DE LA SALLE UNIVERSITY – DASMARIÑAS

College of Business Administration and Accountancy

Accountancy Department
Management Accounting Part II

Classroom Exercises
Functional-Based Responsibility Accounting

Benefits of Decentralization
1. Top management freed to concentrate on strategy
2. Lower-level managers gain experience in decision-making
3. Decision-making authority leads to job satisfaction
4. Lower-level decisions often based on better information
5. Lower level managers can respond quickly to customers

Disadvantages of Decentralization
1. May be a lack of coordination among autonomous manager
2. Lower-level managers may make decisions without seeing the “big picture”
3. Lower-level manager’s objectives may not be those of the organization
4. May be difficult to spread innovative ideas in the organization

Responsibility Reporting System

Exercise 1. Marcum Company’s organization chart includes the president; the vice president of
production; three assembly plants – Manila, Cavite, and Laguna; and two departments within each plant –
Machining and Finishing. Budget and actual manufacturing cost data for May 2013 are as follows:

Finishing Department-Manila: Direct Materials P41,000 actual, P45,000 budget; direct labor
P83,000 actual, P82,000 budget; manufacturing overhead P51,000 actual, P49,200 budget.

Machining Department-Manila: Total manufacturing costs P220,000 actual, P214,000 budget.

Cavite Plant: Total manufacturing costs P424,000 actual, P421,000 budget.

Laguna Plant: Total manufacturing costs P494,000 actual, P499,000 budget.

The Manila plant manager’s office costs were P95,000 actual and P92,000 budget. The vice president of
production’s office costs were P132,000 actual and P130,000 budget. Office costs are not allocated to
departments and plants.

Required: Prepare the reports in a responsibility system for:

(a) The Finishing Department – Manila
(b) The plant manager – Manila
(c) The vice president of production

Exercise 2. Kojak Company uses a responsibility reporting system. It has divisions in Sta. Rosa, Calamba,
and San Pablo. Each division has three production departments: Cutting, Shaping, and Finishing. The
responsibility for each department rests with a manager who reports to the division production manager.
Each division manager reports to the vice president of production. There are also vice presidents for
marketing and finance. All vice presidents report to the president.
In January 2013, incomplete manufacturing overhead cost data and variance analysis for the
departments and divisions were as shown below.

Individual Costs – Master Flexible Spending Activity

Calamba Cutting Dept. Actual Budget Budget Variance Variance
Variable Costs
Gas and Oil P 37,500 ? P 38,500 ? P 3,500 U
Indirect Labor ? P 50,000 55,000 P 2,000 F ?
Utilities ? ? 8,250 1,150 F 750 U
Maintenance 5,200 ? ? 300 F 500 U
Fixed Costs
Rent ? 8,000 ? 200 U ?
Supervision 8,800 ? ? 200 F ?
 Actual Comparison with Master Budget
Total costs
Shaping Department - Calamba P 158,000 P 10,000 favorable
Finishing Department - Calamba 210,000 2,000 favorable
Sta. Rosa Division 676,000 3,000 unfavorable
San Pablo Division 722,000 7,000 favorable

Additional overhead costs were incurred as follows: Calamba division production manager—
actual costs P52,500, budget P51,000; vice president of production—actual costs P65,000, budget
P64,000; president—actual costs P76,400, budget P74,200. These expenses are not allocated.
The vice presidents who report to the president, other than the vice president of production, had
the following expenses.

Vice president Actual Budget

Marketing P 133,600 P 130,000
Finance 108,000 105,000

Required: Prepare the following reports (using master budget) in a responsibility reporting system:
(a) Manufacturing overhead – Cutting Department manager
(b) Manufacturing overhead – Calamba division manager
(c) Manufacturing overhead – Vice president of production
(d) Manufacturing overhead and expenses – President

Segment Reporting & Analysis

Economic Value Added
The following data pertain to Dana Industries:

Interest rate on debt capital: 9%

Cost of equity capital: 12%
Before-tax operating income: $35 million
Market value of debt capital: $60 million
Market value of equity capital: $120 million
Total assets: $150 million
Income tax rate: 30%
Total current liabilities: $15 million

Required:
1. Compute Dana’s weighted-average cost of capital.
2. Compute Dana’s economic value added.
Transfer Pricing in Multinational Corporations (MNC)

1. Inter-Land, Inc., transfers a product between its U.S. Division and its Danish division. The product sells
for $45 in the United States. The cost of shipping to Denmark is $3.20, and Danish duty is $9. The
U.S. division pays approximately $4.50 per unit for advertising and related selling expenses. Using the
comparable uncontrolled price method, calculate the transfer price.

2. The U.S. division of Inter-Land, Inc., purchases a product from the Danish division, which sells for $80
per unit in the United States. The U.S. division typically has a 25 percent markup on goods. Calculate
the transfer price under the resale price method.

