Ex 24-21 Decision on transfer pricing

Based on Dart Industries’ data in Exercise 24–20, assume that a transfer price of $158 has been established and that 40,000 units of materials are transferred, with no reduction in the Components Division’s current sales.

a. How much would Dart Industries’ total income from operations increase?

b. How much would the Instrument Division’s income from operations increase?

c. How much would the Components Division’s income from operations increase?

d.  If the negotiated price approach is used, what would be the range of accept-

able transfer prices and why?

Answer:

a. Increase in Dart Industries’ 

Income from Operations 

 

= 

 Market 

Price 

 

– 

 Variable Cost 

per Unit 

 

× 

Units 

Transferred 

 $2,200,000 =  ($180 –  $125) × 40,000 

This amount is the same amount by which Dart Industries’ income from 

operations increased in Ex. 24–20, when a transfer price of $145 was used. 

b. Increase in the Instrument Division’s   Market   Transfer  Units 

 Income from Operations =  Price –  Price × Transferred 

 $880,000 = ($180 –  $158) × 40,000 

This is the amount the Instrument Division saves by purchasing from the 

Components Division at an internal price that is lower than the market price. 

c. Increase in the Components Division’s   Transfer   Variable Cost  Units 

 Income from Operations = Price –  per Unit × Transferred 

 $1,320,000 =  ($158 –  $125) × 40,000 

This is the amount the Components Division earns by using available excess capacity 

to produce and sell products above variable cost to the Instrument Division. 

d. Any transfer price will cause the total income of the company to increase, 

as long as the supplier division capacity is used toward making materials for 

products that are ultimately sold to the outside. However, transfer prices should 

be set between variable cost and selling price in order to give the division 

managers proper incentives. A transfer price set below variable cost would 

cause the supplier division to incur a loss, while a transfer price set above 

market price would cause the purchasing division to incur opportunity costs. 

Neither situation is an attractive alternative for an investment center manager. 

Thus, the general rule is to negotiate transfer prices between variable cost and 

market price when the supplier division has excess capacity. The range of 

acceptable transfer prices for Dart Industries would be between $180 and $125. 

Ex 24-20 Decision on transfer pricing

Materials used by the Instrument Division of Dart Industries are currently purchased from outside suppliers at a cost of $180 per unit. However, the same materials are available from the Components Division. The Components Division has unused capacity and can produce the materials needed by the Instrument Division at a variable cost of $125 per unit.

a. If a transfer price of $145 per unit is established and 40,000 units of materials are transferred, with no reduction in the Components Division’s current sales, how much would Dart Industries’ total income from operations increase?

b. How much would the Instrument Division’s income from operations increase?

c. How much would the Components Division’s income from operations increase?


Answer:

a. Increase in Dart Industries’ Market Variable Cost Unit 
 Income from Operations =  Price –  per Unit × Transferred 
$2,200,000 = ($180 –  $125) × 40,000 

b. 

Increase in the Instrument Division’s 
Income from Operations 

= 


Market 
Price 

– 


Transfer 
Price 

× 

Unit 
Transferred 
 $1,400,000 = ($180 –  $145) × 40,000 

c. 

Increase in the Components Division’s 
Income from Operations 

= 
  
Transfer 
Price 

– 


Variable Cost 
per Unit 

× 

Unit 
Transferred 
 $800,000 = ($145 –  $125) × 40,000 

Ex 24-19 balanced scorecard

Several years ago, United Parcel Service (UPS) believed that the Internet was going to change the parcel delivery market and would require UPS to become a more nimble and customer-focused organization. As a result, UPS replaced its old measurement system, which was 90% oriented toward financial performance, with a balanced scorecard. The scorecard emphasized four “point of arrival” measures, which were:

1. Customer satisfaction index—a measure of customer satisfaction.

2. Employee relations index—a measure of employee sentiment and morale.

3. Competitive position—delivery performance relative to competition.

4. Time in transit—the time from order entry to delivery.

a.  Why did UPS introduce a balanced scorecard and nonfinancial measures in
its new performance measurement system?

b.  Why do you think UPS included a factor measuring employee sentiment?


