CHAPTER 22
RESPONSIBILITY ACCOUNTING
AND TRANSFER PRICING
Brief Learning
Exercises Topic Objectives Skills
B. Ex. 22.1 Contribution margin effects 22-5 Analysis
B. Ex. 22.2 Contribution margin vs. responsibility margin 22-2, 22-3 Analysis, judgment
B. Ex. 22.3 Responsibility center design 22-1, 22-2 Analysis, judgment
B. Ex. 22.4 Transfer Prices 22-6 Analysis
B. Ex. 22.5 Contribution margin ratios 22-2, 22-3 Analysis
B. Ex. 22.6 Identifying transfer prices 22-6 Analysis
B. Ex. 22.7 Tracing common costs 22-4 Analysis
B. Ex. 22.8 Common or traceable costs 22-1, 22-4 Analysis
B. Ex. 22.9 Responsibility accounting system 22-2 Analysis, judgment
B. Ex. 22.10 Evaluating responsibility center managers 22-4, 22-5 Analysis
Learning
Exercises Topic Objectives Skills
22.1 Accounting terminology
22-1, 22-4,
22-6
Analysis
22.2 Types of responsibility centers 22-1 Analysis, judgment
22.3 Classification of costs in an income statement 22-4 Analysis
22.4 Real World: Home Depot’s segments 22-1, 22-2 Analysis, research
22.5 Preparing a responsibility income statement 22-1–22–5 Analysis
22.6
Evaluation of responsibility centers and center
managers
22-1, 22-2 Analysis, judgment
22.7 Closing an unprofitable business unit
22-1–22–3,
Analysis
22.8 Cost-volume-profit analysis 22-1–22–4 Analysis
22.9 Transfer pricing
22-1, 22-2,
22-6
Analysis, judgment
22.10 Types of responsibility centers 22-1–22-3
Analysis,
communication,
judgment
22.11 Corporate costs; traceable or common 22-2, 22-4 Analysis, judgment
22.12 Transfer prices and responsibility margins
22-3, 22-5,
Analysis
22.13 Transfer price and international taxes 22-6 Analysis
22.14 Responsibility centers in a golf resort 22-1, 22-2 Analysis, judgment
22.15
Real World: Home Depot’s responsibility
centers
22-1–22-3
Analysis,
communication,
research
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Topic Skills
22.1 A,B
Preparing and using responsibility income
statements
22-3–22–5 Analysis, communication
22.2 A,B
Preparing and using responsibility income
statements
22-3–22–5 Analysis, communication
22.3 A,B
Preparing and using responsibility income
statements
22-3–22–5 Analysis
22.4 A,B
Preparing responsibility income statements
in a Responsibility accounting system
22-3–22–5
Analysis, communication,
judgment
22.5 A,B Analysis of responsibility income statements 22-3–22–5 Analysis
22.6 A,B Evaluating an unprofitable business center 22-3–22–5
Analysis, communication,
judgment
22.7 A,B Transfer pricing decisions 22-1, 22-6
Analysis, communication,
judgment
22.8 A,B Transfer pricing with external market prices 22-1, 22-6
Analysis, communication,
judgment
Critical Thinking Cases
22.1
Allocating fixed costs to responsibility
centers
Analysis, communication,
judgment
22.2 An ethical dilemma
Analysis, communication,
judgment
22.3 Hospital profit centers
Analysis, communication,
judgment
22.4
Real World: General Mills & Kirby
(Internet) Comparing responsibility centers
22-1–22–3
Analysis, communication,
judgment, research,
technology
22. 5
Real World: University of Minnesota
(Ethics, fraud & corporate governance)
22-1, 22-2
Analysis, communication,
judgment
Problems
Learning
Objectives
Sets A, B
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
Problems (Sets A and B)
Chocolatiers Company/Fasteners, Inc. Easy
Students prepare responsibility income statements and determine the
product line in which it would be most advantageous to invest
advertising dollars.
Regal Flair Enterprises/Brown Enterprises Medium
Prepare a responsibility income statement and identify the business units
that will provide the most benefit from short-run product promotion and
from long-run expansion. Requires an understanding of the different
roles of contribution margin and responsibility margin in managerial
decisions.
Giant Chef Equipment Company/Glassware Company Medium
Prepare a responsibility income statement and use the data to perform
cost-volume-profit analysis.
Muscle Bound Company/Freeze, Inc. Strong
Prepare income statements at two successive levels of responsibility.
Also, compute the return on assets for two investment centers and use
data in several managerial decisions.
