Chapter 14 - Answer - MANAGEMENT ACCOUNTING Solutions...

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MANAGEMENT ACCOUNTING - Solutions Manual CHAPTER 14 RESPONSIBILITY ACCOUNTING AND TRANSFER PRICING I. Questions 1. Cost centers are evaluated by means of performance reports. Profit centers are evaluated by means of contribution income statements (including cost center performance reports), in terms of meeting sales and cost objectives. Investment centers are evaluated by means of the rate of return which they are able to generate on invested assets. 2. Overall profitability can be improved (1) by increasing sales, (2) by reducing expenses, or (3) by reducing assets. 3. ROI may lead to dysfunctional decisions in that divisional managers may reject otherwise profitable investment opportunities simply because they would reduce the division’s overall ROI figure. The residual income approach overcomes this problem by establishing a minimum rate of return which the company wants to earn on its operating assets, thereby motivating the manager to accept all investment opportunities promising a return in excess of this minimum figure. 4. A cost center manager has control over cost, but not revenue or investment funds. A profit center manager, by contrast, has control over both cost and revenue. An investment center manager has control over 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 two departments or divisions. Transfer prices are needed for performance evaluation purposes. 6. The use of market price for transfer purposes will create the actual conditions under which the transferring and receiving units would be operating if they were completely separate, autonomous companies. It is generally felt that the creation of such conditions provides managerial incentive, and leads to greater overall efficiency in operations. 7. Negotiated transfer prices should be used (1) when the volume involved is large enough to justify quantity discounts, (2) when selling and/or administrative expenses are less on intracompany sales, (3) when idle 14-1
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Chapter 14 Responsibility Accounting and Transfer Pricing capacity 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 that benefits a particular division, but works to the disadvantage of the company as a whole. An example would be a transfer between divisions when no transfers should be made (e.g., where a better overall contribution margin could be generated by selling at an intermediate stage, rather than transferring to the next division). Suboptimization can also result if transfer pricing is so inflexible that one division buys from the outside when there is substantial idle capacity to produce the item internally. If divisional managers are given full autonomy in setting, accepting, and rejecting transfer prices, then either of these situations can be created, through selfishness, desire to “look good”, pettiness, or bickering.
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