Answer:
a. UPS wanted a performance measurement system that would focus more on the underlying drivers, or levers, of financial success. It believed that focusing on the financial numbers by themselves would not reveal how financial objectives were to be achieved, especially with new demands coming from customers in the Internet age. The balanced scorecard provides information on how the financial targets are to be achieved. Using common measures throughout the organization also aligns the organization, while simultaneously communicating priorities. Apparently, UPS determined that its future success as an organization depended on “point of arrival” measures. These measures emphasized customer
performance to a much higher degree than would straight financial numbers.

b. The employee sentiment number is common in service businesses. The employees are the face of the company to the customer. If employees feel poorly about the organization, or if they feel that they don’t make a difference, then they are not likely to deliver premium service experiences to their customers. Just
think of the variety of fast food experiences you may have had in the past month. Sometimes, the service is excellent with a smile; at other times, it’s poor with a scowl. Measuring the improving employee morale is critical to organizations relying on front-line employees that deliver the customer experience.

Ex 24-18 balanced scorecard

American Express Company is a major financial services company, noted for its American Express® card. Below are some of the performance measures used by the company in its balanced scorecard.

Average card member spending           | Number of Internet features
Cards in force                                       | Number of merchant signings
Earnings growth                                   | Number of new card launches
Hours of credit consultant training       | Return on equity
Investment in information technology  | Revenue growth
Number of card choices

For each measure, identify whether the measure best fits the innovation, customer, internal process, or financial dimension of the balanced scorecard.


Answer:

Although there is some judgment in classifying each of these measures, the following represents the author’s assessment with explanations: 

Average card member spending | Customer—demonstrates the usefulness of the card to the customer. 
Cards in force | Customer—if customers did not value the 
card, they would not have one. 
Earnings growth | Financial 
Hours of credit consultant training | Internal process—advisors will do their job better if they are trained. 
Investment in information technology | Internal process (or innovation)—shows the investment in improving processes. 
Number of Internet features | Internal process (or innovation)—shows new process investments in a new channel. 
Number of merchant signings | Customer—the larger the number of 
merchants that honor the card, the more valuable it is to cardholders. 
Number of card choices | Customer—more choices are more valuable 
to customers. 
Number of new card launches | Innovation—measures the new cards  (affinity, regional, etc.) being developed and marketed. 
Return on equity | Financial 
Revenue growth | Financial 

Ex 24-17 rate of return on investment, residual income

Starwood Hotels & Resorts Worldwide provides lodging services around the world. The company is separated into two major divisions.

• Hotel Ownership: Hotels owned and operated by Starwood.

• Vacation Ownership: Resort properties developed, owned, and operated for timeshare vacation owners.

Financial information for each division, from a recent annual report, is as follows (in millions):


                                               Hotel           |     Vacation  
                                         Ownership         |    Ownership
Revenues                             $4,383            |     $  688
Income from operations            571           |         105
Total assets                              6,440          |      2,139

a. Use the DuPont formula to determine the return on investment for each of the Starwood business divisions. Round whole percents to one decimal place and investment turnover to two decimal places.

b. Determine the residual income for each division, assuming a minimum acceptable income of 5% of total assets. Round minimal acceptable return to the nearest million dollars.

c.  Interpret your results.


Answer:

a.  
Rate of Return 
on Investment   = 
Income from Operations 
Revenues 

× Revenues 
Hotel Ownership: $571 ×
 $4,383 
$4,383 $6,440 
=   13.0% × 0.68 
=   8.8% (rounded) 
Vacation Ownership: $105 ×
 $688 
$688 $2,139 
=   15.3% × 0.32 
=   4.9% (rounded) 
b. Hotel 
Ownership 
Income from operations……………………………… 
Less:  Minimum return (5% of assets)…………… 
Residual income (loss)……………………………… 
* $6,440 × 5% 
** $2,139 × 5% 

$571 
  322* 
$249 
c. The Vacation Ownership (VO) segment has the weakest return on investment, 
which is mainly the result of a weak investment turnover. The VO segment earns 
profit margins that are higher than the profit margins in the Hotel Ownership (HO) 
segment (15.3% vs. 13.0%). However, weak investment turnover is causing the 
ROI for the VO segment to be less than the assumed minimum acceptable return. 
The residual income is negative for VO, which is consistent with a ROI less than the 
acceptable 5% minimum return. This weak performance is due primarily to the 
deterioration in the real estate market that has occurred in recent years. The 
profit margin and investment turnover in the VO segment are closely tied to the 
strength of the real estate market and the overall economy, both of which 
deteriorated significantly in the preceding years. 
The HO segment ROI is also affected by the global economy, but is still generating 
a solid ROI. Stable profit margins and investment turnover generate a ROI that is 
above the minimum acceptable return. The residual income is positive, which is 
consistent with a ROI that is greater than the 5% minimum return. 

