MAS_1.3.

1 INTEGRATED REVIEW & REFRESHER COURSE

R.D.BALOCATING
UNIVERSITY OF LUZON
COLLEGE OF ACCOUNTANCY
CPA REVIEW CENTER

MANAGEMENT ADVISORY SERVICES

RESPONSIBILITY ACCOUNTING & TRANSFER PRICING

 Responsibility Accounting System

- a system of measuring and reporting operating performance by individual levels of responsibility.
- has four essential elements
1. Assigning responsibility
2. Establishing performance measures or benchmarks
3. Evaluating performance
4. Assigning rewards.
- types of responsibility center:
Responsibility______ _
Responsibility Center Costs Revenue Investment
1. Cost Center X
2. Revenue Center X
3. Profit Center X X
4. Investment Center X X X
- can function best in a decentralized organization.
 Decentralization
- the practice of delegating decision-making authority to lower levels.
- issues that must be addressed in decentralization are:
 degree of decentralization
 how to measure performance
 appropriate method to compensate management
 appropriate transfer prices
- benefits:
a. Generally, those closest to a problem are most familiar with the problem and its root causes.
b. Top management is left with more time to devote to long-range strategic planning, since
decentralization removes the responsibility for much of the day-to-day decision making.
c. Managers allowed to make decisions in a decentralized environment have higher job satisfaction.
d. Managers given increased responsibility for decision making early in their careers generally become
better managers.
e. Decisions are often made in a more timely fashion.
- drawbacks:
a. A lack of company focus can occur.
b. Managers may not be properly trained in decision making at the early stages of their careers.
c. There may be a lack of coordination and communication between segments.
d. Decentralization may make it more difficult to share unique and innovative ideas.
e. Decentralization may result in duplicative efforts and duplicative costs.

 Transfer Price
- the price charged by one segment of an organization for goods or services provided to another segment.
- approaches in setting transfer price
a. cost-based transfer pricing
 variable costs
 absorption costs
b. market-based transfer pricing
c. negotiated transfer pricing
- Model for Computing Transfer Prices
a. Minimum transfer price = Variable costs + Lost contribution margin
b. Maximum transfer price = Market price (if available)
c. A good should be transferred internally whenever the minimum transfer price (set by the selling
division) is less than the maximum transfer price (set by the buying division). By using this rule, total
profits of the firm are not decreased by an internal transfer.
- International Aspects of Transfer Pricing
a. The focus of transfer pricing when international divisions are involved centers on minimizing taxes,
duties, and foreign exchange risks.
MAS_1.3.1 INTEGRATED REVIEW & REFRESHER COURSE
R.D.BALOCATING
b. Managers should be aware and sensitive to geographic, political, and economic circumstances in the
environment in which they operate.

PROBLEM 1
Fill in the missing information:
A B C
Sales P750,000 P600,000
Net operating income 60,000 27,000
Average operating assets 300,000 200,000
Margin (return on sales) 7.50%
Asset turnover 1.8
ROI 27%

PROBLEM 2
Frankel Company uses the residual income approach to measure performance in its divisions. For the year 2021,
Division a reported the following data: sales, P2,000,000; net operating income, P160,000; average operating assets,
P800,000. The company feels that the divisions should earn a minimum return of 16% on their assets. Compute
Division A’s residual income (RI) for 2021.

PROBLEM 3
Alpha Company had after-tax operating income last year of P115,000. Two sources of financing were used by the
company: P1.3M of bonds paying 8% interest and P700,000 in common stock. Assume the cost of common stock is
12%. Tax rate is 30%. Total capital employed is P1.5M.
a. What is the after-tax cost of bonds?
b. What is the weighted-average cost of capital?
c. Calculate the EVA for Alpha Company. Is the company creating wealth or not?

PROBLEM 4
Calculate the ROI, RI, EVA using the following information:
January 2015 operating income P300,000
January 2015 sales 450,000
Assets at December 31, 2014 500,000
Assets at January 31, 2015 510,000
January income taxes 90,000
Current liabilities at January 31, 2015 250,000
Costs of capital 19%
Desired ROI 52%

PROBLEM 5

The Kelly Division of Zimmer Company sells all of its output to the Finishing Division of the company. The only
product of the Kelly Division is chair legs that are used by the Finishing Division. The retail price of the legs is P20
per leg. Each chair completed by the Finishing Division requires four legs. Production quantity and cost data for 2021
are as follows:

Chair legs 30,000

Direct materials P135,000
Direct labor P90,000
Factory overhead (25% is variable) P90,000
Operating expenses (20% is variable) P150,000

Required:

