Responsibility Accounting and Performance Evaluation

How does capacity affect transfer pricing decisions? 

Decentralization divides company operations into various reporting units. Most decentralized subunits can be described as one of four different types of responsibility centers.

Requirements 

1. Explain why companies decentralize. Describe some typical methods of decentralization. 

2. List the four most common types of responsibility centers, and describe their responsibilities.

Question: Each of the following managers works for a national chain of hotels and has been given certain decision-making authority. Classify each of the managers according to the type of responsibility center he or she probably manages. 

a. Manager of the Central Reservation Office 

b. Managers of various corporate-owned hotel locations 

c. Managers of the Northeast and Southeast Corporate Divisions 

d. Manager of the Housekeeping Department at one hotel 

e. Manager of the complimentary breakfast buffet at one hotel

 Well-designed performance evaluation systems accomplish many goals. Consider the following actions, and state which goal is being achieved by the action:

a. Comparing targets to actual results 

b. Providing subunit managers with performance targets 

c. Comparing actual results with industry standards 

d. Providing bonuses to subunit managers who achieve performance targets 

e. Aligning subunit performance targets with company strategy 

f. Comparing actual results of competitors 

g. Taking corrective actions 

h. Using the adage “you get what you measure” when designing the performance evaluation system

Consider the following key performance indicators, and classify each according to the balanced scorecard perspective it addresses. Choose from financial perspective, customer perspective, internal business perspective, or learning and growth perspective. 

a. Number of employee suggestions implemented 

b. Revenue growth 

c. Number of on-time deliveries 

d. Percentage of sales force with access to real-time inventory levels 

e. Customer satisfaction ratings 

f. Number of defects found during manufacturing 

g. Number of warranty claims 

h. Return on investment 

i. Variable cost per unit

j. Percentage of market share 

k. Number of hours of employee training 

l. Number of new products developed 

m. Yield rate (number of units produced per hour) 

n. Average repair time 

o. Employee satisfaction 

p. Number of repeat customers

 Well-designed performance evaluation systems accomplish many goals. Consider the following actions, and state which goal is being achieved by the action:

a. Comparing targets to actual results 

b. Providing subunit managers with performance targets 

c. Comparing actual results with industry standards 

d. Providing bonuses to subunit managers who achieve performance targets 

e. Aligning subunit performance targets with company strategy 

f. Comparing actual results of competitors 

g. Taking corrective actions 

h. Using the adage “you get what you measure” when designing the performance evaluation system

 Each of the following managers works for a national chain of hotels and has been given certain decision-making authority. Classify each of the managers according to the type of responsibility center he or she probably manages. 

a. Manager of the Central Reservation Office 

b. Managers of various corporate-owned hotel locations 

c. Managers of the Northeast and Southeast Corporate Divisions 

d. Manager of the Housekeeping Department at one hotel 

e. Manager of the complimentary breakfast buffet at one hotel

Management by exception is a term often used in performance evaluation. Describe management by exception and how it is used in the evaluation of cost, revenue, and profit centers.

Consider the following data, and determine which of the corporate divisions is more profitable. Explain your reasoning. 

                                     Domestic           International 

Operating income     \( 10,000,000     \) 11,000,000 

Average total assets   24,000,000       32,000,000

XTreme Sports Company makes snowboards, downhill skis, cross-country skis, skateboards, surfboards, and inline skates. The company has found it beneficial to split operations into two divisions based on the climate required for the sport: Snow Sports and Non-snow Sports. The following divisional information is available for the past year:

XTreme’s management has specified a 13% target rate of return. Calculate each division’s profit margin ratio. 

Interpret your results.

Refer to the information in Short Exercise S24-7. 

Requirements 

1. Compute each division’s asset turnover ratio (round to two decimal places). Interpret your results. 

2. Use your answers to Requirement 1, along with the profit margin ratio, to recalculate ROI using the expanded formula. Do your answers agree with the basic ROI in Short Exercise S24-7?