Ex 24-16 Determining missing items from computations

Data for the North, South, East, and West divisions of Free Bird Company are as follows:


Sales
income from  
Operations
invested  
Assets
rate of return  
on investment profit Margin
investment 
turnover
North $750,000 (a) (b) 20% 8% (c)
South (d) $75,600 (e) (f ) 12% 1.8
East $840,000 (g) $280,000 18% (h) (i)
West $1,100,000 $99,000 $550,000 (j) (k) (l)

a. Determine the missing items, identifying each by the letters (a) through (l). Round percents and investment turnover to one decimal place.

b. Determine the residual income for each division, assuming that the minimum acceptable rate of return established by management is 10%.

c. Which division is the most profitable in terms of (1) return on investment and (2) residual income?


Answer:
a.
 (a) $60,000 ($750,000 × 8%)
 (b) $300,000 ($60,000 ÷ 20%)
 (c) 2.5 (20% ÷ 8%) or $750,000 ÷ $300,000
 (d) $630,000 ($75,600 ÷ 12%)
 (e) $350,000 ($630,000 ÷ 1.8)
 (f) 21.6% (12% × 1.8)
 (g) $50,400 ($280,000 × 18%)
 (h) 6.0% ($50,400 ÷ $840,000)
 (i) 3.0 ($840,000 ÷ $280,000)
 (j) 18.0% ($99,000 ÷ $550,000)
 (k) 9.0% ($99,000 ÷ $1,100,000)
 (l) 2.0 ($1,100,000 ÷ $550,000)

b.
 North Division: $30,000 [$60,000 – ($300,000 × 10%)]
 South Division: $40,600 [$75,600 – ($350,000 × 10%)]
 East Division: $22,400 [$50,400 – ($280,000 × 10%)]
 West Division: $44,000 [$99,000 – ($550,000 × 10%)]
c.
 (1) The South Division has the highest return on investment    (21.6%).
 (2) The West Division has the largest residual income.

Ex 24-15 Determining missing items in rate of return and residual income computations

Data for Magnum Company are presented in the following table of rates of return on investment and residual incomes:


invested  
Assets
income  
from  
Operations
rate of  
return on  
investment
Minimum  
rate of  
return
Minimum  
Acceptable  
income from  
Operations
residual 
income
$860,000 $215,000 (a) 17% (b) (c)
$540,000 (d) (e) (f ) $70,200 $27,000
$320,000 (g) 20% (h) $48,000 (i)
$460,000 $92,000 (j) 16% (k) (l)

Determine the missing items, identifying each item by the appropriate letter.


Answer:
a. 25.0% ($215,000 ÷ $860,000)   |  g. $64,000 ($320,000 × 20%)
b. $146,200 ($860,000 × 17%)      |  h. 15.0% ($48,000 ÷ $320,000)
c. $68,800 ($215,000 – $146,200) |  i. $16,000 ($64,000 – $48,000)
d. $97,200 ($70,200 + $27,000)     |  j. 20.0% ($92,000 ÷ $460,000)
e. 18.0% ($97,200 ÷ $540,000)      |  k. $73,600 ($460,000 × 16%)
f. 13.0% ($70,200 ÷ $540,000)      |  l. $18,400 ($92,000 – $73,600)

Ex 24-14 rate of return on investment

The Walt Disney Company has four profitable business segments, described as follows:

• Media Networks: The ABC television and radio network, Disney channel, ESPN, A&E, E!, and Disney.com.

• Parks and Resorts: Walt Disney World Resort, Disneyland, Disney Cruise Line, and other resort properties.

