Chapter 22 – Responsibility Accounting and Transfer Pricing
Financial and Managerial Accounting, 17/e 22-1
22 RESPONSIBILITY ACCOUNTING
AND TRANSFER PRICING
Chapter Summary
Chapter 22 surveys the accounting information needs of a decentralized
organization. Three types of business responsibility centers are analyzed: cost, profit, and
investment centers. The decision-making authority assigned to its managers distinguishes
each. Because management’s responsibilities differ among the types of centers, the
accounting information required for planning, control, and performance evaluation differs
according to the nature of these responsibilities.
A responsibility accounting system supports performance evaluation of each type
of center within a business. The design of a system to measure performance of each
responsibility center is explored by means of a detailed illustration. The example
emphasizes that the system must be designed to record revenues and costs for the smallest
areas of managerial responsibility. Income statements for larger centers are then obtained
by aggregation across the subordinate units. The design principles for assigning costs to
centers require classifying costs according to behavior, and charging a center with only
those costs directly traceable to it. Application of these principles leads to the
contribution format of the income statement.
We distinguish carefully between contribution margin and responsibility margin.
The former is used to evaluate the effects of short-run decisions on profitability.
Responsibility margin is shown more useful when addressing long-run decisions because
it incorporates potential changes in fixed costs. We emphasize that the decision–
usefulness of the responsibility margin is seriously compromised when common fixed
costs are allocated to centers.
A discussion of transfer pricing concludes the main body of the chapter. The
Supplemental Topic section extends the results of the chapter to manufacturing firms by
introducing the distinction between variable and absorption costing systems.
Learning objectives
1. Distinguish among cost centers, profit centers, and investment centers.
2. Explain the need for responsibility center information and describe a responsibility
accounting system.
3. Prepare an income statement showing contribution margin and responsibility margin.
4. Distinguish between traceable and common fixed costs.
5. Explain the usefulness of contribution margin and responsibility margin in making
short-term and long-term decisions.
Chapter 22 – Responsibility Accounting and Transfer Pricing
6. Describe three transfer pricing methods and explain when each is useful.
Brief topical outline
A Responsibility centers
1 The need for information about responsibility center performance
2 Cost centers, profit centers, and investment centers
a Cost centers
b Profit centers
c Investment centers – see Your Turn (page 960)
B Responsibility accounting systems
1 Responsibility accounting: an illustration
2 Assigning revenue and costs to responsibility centers – see Your Turn
(page 962)
3 Variable costs
4 Contribution margin
5 Fixed costs
6 Traceable fixed costs
7 Common fixed costs
a Common fixed costs include costs traceable to service departments
b Common fixed costs are traceable to larger responsibility centers
8 Responsibility margin
9 When is a responsibility center “unprofitable”?
10 Evaluating responsibility center managers
11 Arguments against allocating common fixed costs to business centers
12 Transfer Prices
a Transfer prices for profit centers
b Transfer prices when market prices don’t exist
c Transfer prices for multinational companies
d Some concluding comments on transfer prices
13 Nonfinancial objectives and information – see Ethics, Fraud &
Corporate Governance (page 971)
C Responsibility center reporting in financial statements
1 International financial reporting standards and responsibility center
reporting
D Concluding remarks
Chapter 22 – Responsibility Accounting and Transfer Pricing
Financial and Managerial Accounting, 17/e 22-3
Topical coverage and suggested assignment
Homework Assignment
(To Be Completed Prior to Class)
Class
Meetings
on Chapter
Topical
Outline
Coverage
Discussion
Questions
Brief
Exercises
Exercises
Problems
Critical
Thinking
Cases
1
A – B
1, 2, 3
2, 3
2, 4
1
1
2
B-
Transfer
Prices
4, 5
4, 6
9
3
3
C – D
9, 14, 15
10
12, 13
8
Comments and observations
Teaching objectives for Chapter 22
In this chapter, we introduce the idea of measuring the performance of the various centers
within a business organization. We use a “contribution margin” format in segmented
income statements, thus drawing heavily upon the content of Chapter 20. In presenting
this chapter, our classroom objectives are to:
1 Explain the concept of business centers, distinguishing between cost centers, profit
centers, and investment centers. Discuss the usefulness of information regarding
segment operations.