Compute the transfer price for a chair leg using:

a. market price.
b. variable product costs plus a fixed fee of 20 percent.
c. absorption product cost plus 20 percent markup.
d. variable costs.
e. full cost plus 10 percent markup.
MAS_1.3.1 INTEGRATED REVIEW & REFRESHER COURSE
R.D.BALOCATING
PROBLEM 6

Parch Company’s Division A produces small valve that is used by many outside manufacturers as a key part in their
products. Cost and sales data relating to the valve are given below:
Selling price per unit P50
Variable costs per unit 30
Fixed costs per unit** 12
** based on Division A’s capacity of 40,000 valves per year.
Parch Company’s Division B is introducing a new product that will use a valve such as the one produced in Division
A. An outside supplier has quoted Division B a price of P48 per valve. This represents the normal price of P50, less
a quantity discount due to the large number of valves which Division B will be purchasing. Division B would like to
purchase the valves from Division A, if an acceptable transfer price can be worked out.
a. Assume that Division A is presently selling all of the valves it can produce to outside customers. Use the
transfer pricing formula to determine the transfer price it should quote Division B
Transfer price = Variable costs per unit + Lost contribution margin on outside sales
b. Should Division B purchase the valves from Division A or from outside supplier? Explain.
c. Assume Division B needs 15,000 valves per year. If it purchases the valves from Division A at the price you
have computed above, what is the effect on overall company profits?
d. Refer to the original data. Assume that Division A has ample idle capacity to handle all of Division B’s needs.
What is the minimum acceptable transfer price between the two Divisions.
e. Under the conditions given in “ d “ above, what is the maximum acceptable transfer price between the two
divisions?

PROBLEM 7
Division of A of LHD Company expects the following results. Answer each question independently.

To Division B To Outsiders
Sales (20,000 x 10) 200,000
(20,000 x 12) 240,000
Variable costs at 6 120,000 120,000
Contribution margin 80,000 120,000
Fixed costs, all common, allocated
on the basis of relative units 60,000 60,000
Profit 20,000 60,000

Division B has the opportunity to buy its needs for 20,000 units from an outside supplier at P8 each.

 Division A refuses to meet the P8 price, sales to outsiders cannot be increased, and Division B buys from the
outside supplier. Compute the effect on the income of LHD.
 Division A cannot increase its sales to outsiders, does meet the P8 price, and Division B continues to buy from
A. Compute the effect on the income of LHD.
 Suppose that Division A could sell the 20,000 units now taken by Division B to outsiders at P9 each without
disturbing sales at the regular P12 price. Division B buys outside at P8 and Division a increases its sales to
outsiders. Find the effect on the income of LHD.

MULTIPLE CHOICE
Use the following for the next two questions:
Lagnut Manufacturing Company reported the following information at the end of its most recent fiscal year.
Sales P90,000
Net operating income 3,600
Operating assets 30,000
Stockholder’s equity 25,000
Minimum required rate of return 10%
1. Lagnuts residual income was;
a. P1,100 b. P5,400 c. P 360 d. P 600

2. Lagnuts return on investment was:

a. 4% b. 12% c. 14.4% d. 18%

Use the following income statement for the next two questions
Sales P50,000
Net operating income 3,000
MAS_1.3.1 INTEGRATED REVIEW & REFRESHER COURSE
R.D.BALOCATING
Operating assets 20,000
Stockholder’s equity 12,500
Minimum required rate of return 10%
3. The residual income would be:
a. P1,000 b. P1,250 c. P1,750 d. P2,000
4. Return on investment would be:
a. 6% b. 10% c. 15% d. 24% e. 50%

USE THE FOLLOWING INFORMATION FOR THE NEXT TWO QUESTIONS.

A responsibility center which is accounted for as an investment center had sales for the period of P10,000,000.
Cost of goods sold amounted to P7,000,000, while all other expenses totaled 50% of gross margin. To produce
its income the investment center employed P15,000,000 worth of assets.
5. Assuming a 9% minimum required rate of return, residual income would be:
a. P450,000 b. P150,000 c. P600,000 d. P800,000 e. Some other number
6. The return on investment would be:
a. 10% b. 12% c. 15% d. 20% e. 66%

7. The following information pertains to Division X of Marlow Company:

Division X
Net earnings for division P25,000
Asset base for division P100,000
Target rate of return 15%
Margin 20%
Weighted average cost of capital 12%
What is EVA?
a. P3,000 b. P13,000 c. P8,000 d. P5,000