• Studio Entertainment: Walt Disney Pictures, Touchstone Pictures, Hollywood Pictures, Miramax Films, and Buena Vista Theatrical Productions.

• Consumer Products: Character merchandising, Disney stores, books, and magazines.

Disney recently reported sector income from operations, revenue, and invested assets (in millions) as follows:


income from  
Operations revenue
invested  
Assets
Media Networks $6,146 $18,714 $27,244
Parks and Resorts 1,553 11,797 19,530
Studio Entertainment 618 6,351 12,221
Consumer Products 816 3,049 4,992

a. Use the DuPont formula to determine the rate of return on investment for the four Disney sectors. Round whole percents to one decimal place and investment turnover to two decimal places.

b.  How do the four sectors differ in their profit margin, investment turnover,
and return on investment?


Answer:

a. 
Media Networks: $6,146 P
arks and Resorts: $1,553 S
tudio Entertainment: $618 C
onsumer Products: $816 b
. The four sectors are different from each other. Media Networks combines a good profit 
margin with a very low investment turnover. Media Networks is sensitive to advertising 
revenue, while the Studio Entertainment sector is sensitive to producing box office hits. 
The Parks and Resorts sector has a good profit margin at 13.2% with a fairly low 
investment turnover. The combination produces a respectable ROI of 7.9%. Studio 
Entertainment has a weak profit margin and a weak investment turnover generating only 
a 5% return on investment. The Consumer Products division combines a good profit 
margin with a good investment turnover. The combination produces a sound ROI of 
16.3%. 

Ex 24-13 profit margin, investment turnover, and rate of return on investment

The condensed income statement for the Consumer Products Division of Milner Industries Inc. is as follows (assuming no service department charges):

Sales                                  $7,000,000
Cost of goods sold.             4,500,000
Gross profit                       $2,500,000
Administrative expenses       750,000
Income from operations   $1,750,000

The manager of the Consumer Products Division is considering ways to increase the rate of return on investment.

a. Using the DuPont formula for rate of return on investment, determine the profit margin, investment turnover, and rate of return on investment of the Consumer Products Division, assuming that $5,000,000 of assets have been invested in the Consumer Products Division.

b. If expenses could be reduced by $350,000 without decreasing sales, what would be the impact on the profit margin, investment turnover, and rate of return on investment for the Consumer Products Division?


Answer:


a. Rate of Return 
on Investment   =   Profit Margin × Investment Turnover 
Rate of Return   = Income from Operations 
on Investment Sales Invested Assets 
ROI   = $1,750,000 × $7,000,000 
ROI   =   25% × 1.40 
ROI   =   35% 
b. The profit margin would increase from 25% to 30%, the investment turnover 
would remain unchanged, and the rate of return on investment would increase 
from 35% to 42%, as shown below. 
Rate of Return 
on Investment   =   Profit Margin × Investment Turnover 
Rate of Return 
on Investment   = 
ROI   = $2,100,000 * 
ROI   =   30% × 1.40 
ROI   =   42% 
* $1,750,000 + $350,000 

Ex 24-12 Determining missing items in rate of return computation

One item is omitted from each of the following computations of the rate of return on investment:

Rate of Return on Investment = Profit Margin × Investment Turnover
            12%              =      5%       ×       (a)
            (b)              =      8%       ×       2.00
            14%              =     (c)       ×       1.40
           13.5%             =      6%       ×       (d)
            (e).             =     15%       ×       1.20
Determine the missing items, identifying each by the appropriate letter.


Answer:
a. 2.40 = 12% ÷ 5%
b. 16% = 8% × 2.00
c. 10% = 14% ÷ 1.40
d. 2.25 = 13.5% ÷ 6%
e. 18% = 15% × 1.20

Ex 24-11 residual income

Based on the data in Exercise 24-10, assume that management has established an 8% minimum acceptable rate of return for invested assets.

a. Determine the residual income for each division.

b. Which division has the most residual income?


Answer:

Retail 
Division 
Commercial 
Division 
Internet 
Division 
Income from operations……………………………   $130,000 $72,000 $137,500 
Minimum amount of income from 
operations: 
 $650,000 × 8%……………………………………  52,000  
$400,000 × 8%…………………………………… 
$550,000 × 8%……………………………………     
32,000  
    44,000 
Residual income…………………………………… $  78,000 $40,000 $  93,500 

b. 

