of buying from outside supplier = P47The requirements of the two divisions are incompatible and no transfer willtake place

Transfer price  Cost of buying from outside supplier = P34

In this case, the requirements of the two divisions are compatible and atransfer will hopefully take place at a transfer price within the range:

Variable cost per unit

Transfer price  (P30 – P2) + P20 x 20,00020,000

Transfer price = P28 + P20 = P48

P20  Transfer price  P34

Exercise 9 (Transfer Pricing: Decision Making)

Requirement 1

Division A’s purchase decision from the overall firm perspective:

Purchase costs from outside 10,000 x P150 = P1,500,000Less: Savings of Divisions B’s variable costs 10,000 x P140 = 1,400,000Net Cost (Benefit) for A to buy outside P 100,000Assuming Division B has no outside sales, Division A should buy insidefrom Division B for the benefit of the entire firm

Requirement 3

Assuming the outside price drops from P150 to P130:

Purchase costs from outside 10,000 x P130 = P1,300,000Less: Savings in variable costs 10,000 x P140 = 1,400,000Net Cost (Benefit) for A to buy outside P (100,000)Division A should buy outside

Exercise 10 (Compute the Return on Investment (ROI))

Exercise 11 (Residual Income)

Average operating assets (a) P2,200,000Net operating income P400,000Minimum required return: 16% × (a) 352,000Residual income 48,000P

Total Product S Product T

Net operating income

SalesMargin =

P5,400,000P18,000,000

SalesAverage operating assetsTurnover =

P18,000,000P36,000,000

Less: Variable Costs 3,330,000 1,890,000 1,440,000Contribution Margin P1,770,000 P 810,000 P 960,000Less: Controllable fixed

expenses 501,000 66,000 435,000Contribution to the recovery

Problem 2 (Evaluation of Profit Centers)

Requirement 1

Product

Incremental sales P71,000 P46,000 P117,000Less: Incremental costs 42,000 15,000 96,000

From Product C 21,000

Problem 3 (Evaluation of Performance)

Ranjie Tool CompanyPerformance ReportFor the Year 2005Budgeted Labor Hours 4,000

Actual Labor Hours 4,200

Cost-Volume Formula

Actual 4,200 Hours

Budget Based on 4,200 Hours Variance U (F)

Variable Overhead Costs:

Utilities P0.80 per hour P 3,600 P 3,360 P240

Total Factory Overhead Costs P32,700 P32,360 P340

Problem 4 (Evaluation of Performance)

Requirement 1

Performance Report for the Production Manager

Actual Cost Budget Cost Flexible (U) or (F) Variance

The cost of raw materials rose significantly, possibly because of (1)deficient machinery due to the cutback in maintenance expenditures and/or(2) to the lower labor cost, possibly due to the use of less-skilled workers.Supplies decreased, indicating possible inadequacies for next period’sproduction run.

Requirement 2

Performance Report for the Vice President

Actual Cost

Flexible Budget Cost

Variance (U) or (F)

Controllable costs:

Marketing division P104,000 P102,000 P2,000 (U)Production division 79,000 80,000 1,000 (F)Personnel division 72,000 76,000 4,000 (F)Other costs 68,800 70,000 1,200 (F)

The marketing division is behind its cost allotment The personnel divisioncame in somewhat under its budgeted costs Perhaps there has been acutback in hiring, indicating possible reduction in future production

Problem 5 (Target Sales Price; Return on Investment)

Requirement 1

Return on investment = Operating income / Investment

20% = X / P800,000Target Operating Income = P160,000

Target revenues, calculated as follows:

Operating leverage = contribution margin / operating income

= (P810 – P450) / P160 = 2.25 % change in income = operating leverage x % change inrevenues

= 2.25 x 33.33% = 75%

% change in income

If volume goes to 2,000 units: (P280 – P160) / P160 = 75%

If volume goes to 1,000 units: (P160 – P40) / P160 = 75%

% change in ROI

If volume goes to 2,000 units: (35% - 20%) / 20% = 75%

If volume goes to 1,000 units: (20% - 5%) / 20% = 75%

Problem 6 (Contrasting Return on Investment (ROI) and Residual Income)

Requirement 1

ROI computations:

ROI = Net operating incomeSales x Sales

Average operating assets

operating assets—16% × (a) 480,000 P 1,600,000Residual income P 150,000 P 200,000

Requirement 3

No, the Quezon Division is simply larger than the Pasig Division and forthis reason one would expect that it would have a greater amount ofresidual income Residual income can’t be used to compare theperformance of divisions of different sizes Larger divisions will almostalways look better, not necessarily because of better management butbecause of the larger peso figures involved In fact, in the case above,Quezon does not appear to be as well managed as Pasig Note from Part(1) that Quezon has only an 18% ROI as compared to 21% for Pasig

Problem 7 (Transfer Pricing)

Requirement 1

Since the Valve Division has idle capacity, it does not have to give up anyoutside sales to take on the Pump Division’s business Applying theformula for the lowest acceptable transfer price from the viewpoint of theselling division, we get:

P630,000P9,000,000 x

P9,000,000P3,000,000 = 7% x 3 = 21%P1,800,000

P20,000,000 x

P20,000,000P10,000,000 = 9% x 2 = 18%

Total contribution margin

on lost salesVariable

The Pump Division would be unwilling to pay more than P29, the price it iscurrently paying an outside supplier for its valves Therefore, the transferprice must fall within the range:

P16  Transfer price  P29

Requirement 2

Since the Valve Division is selling all of the valves that it can produce onthe outside market, it would have to give up some of these outside sales totake on the Pump Division’s business Thus, the Valve Division has anopportunity cost, which is the total contribution margin on lost sales:

Since the Pump Division can purchase valves from an outside supplier atonly P29 per unit, no transfers will be made between the two divisions

Variable cost per unitTransfer price  P16 + (P30 – P16) x 10,00010,000

= P16 + P14 = P30

Variable cost per unitTransfer price  (P16 – P3) + (P30 – P16) x 10,00010,000

= P13 + P14 =