8. Compute the cost of capital (rounded) for an investment center with the following information:
Pretax operating income P17,500,000
Assets 6,200,000
Current liabilities 4,000,000
Long-term liabilities 1,500,000
Income tax expense 5,000,000
EVA 12,000,000
a. 28% b. 23% c. 11% d. 9%

9. Young Company has a tax rate of 40 percent. Information for the company is as follows:
Amount After-tax Cost
Mortgage bonds P1,000,000 0.048
Unsecured bonds 3,000,000 0.050
Common stock 6,000,000 0.150
What is the weighted cost of capital?
a. 0.1098 b. 0.2480 c. 0.0827 d. 0.0366

10. (Refer to number 9) What is the EVA if the before-tax operating income is P1,500,000?
a. P1,134,000 b. P402,000 c. P534,000 d. P(198,000)

11. Assume Avionic Industrials reported at year-end that operating income before taxes for the year equaled
P2,400,000. Long-term debt issued by Avionics has a coupon rate equal to 6% and its cost of equity is 8%. The
book value of the debt currently equals its fair value, and the book value of the equity capital for Avionics is
P900,000 less than its fair value. Current assets are listed at P2,000,000 and long-term assets equals P9,600,000.
The claims against those assets are in the form of P1,500,000 in current liabilities and P2,200,000 in long-term
liabilities. The income tax rate for Avionics is 30%. What is the economic value added (EVA)?
a. P731,240 b. P948,760 c. P1,668,760 d. P1,680,000
MAS_1.3.1 INTEGRATED REVIEW & REFRESHER COURSE
R.D.BALOCATING
12. James Webb is the general manager of the Industrial Product Division, and his performance is measured using
the residual income method. Webb is reviewing the following forecasted information for his division for next
year:

Amount (thousands)
Category
Working Capital P 1,800
Revenue 30,000
Plant and equipment 17,200

If the cost of capital is 15% and Webb wants to achieve a residual income target of P2,000,000, what will costs
have to be in order to achieve the target?
a. P9,000,000 b. P10,800,000 c. P25,150,000 d. P25,690,000

13. A management decision may be beneficial for a given profit center, but not for the entire company. From the
overall company viewpoint, this decision would lead to action referred to as:
a. Sub-optimization c. Goal congruence
b. Centralization d. Maximization

14. Some investment opportunities favorable to the firm might be rejected by a divisional manager whose
performance was being evaluated by:
a. rate of return on b. residual income. d. segment margin.
investment. c. contribution margin. e. Sales.

15. The residual income measurement approach has been criticized on the ground that:
a. comparability between divisions is lost.
b. some opportunities favorable to a firm might be rejected by a division.
c. both of the above are criticism.
d. neither of the above are criticism.

16. Which of the following statements is true concerning the term transfer price?
a. It is the price at which goods are transferred between responsibility centers.
b. It should be usually be set at the amount of variable (or incremental) cost
c. It involves the cost of transporting inventory from one investment center to another
d. It is seldom used by manufacturers

17. If being evaluated as a profit center and operating at full capacity, the transfer price to an intra-company division
should be:
a. The outside market price. d. Actual cost
b. Standard cost e. Variable cost

18. The Mars Company has two divisions, A and B. Division A produces and sells a product and can sell its entire
output to outside customers. The following data for Division A’s product is available:
Selling price P25 per unit
Variable cost 12 per unit
Fixed cost 8 per unit
Division B can use division A’s product in its production process and would like to buy this product from Division
A. Division B is presently purchasing the product from an outside supplier at P23 per unit. Assuming that
division A is operating at full capacity, what is the minimum price that division A should charge for the units sold
to division B?
a. P25 d. P12
b. P23 e. Some price between P12 and P23
c. P20

USE THE FOLLOWING INFORMATION FOR THE NEXT THREE QUESTIONS.

Hubcap Division of Motorcar, Inc. sells some of its output to outside firms and some to the Assembly Division of
Motorcar, Inc. Assume the following information:
Variable cost per unit P5
Fixed cost per unit P2
Capacity in units 300,000
Selling price to outsiders P10
MAS_1.3.1 INTEGRATED REVIEW & REFRESHER COURSE
R.D.BALOCATING
19. Assume Hubcap Division could sell its entire output to outsiders at the current price but that Assembly Division
offers to buy half the output at a price of P9 each. Under what circumstances might such a transaction would
benefit Motorcar, Inc.?
a. Only if the increase in variable cost per unit is kept to less than P1
b. Only if total fixed costs per unit remain constant
c. Only if the Assembly Division can buy hubcaps elsewhere for less than P8
d. Only if the variable costs of at least P150,000 can be avoided