Internet Division 

Ex 24-10 rate of return on investment

The income from operations and the amount of invested assets in each division of Steele Industries are as follows:

                               Income from  |  Invested
                                  Operations  |   Assets
Retail Division           $130,000   |  $650,000
Commercial Division     72,000   |   400,000
Internet Division          137,500   |   550,000

a. Compute the rate of return on investment for each division.

b. Which division is the most profitable per dollar invested?


Answer:
a. Retail Division:      20% ($130,000 ÷ $650,000)
   Commercial Division:  18% ($72,000 ÷ $400,000)
   Internet Division:    25% ($137,500 ÷ $550,000)

b. Internet Division

Ex 24-9 profit center responsibility reporting

Full Throttle Sporting Goods Co. operates two divisions—the Winter Sports Division and the Summer Sports Division. The following income and expense accounts were provided from the trial balance as of December 31, 2014, the end of the current fiscal year, after all adjustments, including those for inventories, were recorded and posted:

Sales—Winter Sports Division . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $31,500,000
Sales—Summer Sports Division . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,400,000
Cost of Goods Sold—Winter Sports Division  . . . . . . . . . . . . . . . . . . . . . . . . 18,900,000
Cost of Goods Sold—Summer Sports Division . . . . . . . . . . . . . . . . . . . . . . . 21,112,000
Sales Expense—Winter Sports Division . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,040,000
Sales Expense—Summer Sports Division  . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,096,000
Administrative Expense—Winter Sports Division . . . . . . . . . . . . . . . . . . . . 3,150,000
Administrative Expense—Summer Sports Division. . . . . . . . . . . . . . . . . . . 3,239,600
Advertising Expense  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,357,900
Transportation Expense  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    595,000
Accounts Receivable Collection Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . .    240,000
Warehouse Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,650,000

The bases to be used in allocating expenses, together with other essential information, are as follows:

a. Advertising expense—incurred at headquarters, charged back to divisions on the basis of usage: Winter Sports Division, $611,000; Summer Sports Division, $746,900.

b. Transportation expense—charged back to divisions at a charge rate of $14.00 per bill of lading: Winter Sports Division, 20,400 bills of lading; Summer Sports Division, 22,100 bills of lading.

c. Accounts receivable collection expense—incurred at headquarters, charged back to divisions at a charge rate of $7.50 per invoice: Winter Sports Division, 13,120 sales invoices; Summer Sports Division, 18,880 sales invoices.

d. Warehouse expense—charged back to divisions on the basis of floor space used in storing division products: Winter Sports Division, 124,550 square feet; Summer Sports Division, 140,450 square feet.

Prepare a divisional income statement with two column headings: Winter Sports Division and Summer Sports Division. Provide supporting calculations for service department charges.


Answer:

FULL THROTTLE SPORTING GOODS CO. 
Divisional Income Statements 
For the Year Ended December 31, 2014 
 Winter 
Sports 
Division 
Summer 
Sports 
Division 
Sales $31,500,000 $36,400,000 
Cost of goods sold 18,900,000 21,112,000 
Gross profit $12,600,000 $15,288,000 
Divisional selling expenses $  5,040,000 $  5,096,000 
Divisional administrative expenses 3,150,000 3,239,600 
 $  8,190,000 $  8,335,600 
Income from operations before service   
department charges $  4,410,000 $  6,952,400 
Less service department charges:   
Advertising expense (Note 1) $ 611,000 $ 746,900 
Transportation expense (Note 2) 285,600 309,400 
Accounts receivable collection expense (Note 3) 98,400 141,600 
Warehouse expense (Note 4) 1,245,500 1,404,500 
Total $  2,240,500 $  2,602,400 
Income from operations $  2,169,500 $  4,350,000 
   
Note (1) Winter Sports Division: $611,000 
 Summer Sports Division: $746,900 
Note (2) Winter Sports Division: 
Summer Sports Division: 
(20,400 bills of lading × $14.00 per bill of lading) 
(22,100 bills of lading × $14.00 per bill of lading) 
Note (3) Winter Sports Division: 
Summer Sports Division: 
(13,120 invoices × $7.50 per invoice) 
(18,880 invoices × $7.50 per invoice) 
Note (4) Winter Sports Division: 
Summer Sports Division: 
($2,650,000/265,000 sq. ft.) × 124,550 sq. ft. 
($2,650,000/265,000 sq. ft.) × 140,450 sq. ft. 