Refer to the information in Short Exercise S24-7. Compute each division’s RI. Interpret your results. Are your results consistent with each division’s ROI?

Henderson Company manufactures electronics. The Calculator Division (an investment center) manufactures handheld calculators. The division can purchase the batteries used in the calculators from the Battery Division (another investment center) or from an outside vendor. The cost to purchase batteries from the outside vendor is \(5. The transfer price to purchase from the Battery Division is \)6. The Battery Division also sells to outside customers. The sales price is \(6, and the variable cost is \)3. The Battery Division has excess capacity. 

Requirements 

1. Should the Calculator Division purchase from the Battery Division or the outside vendor? 

2. If Henderson Company allows division managers to negotiate transfer prices, what is the maximum transfer price the manager of the Calculator Division should consider? 

3. What is the minimum transfer price the manager of the Battery Division should consider? 

4. Does your answer to Requirement 3 change if the Battery Division is operating at capacity?

Consider the following key performance indicators, and classify each indicator according to the balanced scorecard perspective it addresses. Choose from the financial perspective, customer perspective, internal business perspective, and the learning and growth perspective.

a. Number of customer complaints 

b. Number of information system upgrades completed 

c. Residual income 

d. New product development time 

e. Employee turnover rate 

f. Percentage of products with online help manuals 

g. Customer retention 

h. Percentage of compensation based on performance 

i. Percentage of orders filled each week 

j. Gross margin growth 

k. Number of new patents 

l. Employee satisfaction ratings 

m. Manufacturing cycle time (average length of production process) 

n. Earnings growth 

o. Average machine setup time 

p. Number of new customers 

q. Employee promotion rate 

r. Cash flow from operations 

s. Customer satisfaction ratings 

t. Machine downtime u. Finished products per day per employee 

v. Percentage of employees with access to upgraded system 

w. Wait time per order prior to start of production

Question: The accountant for a subunit of Speed Sports Company went on vacation before completing the subunit’s monthly responsibility report. This is as far as she got: 

Speed—Subunit X Revenue by Product Actual Results Flexible Budget Variance Flexible Budget Sales Volume Variance Static Budget 

Downhill-RI \( 321,000 (a) (b) \) 17,000 F \( 295,000

Downhill-RII 151,000 (c) \) 161,000 (d) 145,000 

Cross-EXI 285,000 \( 3,000 U 288,000 (e) 303,000 

Cross-EXII 259,000 (f) 255,000 16,500 U 271,500 

Snow-LXI 425,000 2,000 F (g) (h) 404,000 

Total \) 1,441,000 (i) (j) (k) \( 1,418,500 

Requirements 

1. Complete the responsibility report for this subunit. 

2. Based on the data presented, what type of responsibility center is this subunit? 

3. Which items should be investigated if part of management’s decision criteria is to investigate all variances exceeding \)12,000?

Zims, a national manufacturer of lawn-mowing and snow-blowing equipment, segments its business according to customer type: professional and residential. The following divisional information was available for the past year: 

Net Sales Revenue Operating Income Average Total Assets 

Residential \( 550,000 \) 65,280 $ 192,000 

Professional 1,090,000 164,820 402,000 

Management has a 26% target rate of return for each division. 

Requirements 

1. Calculate each division’s ROI. Round all of your answers to four decimal places. 

2. Calculate each division’s profit margin ratio. Interpret your results. 

3. Calculate each division’s asset turnover ratio. Interpret your results. 

4. Use the expanded ROI formula to confirm your results from Requirement 1. What can you conclude?

Refer to the data in Exercise E24-17. Calculate each division’s RI. Interpret your results.

