Solution Manual Cost Accounting 12e by Horngren Ch 22 PDF

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CHAPTER 22MANAGEMENT CONTROL SYSTEMS, TRANSFER PRICING,AND MULTINATIONAL CONSIDERATIONS22-1 A management control system is a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and empl...

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CHAPTER 22 MANAGEMENT CONTROL SYSTEMS, TRANSFER PRICING, AND MULTINATIONAL CONSIDERATIONS 22-1 A management control system is a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and employees. The goal of the system is to improve the collective decisions within an organization. 22-2 To be effective, management control systems should be (a) closely aligned to an organization's strategies and goals, (b) designed to fit the organization's structure and the decision-making responsibility of individual managers, and (c) able to motivate managers and employees to put in effort to attain selected goals desired by top management. 22-3 Motivation combines goal congruence and effort. Motivation is the desire to attain a selected goal specified by top management (the goal-congruence aspect) combined with the resulting pursuit of that goal (the effort aspect). 22-4 1. 2. 3. 4. 5.

The chapter cites five benefits of decentralization: Creates greater responsiveness to local needs Leads to gains from faster decision making Increases motivation of subunit managers Assets management development and learning Sharpens the focus of subunit managers

The chapter cites four costs of decentralization: 1. Leads to suboptimal decision making 2. Focuses managers’ attention on the subunit rather than the company as a whole 3. Increases costs of gathering information 4. Results in duplication of activities 22-5 No. Organizations typically compare the benefits and costs of decentralization on a function-by-function basis. For example, companies with highly decentralized operating divisions frequently have centralized income tax strategies. 22-6 No. A transfer price is the price one subunit of an organization charges for a product or service supplied to another subunit of the same organization. The two segments can be cost centers, profit centers, or investment centers. For example, the allocation of service department costs to production departments that are set up as either cost centers or investment centers is an example of transfer pricing. 22-7 The three general methods for determining transfer prices are: 1. Market-based transfer prices 2. Cost-based transfer prices 3. Negotiated transfer prices

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22-8 1. 2. 3. 4.

Transfer prices should have the following properties. They should promote goal congruence, be useful for evaluating subunit performance, motivate management effort, and preserve a high level of subunit autonomy in decision making.

22-9 No, the chapter illustration demonstrates how division operating incomes differ dramatically under the variable costs, full costs, and market price methods of transfer pricing. 22-10 Transferring products or services at market prices generally leads to optimal decisions when (a) the market for the intermediate product market is perfectly competitive, (b) interdependencies of subunits are minimal, and (c) there are no additional costs or benefits to the company as a whole from buying or selling in the external market instead of transacting internally. 22-11 One potential limitation of full-cost-based transfer prices is that they can lead to suboptimal decisions for the company as a whole. An example of a conflict between divisional action and overall company profitability resulting from an inappropriate transfer-pricing policy is buying products or services outside the company when it is beneficial to overall company profitability to source them internally. This situation often arises where full-cost-based transfer prices are used. This situation can make the fixed costs of the supplying division appear to be variable costs of the purchasing division. Another limitation is that the supplying division may not have sufficient incentives to control costs if the full-cost-based transfer price uses actual costs rather than standard costs. The purchasing division sources externally if market prices are lower than full costs. From the viewpoint of the company as a whole, the purchasing division should source from outside only if market prices are less than variable costs of production, not full costs of production. 22-12 Reasons why a dual-pricing approach to transfer pricing is not widely used in practice include: 1. In this approach, the manager of the supplying division uses a cost-based method to record revenues and does not have sufficient incentives to control costs. 2. This approach does not provide clear signals to division managers about the level of decentralization top management wants. 3. This approach tends to insulate managers from the frictions of the marketplace because costs, not market prices, affect the revenues of the supplying division. 4. It leads to problems in computing the taxable income of subunits located in different tax jurisdictions. 22-13 Disagree. Cost and price information are often useful starting points in the negotiation process. Costs, particularly variable costs of the selling division, serve as a ―floor‖ below which the selling division would be unwilling to sell. Prices that the buying division would pay to purchase products from the outside market serves as a ―ceiling‖ above which the buying division would be unwilling to buy. The price negotiated by the two divisions will, in general, have no specific relationship to either costs or prices. But the negotiated price will generally fall between the variable costs-based floor and the market price-based ceiling.