2 Discuss the criteria appropriately used in evaluating each of the above types of
business centers.
3 Explain and illustrate the concept of responsibility accounting, including:
a Defining centers along lines of managerial responsibility
b Subdividing centers into still-smaller components
c The “contribution margin” format of our responsibility income statements
d The flow of center data from the income statements of smaller centers into the
income statements of larger centers.
4 Distinguish between traceable and common fixed costs. Briefly explain the
subdivision of traceable costs into the categories of controllable and committed fixed
costs.
5 Discuss the nature and usefulness of contribution margin and responsibility margin.
Chapter 22 – Responsibility Accounting and Transfer Pricing
6 Introduce the concept of transfer pricing, and explain its relevance to center
performance evaluation.
General comments
The three major topics in this chapter
center reporting, transfer pricing, and variable
costing
are somewhat independent. We highly recommend coverage of center reporting
and transfer pricing. These topics are of central importance to the functions of planning
and control, and also help to reinforce an understanding of cost behavior patterns. We
view variable costing, however, as a specialized and optional topic, to be covered only if
time is available. Future chapters do not require an understanding of variable costing.
In discussing center reporting, we emphasize two concepts:
1 A business may be segmented in many alternative ways (for instance, first by
territory, and then by product line; or first by product line, and then by territory).
We stress that center information is most useful if the business is divided along
the lines of managerial responsibility.
2 The gathering of information about center revenue and expenses begins at the
level of the smallest responsibility centers. Information for larger responsibility
centers then is determined by combining the data relating to each component part.
(Electronic cash registers provide an excellent example of how revenue
information can be accumulated separately for every profit center.)
We also consider it important to emphasize the distinction between traceable and
common fixed costs (all variable costs normally are traceable to the segment generating
the related revenue). Discussion Questions 5 and 6 and Exercise 3 provide a useful
framework for this discussion. If time is available, we enjoy a classroom discussion of
Case 1. This problem focuses upon the arbitrary nature of allocations of common costs
among benefiting centers.
The fact that common fixed costs tend to become traceable at higher levels of
responsibility is an interesting refinement of this distinction between traceable and
common costs. We cover this point only if it helps to clarify the concepts of traceable
costs and common costs.
Chapter 22 – Responsibility Accounting and Transfer Pricing
Financial and Managerial Accounting, 17/e 22-5
Supplemental Exercises
Group Exercise
Devise an outline for a responsibility accounting system for your college or
university. Specify the decision-making responsibility assigned to the managers of each
type of center you define. What are the appropriate performance measures for the
managers of each center? What type of accounting information would be required to
evaluate the management of each center? What common fixed costs would you avoid
allocating to smaller centers in your system?
Internet Exercise
Chapter 22 presents decentralized structures and responsibility accounting
systems. One of the most successful practitioners of responsibility accounting is the
General Electric Company. Access the company‘s web page at www.ge.com and view a
recent annual report. Describe the information you find in the report regarding the
performance of individual business units within General Electric.
Chapter 22 – Responsibility Accounting and Transfer Pricing
CHAPTER 22 NAME #
10-MINUTE QUIZ A SECTION
Indicate the best answer for each question in the space provided.
1 Which of the following costs is traceable to an individual sales department in a
department store such as Sears?
a Salary of the store manager.
b Depreciation on the store building.
c Salaries of store security guards.
d The corporate plane.
2 The Sports Arena location of Burger Heaven reports monthly sales of $140,000,
variable costs of $63,000, and traceable fixed costs of $54,000. The contribution
margin ratio of this business unit is:
a 70%.
b 45%.
c 55%.
d 30%.
3 In deciding which responsibility centers can benefit most from short-term
marketing efforts, such as advertising specific products, management should give
greatest consideration to the relationship between a center’s sales and:
a Traceable fixed costs.
b Income from operations.
c Contribution margin.
d Responsibility margin.
4 From a long-term perspective, when evaluating the contribution of a particular
profit center to the overall profitability of the company, management should be
most interested in the center’s:
a Traceable fixed costs.
b Income from operations.
c Contribution margin.
d Responsibility margin.
5 The Molding Department of Acadia Corporation is a cost center. The transfer price
used to transfer goods from the Molding Department to the Assembly Department
would most likely be based upon:
a The cost of the units transferred.
b The market value of the units transferred.
c A negotiated amount set by the department managers.
d The average fixed cost per unit transferred.