Ex 24-8 Corrections to service department charges

Wild Sun Airlines Inc. has two divisions organized as profit centers, the Passenger Division and the Cargo Division. The following divisional income statements were prepared:


Wild Sun Airlines inc.
Divisional income Statements
For the Year ended December 31, 2014
passenger Division Cargo Division
Revenues$3,025,000 $3,025,000
Operating expenses 2,450,000   2,736,000
Income from operations before
service department charges $ 575,000 $  289,000
Less service department charges:
Training $125,000 $125,000
Flight scheduling 108,000 108,000
Reservations   151,200 384,200   151,200 384,200
Income from operations $ 190,800 $  (95,200)

The service department charge rate for the service department costs was based on
revenues. Since the revenues of the two divisions were the same, the service department charges to each division were also the same.

The following additional information is available:

                                                    Passenger |   Cargo  |
                                                     Division  | Division |  Total
Number of personnel trained                350 |       150  |    500
Number of flights                                  800 |    1,200  |  2,000
Number of reservations requested    20,000 |          0  | 20,000

a. Does the income from operations for the two divisions accurately measure performance? Explain.

b. Correct the divisional income statements, using the activity bases provided above in revising the service department charges.


Answer:


a.  The reported income from operations does not accurately measure performance because 
the service department charges are based on revenues. Revenues are not associated 
with the profit center manager’s use of the service department services. For example, 
the Reservations Department serves only the Passenger Division. Thus, by charging 
this cost on the basis of revenues, these costs are incorrectly charged to the Cargo 
Division. Additionally, the Passenger Division requires additional personnel. Since 
these personnel must be trained, the training costs assigned to the Passenger Division 
should be greater than the Cargo Division. 
b. 
WILD SUN AIRLINES INC. 
Divisional Income Statements 
For the Year Ended December 31, 2014 
 Passenger Division Cargo Division 
Revenues  $3,025,000  $3,025,000 
Operating expenses  2,450,000  2,736,000 
Income from operations     
before service department     
charges  $   575,000  $   289,000 
Less service department     
charges:     
Training (Note 1) $175,000  $  75,000  
Flight Scheduling (Note 2) 86,400  129,600  
Reservations (Note 3) 302,400 563,800 0 204,600 
Income from operations  $ 11,200  $ 84,400 
     
Supporting calculations for controllable service department charges: 
Training: Passenger Division, ($250,000 ÷ 500 personnel trained) × 350 
personnel trained 
Cargo Division, ($250,000 ÷ 500 personnel trained) × 150 
personnel trained 
Flight Scheduling: Passenger Division, ($216,000 ÷ 2,000 flights) × 800 flights 
Cargo Division, ($216,000 ÷ 2,000 flights) × 1,200 flights 
Reservations: Passenger Division, ($302,400 ÷ 20,000 reservations) × 20,000 
reservations 
Cargo Division, ($302,400 ÷ 20,000 reservations) × 0 reservations 

Ex 24-7 Divisional income statements with service department charges

Van Emburgh Technology has two divisions, Consumer and Commercial, and two corporate service departments, Tech Support and Accounts Payable. The corporate expenses for the year ended December 31, 2014, are as follows:

Tech Support Department.                       | $   676,000
Accounts Payable Department                 |     256,000
Other corporate administrative expenses |     402,000
Total corporate expense                           | $1,334,000

The other corporate administrative expenses include officers’ salaries and other expenses required by the corporation. The Tech Support Department charges the divisions for services rendered, based on the number of computers in the department, and the Accounts Payable Department charges divisions for services, based on the number of checks issued for each department. The usage of service by the two divisions is as follows:

                                       Tech Support  |  Accounts payable
Consumer Division       250 computers |    3,400 checks
Commercial Division    150                  |    6,600
Total                              400 computers |   10,000 checks

The service department charges of the Tech Support Department and the Accounts
Payable Department are considered controllable by the divisions. Corporate administrative expenses are not considered controllable by the divisions. The revenues, cost of goods sold, and operating expenses for the two divisions are as follows:

                                     Consumer |   Commercial
Revenues                    $5,944,000 |   $4,947,200
Cost of goods sold.       3,298,400 |    2,500,000
Operating expenses       1,172,000 |    1,236,800

Prepare the divisional income statements for the two divisions.