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22-14 Yes. The general transfer-pricing guideline specifies that the minimum transfer price equals the incremental cost per unit incurred up to the point of transfer plus the opportunity cost per unit to the supplying division. When the supplying division has idle capacity, its opportunity cost per unit is zero; when the supplying division has no idle capacity, its opportunity cost per unit is positive. Hence, the minimum transfer price will vary depending on whether the supplying division has idle capacity or not. 22-15 Alternative transfer-pricing methods can result in sizable differences in the reported operating income of divisions in different income tax jurisdictions. If these jurisdictions have different tax rates or deductions, the net income of the company as a whole can be affected by the choice of the transfer-pricing method. 22-16 (15min.) Management control systems, balanced scorecard. Durham produces and sells furniture of unique design and outstanding quality. Clearly, it is pursuing a product-differentiation strategy, and its balanced-scorecard-based management control system should reflect that strategy and measure and communicate the degree to which the organization meets its strategic goals. Some possible financial and non-financial measures are: Financial measures (for financial perspective): Profit margins, stock price, net income, return on investment, cash flow from operations, design costs as a percentage of sales. Non-financial measures: market share in the high-end furniture segment, customer repeat purchases, number of mentions of Durham furniture in design and architecture magazines (customer perspective), recognized quality certifications, number of innovative designs, (internal business process perspective), ability to attract and keep the best designers, employee satisfaction, empl oyee pride in Durham’s identity (learning-and-gr owth perspective).

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22-17 (25 min.) Decentralization, responsibility centers. 1. The manufacturing plants in the Manufacturing Division are cost centers. Senior management determines the manufacturing schedule based on the quantity of each type of lighting product specified by the sales and marketing division and detailed studies of the time and cost to manufacture each type of product. Manufacturing managers are accountable only for costs. They are evaluated based on achieving target output within budgeted costs. 2a. If manufacturing and marketing managers were to directly negotiate the prices for manufacturing various products, Quinn should evaluate manufacturing plant managers as profit centers—revenues received from marketing minus the costs incurred to produce and sell output. 2b. Quinn Corporation would be better off decentralizing its marketing and manufacturing decisions and evaluating each division as a profit center. Decentralization would encourage plant managers to increase total output to achieve the greatest profitability, and motivate plant managers to cut their costs to increase margins. Manufacturing managers would be motivated to design their operations according to the criteria that meet the marketing managers’ approval, thereby improving cooperation between manufacturing and marketing. Under Quinn’s existing system, manufacturing managers have every incentive not to improve. Manufacturing managers’ incentives are to get as high a cost target as possible so that they can produce output within budgeted costs. Any significant improvements could result in the target costs being lowered for the next year, increasing the possibility of not achieving budgeted costs. By the same line of reasoning, manufacturing managers would also try to limit their production so that production quotas would not be increased in the future. Decentralizing manufacturing and marketing decisions overcomes these problems.

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22-18 (15 min.) Decentralization, goal congruence, responsibility centers. 1. The environmental-management group appears to be decentralized because its managers have considerable freedom to make decisions. They can choose which projects to work on and which projects to reject. Top management will adjust the size of the environmental-management group to match the demand for the group’s services by operating divisions. 2. The environmental-management group is a cost center. The group is required to charge the operating divisions for environmental services at cost and not at market prices that would help earn the group a profit. 3.

The benefits of structuring the environmental-management group in this way are: a. The operating managers have incentives to carefully weigh and conduct cost-benefit analyses before requesting the environmental group’s services. b. The operating managers have an incentive to follow the work and the progress made by the environmental team. c. The environmental group has incentives to fulfill the contract, to do a good job in terms of cost, time, and quality, and to satisfy the operating division to continue to get business. The problems in structuring the environmental-management group in this way are: a. The contract requires extensive internal negotiations in terms of cost, time, and technical specifications. b. The environmental group needs to continuously ―sell‖ its services to the operating division, and this could potentially result in loss of morale. c. Experimental projects that have long-term potential may not be undertaken because operating division managers may be reluctant to undertake projects that are costly and uncertain, whose benefits will be realized only well after they have left the division.