Chapter 22 – Responsibility Accounting and Transfer Pricing
Financial and Managerial Accounting, 17/e 22-7
CHAPTER 22 NAME #
10-MINUTE QUIZ B SECTION
The uptown branch of Kenny’s Deli is organized as an investment center. The
following information is available for the current year:
Sales …………………………………………………………………………………………………….. $220,000
Variable expenses ………………………………………………………………………………….. $100,000
Traceable fixed costs ……………………………………………………………………………… $56,000
Average total assets of the uptown branch ………………………………………………… $95,000
Answer the following questions. If you select answer d, indicate the correct amount in
the space provided.
1 Refer to the above data. The contribution margin at Kenny’s uptown branch
during the current year is:
a $9,000.
b $84,000.
c $120,000.
d $56,000.
2 Refer to the above data. The contribution margin ratio is:
a 40%.
b 50%.
c 55%.
d 25%.
3 Refer to the above data. The responsibility margin for the uptown branch during
the year is:
a $164,000.
b $44,000.
c $120,000.
d $64,000.
4 Refer to the above data. If sales volume decreased by 10% and traceable fixed
costs decreased by 20% what would be the new contribution margin?
a 75,600.
b 108,000.
c 79,200.
d $80,000.
5 Refer to the above data. A 10% increase in the sales volume at the uptown store
would be expected to increase the location’s responsibility margin by:
a $30,000.
b $12,000.
c $20,000.
d Some other amount. $____________
Chapter 22 – Responsibility Accounting and Transfer Pricing
CHAPTER 22 NAME #
10-MINUTE QUIZ C SECTION
The downtown branch of Emily’s Bakery is organized as an investment center. The following
information is available for the current year.
Sales …………………………………………………………………………………………………………….. $448,000
Variable expenses …………………………………………………………………………………………… $217,000
Traceable fixed costs ………………………………………………………………………………………. $230,000
Average total assets invested in this segment …………………………………………………….. $168,000
Compute the following measures for this investment center:
a Contribution margin: $____________
b Contribution margin ratio: ____________%
c Responsibility margin: $____________
d Return on assets: ____________%
e Increase in responsibility margin that would be expected to result from a 10% increase in
sales volume. $____________
Chapter 22 – Responsibility Accounting and Transfer Pricing
Financial and Managerial Accounting, 17/e 22-9
SOLUTIONS TO CHAPTER 22 10-MINUTE QUIZZES
QUIZ A
Learning Objective: 3, 4, 5, 6
QUIZ B
1 C ($220,000 – $100,000 = $120,000)
QUIZ C
a $448,000 – $217,000 = $231,000
Learning Objective: 3, 4, 5
Chapter 22 – Responsibility Accounting and Transfer Pricing
Assignment Guide to Chapter 22
Brief Exercises
Exercises
Problems
Cases
Net
1 – 10
1 – 15
1
2
3
4
5
6
7
8
1
2
3
5
4
Time estimate (in minutes)
< 15
< 15
40
40
25
30
25
40
30
40
35
40
30
20
30
Difficulty rating
E
E
M
S
M
M
M
M
M
M
M
M
M
M
M
Learning Objectives:
3, 8
1, 2, 4, 5, 6,
7, 8, 9, 10,
14, 15
√
√
√
√
√
√
√
1. Distinguish among cost centers,
profit centers, and investment
centers.
2. Explain the need for responsibility
center information and describe a
responsibility accounting system.
2, 3, 5, 9
4, 5, 6, 7, 8,
9, 10, 11, 14,
15
√
√
√
√
3. Prepare an income statement
showing contribution margin and
responsibility margin.
2, 5
5, 7, 8, 10,
12, 15
√
√
√
√
√
√
√
√
4. Distinguish between traceable and
common fixed costs.
7, 8, 10
1, 3, 5, 8, 11
√
√
√
√
√
√
√
5. Explain the usefulness of the
contribution margin and
responsibility margin in making
short-term and long-term decisions.
1, 10
5, 7, 12
√
√
√
√
√
√
√
6. Describe three transfer pricing
methods and explain when each is
useful.
4, 6
1, 9, 12, 13
√
√
√