One subunit of Racer Sports Company had the following financial results last month:

Subunit X        Actual Results       Flexible Budget  Flexible Budget   % Variance

                                                                                       Variance (F or U)     (F or U)

Net Sales 

Revenue               \( 476,000                   \) 451,000

Variable 

Expenses                261,000                      251,000

Contribution 

Margin                     215,000                     200,000

Traceable 

Fixed Expenses        40,000                      26,000

Divisional 

Segment Margin    \( 175,000               \) 174,000

Requirements

1. Complete the performance evaluation report for this subunit (round to two decimal places).

2. Based on the data presented and your knowledge of the company, what type of responsibility center is this subunit?

3. Which items should be investigated if part of management’s decision criteria is to investigate all variances equal to or exceeding \(8,000 and exceeding 10% (both criteria must be met)?

4. Should only unfavorable variances be investigated? Explain.

5. Is it possible that the variances are due to a higher-than-expected sales volume? Explain.

6. Will management place equal weight on each of the variances exceeding \)8,000? Explain.

7. Which balanced scorecard perspective is being addressed through this performance report? In your opinion, is this performance report a lead or a lag indicator? Explain.

8. List one key performance indicator for the three other balanced scorecard perspectives. Make sure to indicate which perspective is being addressed by the indicators you list.

The Trolley Toy Company manufactures toy building block sets for children. Trolley is planning for 2019 by developing a master budget by quarters. Trolley’s balance sheet for December 31, 2018, follows:

Other budget data for Trolley Toy Company: 

a. Budgeted sales are 1,400 sets for the first quarter and expected to increase by 150 sets per quarter. Cash sales are expected to be 30% of total sales, with the remaining 70% of sales on account. Sets are budgeted to sell for \)90 per set. 

b. Finished Goods Inventory on December 31, 2018, consists of 200 sets at \(27 each. 

c. Desired ending Finished Goods Inventory is 40% of the next quarter’s sales; first quarter sales for 2020 are expected to be 2,000 sets. FIFO inventory costing method is used. 

d. Raw Materials Inventory on December 31, 2018, consists of 600 pounds. Direct materials requirement is 3 pounds per set. The cost is \)2 per pound. 

e. Desired ending Raw Materials Inventory is 10% of the next quarter’s direct materials needed for production; desired ending inventory for December 31, 2019, is 600 pounds; indirect materials are insignificant and not considered for budgeting purposes. 

f. Each set requires 0.30 hours of direct labor; direct labor costs average \(12 per hour. 

g. Variable manufacturing overhead is \)3.60 per set. 

h. Fixed manufacturing overhead includes \(7,000 per quarter in depreciation and \)2,585 per quarter for other costs, such as utilities, insurance, and property taxes. 

i. Fixed selling and administrative expenses include \(11,000 per quarter for salaries; \)1,500 per quarter for rent; \(1,350 per quarter for insurance; and \)1,500 per quarter for depreciation.

j. Variable selling and administrative expenses include supplies at 2% of sales.

k. Capital expenditures include \(45,000 for new manufacturing equipment, to be purchased and paid for in the first quarter. 

l. Cash receipts for sales on account are 40% in the quarter of the sale and 60% in the quarter following the sale; Accounts Receivable balance on December 31, 2018, is expected to be received in the first quarter of 2019; uncollectible accounts are considered insignificant and not considered for budgeting purposes. 

m. Direct materials purchases are paid 90% in the quarter purchased and 10% in the following quarter; Accounts Payable balance on December 31, 2018, is expected to be paid in the first quarter of 2019. 

n. Direct labor, manufacturing overhead, and selling and administrative costs are paid in the quarter incurred. 

o. Income tax expense is projected at \)3,500 per quarter and is paid in the quarter incurred. 

p. Trolley desires to maintain a minimum cash balance of \(55,000 and borrows from the local bank as needed in increments of \)1,000 at the beginning of the quarter; principal repayments are made at the beginning of the quarter when excess funds are available and in increments of \(1,000; interest is 10% per year and paid at the beginning of the quarter based on the amount outstanding from the previous quarter.