3. Howell Company has a division in the United States that produces computerized thermostats for
heating units. These thermostats are transferred to a division in Luxembourg. The thermostats can
be (and are) sold externally in the United States for $30 each. It costs $2.35 per thermostat for
shipping and $2.70 per thermostat for import duties. When the thermostats are sold externally,
Howell spends $3 per thermostat for commissions and an average of $1 per thermostat for
advertising.
a. Which Section 482 method should be used to calculate the allowable transfer price?
b. Using the appropriate Section 482 method, calculate the transfer price.

4. Assume that Valley Electronics transfers a component from a U.S. division to a German division for
$11.70. The landing costs are $2.50 per unit, and the avoidable commissions and advertising total
$0.50 per unit. The component has a market price within the United States of $10. Is the company
complying with the comparable uncontrolled price method? Would the IRS be concerned if the
transfer price is greater than the market price after adjustments? Why or why not?

5. Assume that a manufacturing division in the United States transfers a component to a marketing
division for resale. The resale price is $8, the gross profit percentage (gross profit divided by sales) is
25 percent, the landing costs total $1.20 per unit. Suppose that the actual transfer price (excluding
landing costs) is $4.50. Should the company continue transferring at $4.50?

6. Suppose that a U.S. division has excess capacity. A European division has offered to buy a component
that would increase the U.S. division’s utilization of its capacity. The component has an outside
market in the United States with a unit selling price of $12. The variable costs of production for the
component are $6. Landing costs total $2 per unit, and an internal transfer avoids $1.25 per unit of
marketing costs. The European division can purchase the component locally for $12.
a. Ignoring income taxes, what is the minimum price that the European division should pay for
the component (including landing costs)? The maximum price?
b. Assuming that the joint benefit is split equally, what is the transfer price?

7. Sprint, Inc., has a Pennsylvania-based division that produces electronic components, with a very
strong domestic market for circuit no. 222. The variable production cost is $140, and the division can
sell its entire output for $190. Sprint is subject to a 30% income tax rate.

Alternatively, the Pennsylvania division can ship the circuit to a division that is located in Mississippi,
to be used in the manufacture of a global positioning system (GPS). Information about the global
positioning system and Mississippi's costs follow.

Selling price: $380

Circuit shipping and handling fees to Mississippi: $10
Labor, overhead, and additional material costs of GPS: $120

A. Assume that the transfer price for the circuit was $160. How would Pennsylvania's divisional
manager likely react to a corporate decision to transfer the circuits to Mississippi? Why?
B. Calculate Pennsylvania income, Mississippi income, and income for the company as a whole
if the transfer took place at $160 per circuit.
C. Assuming that transfers took place at a price higher than $160, would the revised price
increase, decrease, or have no effect on Sprint's income? Briefly explain.
D. Assume that Sprint moved its GPS production facility to a division located in Germany, which
is subject to a 45% tax rate. The transfer took place at $180. Shipping fees (absorbed by the
overseas division) doubled to $20; the German division paid an import duty equal to 10% of
the transfer price; and labor, overhead, and additional material costs were $150 per GPS. If
the German selling price of the GPS amounted to $450, calculate Pennsylvania income,
German income, and income for Sprint as a whole.
E. Suppose that U.S. and German tax authorities allowed some discretion in how transfer prices
were set. Given the difference in tax rates, should Sprint attempt to generate the majority of
its income in Pennsylvania or Germany? Why?
 Solution Key

Answer:
A. The manager would be unhappy, as the division is being forced to take a "hit" of $30 per
circuit ($190 vs. $160).

B. Pennsylvania: $160 - $140 = $20; $20 - ($20 x 30%) = $14

Mississippi: $380 - $10 - $120 - $160 = $90; $90 - ($90 x 30%) = $63
Sprint, Inc.: $14 + $63 = $77

A. Sprint's income is unaffected, as the transfer price is a wash between the divisions. In other
words, Pennsylvania's revenue is offset by Mississippi's cost.

B. Pennsylvania: $180 - $140 = $40; $40 - ($40 x 30%) = $28

Germany: $450 - $20 - $150 - $180 - ($180 x 10%) = $82; $82 - ($82 x 45%) = $45.10
Sprint, Inc.: $28.00 + $45.10 = $73.10

E. Tax rates are lower in the U.S. than in Germany (30% vs. 45%). Thus, Sprint would benefit if it
generated the majority of its income in Pennsylvania.

Economic Value Added, Weighted-Average Cost of Capital

1. WACC = [(9% x 70%) x $60,000,000) + (12% x $120,000,000)] ÷ ($60,000,000 + $120,000,000)
WACC = ($3,780,000 + $14,400,000) ÷ $180,000,000
WACC = 10.1%

2. EVA = ($35,000,000 x 70%) - [($150,000,000 - $15,000,000) x 10.1%]

EVA = $24,500,000 - $13,635,000
EVA = $10,865,000

3. Economic value added (EVA) measures the amount of shareholder wealth being created from a
company’s activities and operations. To expand, debt and equity capital are used to fund
activities—activities that are hopefully conducted in a profitable manner. Profits cover the cost of
the related capital, with shareholders benefiting from the residual (i.e., EVA).