Butterfield, Inc./Sotheby, Inc. Strong
Given income statements at two levels of responsibility, students are
asked to make several decisions based upon the data and to explain the
“disappearance” of the common costs as the responsibility centers are
redefined. Also calls for a revised version of one responsibility
statement reflecting different sales levels.
Flywiz, Inc./Footware, Inc. Easy
Students are asked to evaluate a decision to close a seemingly
unprofitable unit of a business. However, upon closer examination, they
may discover that seasonality is distorting the data and that products of
the unprofitable unit support sales in the more profitable unit.
Below are brief descriptions of each problem and case. These descriptions are accompanied by the
estimated time (in minutes) required for completion and by a difficulty rating. The time estimates
assume use of the partially filled-in working papers.
22.1 A,B
20
22.4 A,B
60
30
22.3 A,B
30
22.2 A,B
22.6 A,B
15
22.5 A,B
45
Tots-To-Go/Eastrise Corporation Easy
Students are asked to evaluate a transfer price used by two responsibility
centers of a business. The manager of one center wants the transfer price
reduced. Students are to recognize that, regardless of the transfer price
used, the profit of the entire company remains the same. Students must
also consider opportunity costs and the way in which center managers
are evaluated.
Sparta and Associates/Westminster, Inc. Medium
Students investigate market-based transfer prices versus less than market
transfer prices. Students will see the loss in profits to the entire company
when divisions purchase from outside the company rather than
transferring within the company.
22.8 A,B
40
22.7 A,B
20
Critical Thinking Cases
Land’s End Hotel Medium
A conceptual (nonnumerical) case focusing upon the problems that often
arise from efforts to allocate common fixed costs among profit centers. A
practical problem, in that many businesses make such
allocations—perhaps without recognizing the pitfalls.
Osborn Diversified Products, Inc. Medium
A computer error results in the overstatement of a division manager’s
bonus. He needs the money because he has large medical bills and a
daughter in college. The only other person who may be aware of the
problem is another division manager who is angry with the company.
This is a good problem to assign to small groups or teams of students.
Hospital Profit Centers Medium
Students identify cost and profit centers for hospitals. Students consider
the ethical implications of having a type of surgery as a profit center.
General Mills and the Kirby Company Medium
Internet
Students are asked to visit the web pages of two companies and decide
how responsibility centers could be assigned within each. They are also
asked to think of examples of investment centers, profit centers, and cost
centers within each firm. Finally, they are asked what characteristics lead
to the differences in the responsibility center systems.
22.5 University Ethics 20 Medium
Ethics, Fraud & Corporate Governance
Students evaluate the ethical implications when a university views
students as a profit center.
22.2
40
22.1
35
22.4
30
22.3
30
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1.
2.
3.
4.
5.
6.
Management makes use of accounting information about individual responsibility centers of the
A cost center is a part of the business that incurs cost but that does not directly generate
revenue. Examples include service departments such as the accounting, janitorial, laundry, or
Three types of transfer prices are market-based, cost-based, and negotiated. Market-based
Unless the costs of operating the service center can be traced directly to one or more of the
In a responsibility accounting system, the recording of revenue and costs should begin with the
Traceable fixed costs are fixed costs that arise because of the existence of a particular business
unit and that would be eliminated if that unit were closed. Common fixed costs are fixed costs
7.
territory is divided by the product line, this cost is directly traceable to the activities of the
9.
10.
12
8.
The transfer price for a product will divide that product’s profits between different divisions.
This statement is not a logical criterion for closing departments. First, a business unit that has
any responsibility margin is contributing to the common fixed costs and profitability of the
11.
All the elements of responsibility margin—revenue, variable costs, and traceable fixed
costs—will be eliminated if a center is closed. Without considering other issues, this information
Controllable fixed costs and committed fixed costs are subclassifications of fixed costs
traceable to a responsibility center. The controllable fixed costs are those that are readily
Contribution margin is a measurement of performance that takes into consideration only
revenue and variable costs. Therefore, this measurement is useful in evaluating the probable
13.
14.
15.
A profit center is evaluated based upon its ability to generate profits. If cost is used as a transfer
price, the center has no opportunity to earn a profit on the products that it produces and transfers
Managers of responsibility centers are typically held accountable for costs or profits. In a cost
center the manager is held accountable for the costs incurred to meet the obligations of the center.
No. The costs relating to operations of the corporate headquarters cannot be traced to the revenue
of specific restaurants on a basis of cause and effect. With respect to the individual restaurants,
SOLUTIONS TO BRIEF EXERCISES
B. Ex. 22.1
B. Ex. 22.2
B. Ex. 22.3
B. Ex. 22.4
Department B. Short-run product promotion affects revenue and variable costs but
Divisions Two and Three make investment decisions and should be designated as
investment centers. Divisions One, Four, and Five sell their products in external
The contribution margin for the combo is $1.75 – ($0.89 + $0.37 + $0.42) = $0.07.