Requirements 

1. Prepare Trolley’s operating budget and cash budget for 2019 by quarter. Required schedules and budgets include: sales budget, production budget, direct materials budget, direct labor budget, manufacturing overhead budget, cost of goods sold budget, selling and administrative expense budget, schedule of cash receipts, schedule of cash payments, and cash budget. Manufacturing overhead costs are allocated based on direct labor hours. 

2. Prepare Trolley’s annual financial budget for 2019, including budgeted income statement and budgeted balance sheet. 

3. Trolley sold 7,000 sets in 2019, and its actual operating income was as follows:

Prepare a flexible budget performance report through operating income for 2019. Show product costs separately from selling and administrative costs. To simplify the calculations due to sets in beginning inventory having a different cost than those produced and sold in 2019, assume the following product costs:

4. What was the effect on Trolley’s operating income of selling 500 sets more than the static budget level of sales? 

5. What is Trolley’s static budget variance for operating income? 

6. Explain why the flexible budget performance report provides more useful information to Trolley’s managers than the static budget performance report. What insights can Trolley’s managers draw from this performance report? 

7. During 2019, Trolley recorded the following cost data:

Standard Cost Information

Actual Cost Information

Compute the cost and efficiency variances for direct materials and direct labor. 

8. For manufacturing overhead, compute the variable overhead cost and efficiency variances and the fixed overhead cost and volume variances. 

9. Prepare the standard cost income statement for 2019. 

10. Calculate Trolley’s ROI for 2019. To calculate average total assets, use the December 31, 2018, balance sheet for the beginning balance and the budgeted balance sheet for December 31, 2019, for the ending balance. Round all of your answers to four decimal places. 

11. Calculate Trolley’s profit margin ratio for 2019. Interpret your results. 

12. Calculate Trolley’s asset turnover ratio for 2019. Interpret your results. 

13. Use the expanded ROI formula to confirm your results from Requirement 10. Interpret your results. 

14. Trolley’s management has specified a 30% target rate of return. Calculate Trolley’s RI for 2019. Interpret your results.

Question: Determining transfer pricing

The Hernandez Company is decentralized, and divisions are considered investment centers. Hernandez has one division that manufactures oak dining room chairs with upholstered seat cushions. The Chair Division cuts, assembles, and finishes the oak chairs and then purchases and attaches the seat cushions. The Chair Division currently purchases the cushions for \(32 from an outside vendor. The Cushion Division manufactures upholstered seat cushions that are sold to customers outside the company. The Chair Division currently sells 1,800 chairs per quarter, and the Cushion Division is operating at capacity, which is 1,800 cushions per quarter. The two divisions report the following information:

Chair Division Cushion Division

Sales Price per Chair \) 95 Sales Price per Cushion \( 34

Variable Cost (other than cushion) 56 Variable Cost per Cushion 12

Variable Cost (cushion) 32        

Contribution Margin per Chair \) 7 Contribution Margin per Cushion $ 22

Requirements

1. Determine the total contribution margin for Hernandez Company for the quarter.

2. Assume the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its current sales price. What is the total contribution margin for each division and the company?

3. Assume the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its current variable cost. What is the total contribution margin for each division and the company?

4. Review your answers for Requirements 1, 2, and 3. What is the best option for Hernandez Company?

5. Assume the Cushion Division has capacity of 1,800 cushions per quarter and can continue to supply its outside customers with 1,800 cushions per quarter and also supply the Chair Division with 1,800 cushions per quarter. What transfer price should Hernandez Company set? Explain your reasoning. Using the transfer price you determined, calculate the total contribution margin for the quarter.

Question: Using ROI and RI to evaluate investment centers

This problem continues the Piedmont Computer Company situation from Chapter 23. Piedmont Computer Company reported 2020 sales of \(3,600,000 and operating income of \)183,600. Average total assets during 2020 were $600,000. Piedmont Computer Company’s target rate of return is 16%.

Calculate Piedmont Computer Company’s profit margin ratio, asset turnover ratio, ROI, and RI for 2020. Comment on the results.