Answer:


VAN EMBURGH TECHNOLOGY 
Divisional Income Statements 
For the Year Ended December 31, 2014 
 Consumer Division Commercial Division 
Revenues  $5,944,000  $4,947,200 
Cost of goods sold  3,298,400  2,500,000 
Gross profit  $2,645,600  $2,447,200 
Operating expenses  1,172,000  1,236,800 
Income from operations     
before service     
department charges  $1,473,600  $1,210,400 
Less service department     
charges:     
Tech Support Department (Note 1) $422,500  $253,500  
Accounts Payable     
Department (Note 2) 87,040 509,540 168,960 422,460 
Income from operations  $   964,060  $   787,940 
     
Supporting calculations for controllable service department charges: 
Note 1: Consumer Division ($676,000 ÷ 400 computers) × 250 computers = $422,500 
Commercial Division ($676,000 ÷ 400 computers) × 150 computers = $253,500 
Note 2: Consumer Division ($256,000 ÷ 10,000 checks) × 3,400 checks = $87,040 
Commercial Division ($256,000 ÷ 10,000 checks) × 6,600 checks = $168,960 

Ex 24-6 Service department charges and activity bases

Middler Corporation, a manufacturer of electronics and communications systems, uses a service department charge system to charge profit centers with Computing and Communications Services (CCS) service department costs. The following table identifies an abbreviated list of service categories and activity bases used by the CCS department. The table also includes some assumed cost and activity base quantity information for each service for October.


CCS Service  
Category Activity base budgeted Cost
budgeted Activity 
base Quantity
Help desk Number of calls $160,000 3,200
Network center Number of devices monitored 735,000 9,800
Electronic mail Number of user accounts 100,000 10,000
Local voice support Number of phone extensions 124,600 8,900


One of the profit centers for Middler Corporation is the Communication Systems (COMM) sector. Assume the following information for the COMM sector:

• The sector has 5,200 employees, of whom 25% are office employees.

• All the office employees have a phone, and 96% of them have a computer on the
network.

• One hundred percent of the employees with a computer also have an e-mail account.

• The average number of help desk calls for October was 1.5 calls per individual
with a computer.

• There are 600 additional printers, servers, and peripherals on the network beyondthe personal computers.

a. Determine the service charge rate for the four CCS service categories for October.

b. Determine the charges to the COMM sector for the four CCS service categories for October.


Answer:


$160,000 
3,200 calls 

$735,000 
9,800 devices 

$100,000 
10,000 accounts 

$124,600 
8,900 phone extensions 
=  $50 per call 
=  $75 per device monitored 
=  $10 per user or e-mail account 
=  $14 per phone extension 
b. October charges to the COMM sector: 
Help desk charge: 
(5,200 employees × 25% × 96% × 1.5) × $50/call = $93,600 
Network center charge: 
[(5,200 employees × 25% × 96%) + 600] × $75/device = $138,600 
Electronic mail: 
(5,200 employees × 25% × 96% × 100%) × $10/user or e-mail account = $12,480 
Local voice support: 
(5,200 employees × 25%) × $14/phone extension = $18,200 

Ex 24-5 Service department charges

In divisional income statements prepared for Wilborne Construction Company, the Payroll Department costs are charged back to user divisions on the basis of the number of payroll checks, and the Purchasing Department costs are charged back on the basis of the number of purchase requisitions. The Payroll Department had expenses of $119,280, and the Purchasing Department had expenses of $57,750 for the year. The following annual data for Residential, Commercial, and Government Contract divisions were obtained from corporate records:

                                                          Residential | Commercial | Government Contract
Sales                                                    $900,000 | $1,218,750 | $2,800,000
Number of employees:
Weekly payroll (52 weeks per year)             250 |             125 |             150
Monthly payroll                                              50 |             100 |               60
Number of purchase requisitions per year 3,750 |          3,125 |          2,750

a. Determine the total amount of payroll checks and purchase requisitions processed per year by the company and each division.

b. Using the activity base information in (a), determine the annual amount of payroll and purchasing costs charged back to the Residential, Commercial, and Government Contract divisions from payroll and purchasing services.

c.  Why does the Residential Division have a larger service department charge than the other two divisions, even though its sales are lower?