The small contribution margin for the combo likely implies a negative
The transfer price with an available competitive market should be $48. However, if
there is no external competitive market then a cost-based transfer price might
B. Ex. 22.9
B. Ex. 22.10
Disadvantages of allocating common costs are: 1) Because common fixed costs
do not change when a business center is eliminated, inclusion in the business
The three characteristics are: 1) preparing budgets prior to operations; 2)
SOLUTIONS TO EXERCISES
Ex. 22.1 a.
Ex. 22.2 a.
b.
c.
Ex. 22.3 a.
None (Sales taxes are a liability, not an expense.)
Common fixed costs
Variable costs
Traceable fixed costs
An individual video arcade within a chain of video arcades will be
Common fixed costs
A snack bar within one of the company’s arcades will most likely be
A particular game within one of the company’s arcades will most likely
Cost-plus transfer price
None (The statement describes controllable fixed costs.)
Performance margin
Contribution margin
Responsibility margin
Transfer price
Ex. 22.4
Ex. 22.5
Dollars
Percent of
Sales
Dollars
Percent of
Sales
Dollars
Percent of
Sales
$ 1,200,000 100% $ 900,000 100% $ 300,000 100%
540,000 45% 360,000 40% 180,000 60%
Sales
Variable costs
Contribution
Student responses will differ. Below are some suggested measures:
–Country level investment center measures:
• Capital budgeting (activities/growth in the investment center)
Entire Company
Routers Line
Hepras’ responsibility income statement is shown below:
HEPRAS INCORPORATED
Responsibility Income Statement
For the Current Month
Switches Line
Ethernet
$ 660,000 55% $ 540,000 60% $ 120,000 40%
$ 300,000 25% 200,000 22% $ 100,000 33%
$ 360,000 30% $ 340,000 38% $ 20,000 7%
120,000 10%
$ 240,000 20%
Fixed costs
Product
Common fixed
Income from
a. 600,000$
180,000
420,000$
Store 1 Store 2
Net decrease expected in total monthly sales
Ex. 22.6
Store 3. The effect of an advertising campaign upon operating income is determined by
comparing the cost of the advertising ($15,000 per month) with the additional contribution
Store 1. The contribution that each store makes toward common costs and toward the
Store 2. The effectiveness of the store manager’s strategies are best evaluated by looking at the
relationship of revenue to expenses under the manager’s direct control. This relationship is
Ex. 22.7
Decrease in monthly sales from closing Store 3
Less: Increases in sales expected at Stores 1 and 2
($60,000 + $120,000)
Expected increase in monthly operating income from
Store 1: ($60,000 additional sales × 38%)
closure of Store 3
($22,800 + $44,400, per part b)
the negative responsibility margin of Store 3
Expected increase in income from operations resulting
Expected increases in monthly responsibility margin
from increase in responsibility margin of Stores 1 and 2
Expected increase in monthly contribution margin:
Store 2: ($120,000 additional sales × 37%)
Less: Additional traceable fixed costs
Ex. 22.8
11,400$
11,100
13,500
55,500
15,000
Monthly cost of advertising campaign
Store 1: ($30,000 decrease in sales × 38% contribution margin ratio)
Expected increase in monthly income from operations
Store 2: ($150,000 increase in sales × 37% contribution margin ratio)
Store 3: ($30,000 decrease in sales × 45% contribution margin ratio)
Total expected increase in monthly contribution margin
Ex. 22.9
Ex. 22.10 (1)
Cost center
Profit center
Profit center
Cost center
Investment center
Strategy 1: Advertise the name Drexel-Hall:
Expected increase (decrease) in monthly contribution margin:
Store 1: ($228,000 × 5% increase)
Store 2: ($222,000 × 5% increase)
The higher each division’s responsibility margin, the higher each division’s
profitability will be. Thus, since the managers are paid a bonus based on the
Profit center
Store 3: ($270,000 × 5% increase)
Strategy 2: Advertise low prices at Store 2:
Expected increase (decrease) in contribution margin:
Responsibility centers assist managers in evaluating the overall performance of
subunits of a business, and also help in creating future budgets and setting future
15,000
Monthly cost of advertising campaign
Total expected increase in monthly contribution margin*
Expected increase in monthly income from operations
*As the contribution margin of all stores is expected to increase at the same
5% rate, we could shorten our computation by applying the 5% increase
to the companywide contribution margin of $720,000.