20. Assume that only 150,000 units can be sold externally by Hubcap Division and that Assembly offered to buy
50,000 units. What is the lowest price that Hubcap Division can charge on this sale without reducing its own
segment margin?
a. P30 b. P 5 c. P 7 d. P10

21. Assume Hubcap Division is currently selling its entire output externally at P10 each. If Assembly Division wants
to purchase some Hubcap’s output, what is the minimum price that Hubcap can charge the Assembly Division
without reducing its own segment margin?
a. P10 b. P 8 c. P 7 d. P 5 e. P 0

22. East Division and West Division are operated as autonomous investment centers of Greater World, Inc. East
division manufactures a single product and is currently operating at 60% of capacity. Budgeted amounts for the
current year are as follows:
Sales (10,000 units) P1,000,000
Direct labor 250,000
Direct materials 200,000
Overhead (1/3 fixed) 300,000
West division has offered to buy 5,000 units from East but wants a “deal “ on the price. What is the minimum
price that East can charge without reducing its current profitability?
a. P55 b. P65 c. P75 d. P85 e. P100

23. If a computer department does work for other departments, charging flat-price per hour, the computer
department is:
a. An artificial profit center c. An investment center
b. A cost center d. None of the above

24. An artificial profit center

a. has no investment
b. does not provide its goods or services outside the entity
c. cannot control its costs
d. could not be operated as cost center

25. Alcatraz Division of A Corporation sells 80,000 units of part X to the outside market. Part X sells for P20, has a
variable costs of P11, and a fixed cost per unit of P5. Alcatraz has a capacity to produce 100,000 units per period.
Capone Division currently purchases 10,000 units of part X from Alcatraz for P20. Capone has been approached
by an outside supplier willing to supply the parts for P18. What is the effect on A’s overall profit if Alcatraz
refuses the outside price and Capone decides to buy outside?
a. no change c. P40,000 decrease in A’s profit
b. P70,000 decrease in A’s profit d. P20,000 increase in A’s profit

26. Alcatraz Division of A Corporation sells 80,000 units of part X to the outside market. Part X sells for P20, has a
variable costs of P11, and a fixed cost per unit of P5. Alcatraz has a capacity to produce 100,000 units per period.
Capone Division currently purchases 10,000 units of part X from Alcatraz for P20. Capone has been approached
by an outside supplier willing to supply the parts for P18. What is the effect on A’s overall profit if Alcatraz
accepts the outside price and Capone decides to buy inside?
a. no change
b. P70,000 decrease in A’s profit
c. P40,000 decrease in A’s profit
d. P20,000 increase in A’s profit
MAS_1.3.1 INTEGRATED REVIEW & REFRESHER COURSE
R.D.BALOCATING
SEGMENTED REPORTING

Segmented income statements present the results of operations for the whole company and for each individual
segment.

Many accountants feel that organizations should not allocate common costs, or nontraceable costs that benefit
more than one segment (such as the CEO’s salary and headquarters’ depreciation).

Allocations of common costs are often arbitrary, given that many different allocation methods can be used. Such
allocations can lead to misleading financial information and possible erroneous decisions.

The segmented income statement, presented in a contribution format, discloses the segment profit margin,
computed as follows:

Segment contribution margin – Fixed expenses controllable by the segment manager = Profit margin
controllable by the segment manager

Profit margin controllable by the segment manager – Fixed expenses traceable to the segment, but controllable
by others = Segment profit margin

The contribution format shows the amount that each subunit is contributing to cover common fixed costs and
increase profits. It is also somewhat clear which costs would disappear if the segment is discontinued—
useful information for decision situations.

If the segmented income statement is used to evaluate a manager’s performance, care is taken to highlight costs
that are controllable by the manager. Holding an individual responsible for costs that he/she cannot change
decreases the chance that the report will be a positive motivator.

Test Items:
1. From the following data, prepare a segmented income statement for the Bal Company for December 2021:
Total Product X Product Y
Number of units sold - 10,000 12,000
Selling price per unit - P20.00 P25.00
Variable cost per unit:
Production - 9.00 10.00
Selling and administrative - 3.00 3.75
Fixed costs:
Production P155,000
Selling and administrative 20,000
Some P50,000 of the fixed production costs are traceable directly to Product X and P75,000 are traceable to
Product Y. All fixed selling and administrative expenses are common.

2. Select a true statement:

a. Fixed are not important in segment accounting because they are not allocated to segments.
b. If common cost are allocated to segments, a segment may appear unprofitable even though it is contributing
to profits of the firm.
c. Segment margin is usually regarded as the best gauge of short run profitability of the firm
d. A cost item which is a variable expense at one level of segmentation maybe classified as a common expense
at another level of segmentation.