Answer:

Government 
a. Residential Commercial Contract Total 
Number of payroll checks: 
Number of purchase 
Service department charge rates: 
Payroll Department………………………  $119,280 ÷ 29,820 = $4.00/check 
Purchasing Department……………………  $57,750 ÷ 9,625 = $6.00/req. 
Service department charges: 
Government 
Residential Commercial Contract Total 
Payroll Department…………   $54,400 
1 
$
30,800 
2 
$
34,080 
3
 4

Purchasing Department……    22,500 
5 
  18,750 
6 
  16,500 57,750 
Total………………………  $76,900 $49,550 $50,580  
13,600 checks × $4.00 per check 
7,700 checks × $4.00 per check 
8,520 checks × $4.00 per check 
3,750 requisitions × $6.00 per requisition 
3,125 requisitions × $6.00 per requisition 
2,750 requisitions × $6.00 per requisition 
The service department charges are determined by multiplying the service 
department charge rate by the activity base for each division. 
c. Residential’s service department charge is higher than the other two divisions 
because Residential is a heavy user of service department services. Residential 
has many employees on a weekly payroll, which translates into a larger number 
of check-issuing transactions. This may be because residential jobs are less 
productive per labor hour, compared to larger commercial and government 
contract jobs. Additionally, Residential uses purchasing services more than the 
other two divisions. This may be because the division has many different 
smaller jobs requiring frequent purchase transactions. 

Ex 24-4 Activity bases for service department charges

For each of the following service departments, select the activity base listed that is most appropriate for charging service expenses to responsible units.

Service Department         | Activity base
a. Conferences                 | 1. Number of conference attendees
b. Telecommunications    | 2. Number of computers
c. Accounts Receivable    | 3. Number of employees trained
d. Payroll Accounting      | 4. Number of telephone lines
e. Employee Travel          | 5. Number of purchase requisitions
f. Central Purchasing       | 6. Number of sales invoices
g. Training                       | 7. Number of payroll checks
h. Computer Support       | 8. Number of travel claims


Answer:
a. 1     e. 8
b. 4     f. 5
c. 6     g. 3
d. 7     h. 2

Ex 24-3 Service department charges and activity bases

For each of the following service departments, identify an activity base that could be used for charging the expense to the profit center.
a. Legal
b. Duplication services
c. Electronic data processing
d. Central purchasing
e. Telecommunications
f. Accounts receivable


Answer:
Expense.                                     | Activity Bases
a. Legal                                       | Number of hours
b. Duplication services               | Number of pages
c. Electronic data processing      | Central processing unit (CPU) time, number of printed pages, amount of memory usage
d. Central purchasing                  | Number of requisitions, number of purchase orders
e. Telecommunications               | Number of lines, number of minutes        
f. Accounts receivable                | Number of invoices, number of customers

Ex 24-2 Divisional income statements

The following data were summarized from the accounting records for Endless River Construction Company for the year ended June 30, 2014:

Cost of goods sold:                      |   Service department charges:
Commercial Division $732,200  |   Commercial Division $    
Residential Division 338,940      |   Residential Division 54,264
Administrative expenses:            |   Net sales:
Commercial Division $119,840  |   Commercial Division $1,083,600
Residential Division 102,900      |   Residential Division 595,000

Prepare divisional income statements for Endless River Construction Company.


Answer:

ENDLESS RIVER CONSTRUCTION COMPANY 
Divisional Income Statements 
For the Year Ended June 30, 2014 
 Commercial 
Division 
Residential 
Division 
Net sales $1,083,600 $595,000 
Cost of goods sold 732,200 338,940 
Gross profit $   351,400 $256,060 
Administrative expenses 119,840 102,900 
Income from operations before service   
department charges $   231,560 $153,160 
Service department charges 90,048 54,264 
Income from operations $   141,512 $  98,896