Sales Repairs
Department Department
180,000$ 24,000$
94,000 8,000
a.
Entire UK Mexican
Company Division Division
Sales
1,600,000£ 1,600,000£ 700,000£
Operating Expense
650,000 400,000 250,000
Using a transfer price of 700,000 British pounds, the tax liability for each division and for the
company as a whole are:
Ex. 22.13
The total variable costs incurred in Repairs is $8,000. Twenty-five percent of
Ex. 22.12
Variable Costs
Sales
18,000 14,000
Responsibility Margin
Fixed Traceable Costs
Contribution Margin
Entire UK Mexican
Company Division Division
Sales 1,600,000£ 1,600,000£ 800,000£
Ex. 22.14
Ex. 22.15
Ex. 22.13 (continued): Using a transfer price of 800,000 British pounds, the tax liability for
each division and for the company as a whole are:
Student responses will vary, but here is one organizational design:
Home Depot’s Note 1 in Appendix A outlines a couple of different scenarios for
responsibility center organization. First, responsibility centers could be organized
around customer groups. The note mentions do-it-yourself, do-it-for me, and
Jasper Golf Resort*
Operating Expense 650,000 400,000 250,000
SOLUTIONS TO PROBLEMS SET A
20 Minutes, Easy PROBLEM 22.1A
CHOCOLATIERS COMPANY
a. CHOCOLATIERS COMPANY
Responsibility Income Statement
For the Current Month
Entire Company Solid Chocolate Powdered Chocolate
Dollars Percent Dollars Percent Dollars Percent
Sales
1,500,000$ 100% 600,000$ 100% 900,000$ 100%
Variable costs 780,000 52% 240,000 40% 540,000 60%
b.
c.
According to the analysis in part a, the Powdered Chocolate product line is more profitable in terms
of dollars of responsibility margin that it contributes to the entire company.
When determining the profitability of any product line, common fixed costs should not be considered.
Due to the short term nature of such an advertising campaign, fixed production costs will most likely
Fixed costs traceable to product lines 240,000 16% 150,000 25% 90,000 10%
Product responsibility margin 480,000$ 32% 210,000$ 35% 270,000$ 30%
Common fixed costs 75,000 5%
Income from operations 405,000$ 27%
30 Minutes, Medium PROBLEM 22.2A
REGAL FLAIR ENTERPRISES
a. Responsibility income statement:
Entire Company Jewelry Line Apparel Line
Dollars Percent Dollars Percent Dollars Percent
Sales
1,300,000$ 100% 900,000$ 100% 400,000$ 100%
Variable costs 480,000 37% 360,000 40% 120,000 30%
For the Current Month
Responsibility Income Statement
REGAL FLAIR ENTERPRISES
Fixed costs traceable to product lines 465,000 30% 225,000 25% 240,000 60%
Product responsibility margin 355,000$ 27% 315,000$ 35% 120,000$ 10%
Common fixed costs 130,000 10%
Income from operations 225,000$ 17%
PROBLEM 22.2A
REGAL FLAIR ENTERPRISES (concluded)
b.
Jewelry Apparel
Expected increase in contribution margin:
c. Results of investment in each product line:
Jewelry Apparel
Expected increase in contribution margin:
Jewelry ($300,000 × 60%) 180,000$
Apparel ($300,000 × 70%) 210,000$
Because of the relatively high contribution margin in the apparel segment, spending
$80,000 per month to achieve a monthly sales increase of $120,000 will increase overall
Thus, it would appear that an investment in the Apparel line would produce the most
Recommendations on increased advertising:
It appears that increasing advertising expenditures on apparel will increase the
profitability of the business, but spending the proposed amount to advertise jewelry would
reduce profitability.
30 Minutes, Medium PROBLEM 22.3A
GIANT CHEF EQUIPMENT COMPANY
a. Responsibility income statement
Entire Company Commercial Sales Division Home Products Division
Dollars Percent Dollars Percent Dollars Percent
Sales
2,400,000$ 100.0 1,500,000$ 100.0 900,000$ 100.0
Variable costs 1,440,000 60.0 990,000 66.0 450,000 50.0
Contribution margin 960,000$ 40.0 510,000$ 34.0 450,000$ 50.0
GIANT CHEF EQUIPMENT COMPANY
Responsibility Income Statement
For June
Division responsibility margin 600,000$ 25.0 330,000$ 22.0% 270,000$ 30.0%
Common fixed costs 120,000 5.0
Operating Income 480,000$ 20.0%