3. A company’s two divisions, X and Y, have equal sales and variable expenses. X’s division segment margin will be
more than Y’s if it has;
a. more direct fixed expenses c. more common fixed expenses
b. less direct fixed expenses d. less common fixed expenses

4. The difference between contribution margin by segment and segment margin is:
a. direct fixed costs d. allocated costs
b. common variable costs e. variable operating expenses
c. common costs

5. When segment is discontinued:

a. both direct and common fixed costs are eliminated
b. common fixed costs are eliminated, but not direct fixed costs
MAS_1.3.1 INTEGRATED REVIEW & REFRESHER COURSE
R.D.BALOCATING
c. direct fixed cost are eliminated, but not common fixed costs
d. neither common nor direct fixed costs are eliminated

6. Direct fixed costs:

a. arise because of overall operating activities of the company
b. arise because of the existence of a particular segment
c. should never be allocated to segments of the firm
d. should be subtracted from sales to determine the segment margin

7. The difference between the profit margin controllable by a segment manager and the segment profit margin is
caused by:
a. variable operating expenses.
b. allocated common expenses.
c. fixed expenses controllable by the segment manager.
d. fixed expenses traceable to the segment but controllable by others.
e. other revenue.

8. Controllable costs, as used in a responsibility accounting system, consist of:

a. only fixed costs.
b. only direct materials and direct labor.
c. those costs that a manager can influence in the time period under review.
d. those costs about which a manager has some knowledge.
e. those costs that are influenced by parties external to the organization.

9. Common costs:
a. are not easily related to a segment's activities.
b. are easily related to a segment's activities.
c. are charged to the operating segments of a company.
d. are not charged to the operating segments of a company.
e. are best described by characteristics "A" and "D" above.

10. The segmented income statement of Colony Company showed the following
Product A Product B Total
Sales P20,000 P40,000 P60,000
Variable costs P 8,000 P12,000 P20,000
You have learned 1. That Colony Company rents a building for P6,000 per year that is used to produce and sell
both products: 2. That Product A required 10% of that building and Product B uses 40% and the remainder of
the buildings sales and office space for Colony Company and 3. That it costs P3,000 to advertise Product A and
P4,000 to advertise Product B. Based on these facts, the segment margin for each product would be:
Product A Product B Product A Product B
a. P5,000 P8,000 c. P13,000 P20,000
b. P9,000 P24,000 d. P17,000 P36,000

11. Sands Corporation operates two stores: J and K. The following information relates to store J:

Sales revenue P1,300,000

Variable operating expenses 600,000
Fixed expenses:
Traceable to J and controllable by J 275,000
Traceable to J and controllable by others 80,000

J's segment contribution margin is:

a. P345,000. d. P700,000.
b. P425,000. e. P745,000.
c. P620,000.

12. Thompson Corporation operates two stores: A and B. The following information relates to store A:

Sales revenue P900,000

Variable operating expenses 400,000
Fixed expenses:
Traceable to A and controllable by A 275,000
MAS_1.3.1 INTEGRATED REVIEW & REFRESHER COURSE
R.D.BALOCATING
Traceable to A and controllable by 120,000
others

A's segment profit margin is:

a. P105,000. d. P500,000.
b. P225,000. e. P505,000.
c. P380,000.

13. The following data relate to Department no. 3 of Tsay Corporation:

Segment contribution margin P540,000

Profit margin controllable by the segment 310,000
manager
Segment profit margin 150,000

On the basis of this information, Department no. 3's variable operating expenses are:
a. P80,000. d. P390,000.
b. P160,000. e. not determinable.
c. P230,000.

14. The following data relate to Department no. 2 of Young Corporation:

Segment contribution margin P480,000

Profit margin controllable by the segment 230,000
manager
Segment profit margin 110,000

On the basis of this information, fixed costs traceable to Department no. 2 but controllable by others are:
a. P120,000. d. P370,000.
b. P140,000. e. not determinable.
c. P250,000.

15. You Company manufacture and sells a single product which has an economy and a luxury model. The following
data are available:
Economy Luxury
Selling price P40 P100
Variable costs 60% 40%
Fixed overhead is P1,500 of which one-third can be traced to the economy model, one-third can be traced to the
luxury model, and one-third is common cost. Fixed selling and administrative expense is P1,000 of which 20%
can be traced to the economy model, 30% can be traced to the luxury model and 50% is common cost. If 20
units of each are sold, what is the segment margin for the luxury model?
a. P0 c. P400
b. P250 d. P800