To the extent that the focus of the environmental-management group is on short-run projects demanded by the operating divisions, the current structure leads to goal congruence and motivation. Goal congruence is achieved because both operating divisions and the environmental-management group are motivated to work toward the organizational goals of reducing pollution and improving the environment. The operating divisions will be motivated to use the services of the environmental-management group to achieve the environmental goals set for them by top management. The environmental-management group will be motivated to deliver high-quality services in a cost-effective way to continue to create a demand for their services. The one issue that top management needs to guard against is that experimental projects with long-term potential that are costly and uncertain may not be undertaken under the current structure. Top management may want to set up a committee to study and propose such long-run projects for consideration and funding by corporate management.

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22-19 (35 min.) Multinational transfer pricing, effect of alternative transfer-pricing methods, global income tax minimization. 1. This is a three-country, three-division transfer-pricing problem with three alternative transfer-pricing methods. Summary data in U.S. dollars are: China Plant Variable costs: Fixed costs: South Korea Plant Variable costs: Fixed costs: U.S. Plant Variable costs: Fixed costs:

1,000 Yuan ÷ 8 Yuan per $ = $125 per subunit 1,800 Yuan ÷ 8 Yuan per $ = $225 per subunit 360,000 Won ÷ 1,200 Won per $ = $300 per unit 480,000 Won ÷ 1,200 Won per $ = $400 per unit = $100 per unit = $200 per unit

Market prices for private-label sale alternatives: China Plant: 3,600 Yuan ÷ 8 Yuan per $ = $450 per subunit South Korea Plant: 1,560,000 Won ÷ 1,200 Won per $ = $1,300 per unit The transfer prices under each method are: a. Market price • China to South Korea = $450 per subunit • South Korea to U.S. Plant = $1,300 per unit b. 200% of full costs • China to South Korea 2.0 ($125 + $225) = $700 per subunit • South Korea to U.S. Plant 2.0 ($700 + $300 + $400) = $2,800 per unit c. 300% of variable costs • China to South Korea 3.0 $125 = $375 per subunit • South Korea to U.S. Plant 3.0 ($375 + $300) = $2,025 per unit

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Method A Internal Transfers at Market Price 1. China Division Division revenue per unit Cost per unit: Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 40% Division net income per unit 2. South Korea Division Division revenue per unit Cost per unit: Transferred-in cost per unit Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 20% Division net income per unit 3. United States Division Division revenue per unit Cost per unit: Transferred-in cost per unit Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 30% Division net income per unit

2.

Method B Internal Transfers at 200% of Full Costs

Method C Internal Transfers at 300% of Variable Costs

$ 450

$ 700

$ 375

125 225 350 100 40 $ 60

125 225 350 350 140 $ 210

125 225 350 25 10 $ 15

$1,300

$2,800

$2,025

450 300 400 1,150 150 30 $ 120

700 300 400 1,400 1,400 280 $1,120

375 300 400 1,075 950 190 $ 760

$3,200

$3,200

$3,200

1,300 100 200 1,600 1,600 480 $1,120

2,800 100 200 3,100 100 30 $ 70

2,025 100 200 2,325 875 262.5 $ 612.5

Division net income: Market Price

China Division South Korea Division U.S. Division User Friendly Computer, Inc.

$

60 120 1,120 $1,300

200% of Full Costs $ 210 1,120 70 $1,400

300% of Variable Cost $

15.00 760.00 612.50 $1,387.50

User Friendly will maximize its net income by using 200% of full costs as the transfer-price. This is because Method B sources the largest proportion of income in Korea, the country with the lowest income tax rate. 22-7

22-20 (30 min.) Transfer-pricing methods, goal congruence. 1.

Alternative 1: Sell as raw lumber for $200 per 100 board feet: Revenue Variable costs Contribution margin

$200 100 $100 per 100 board feet

Alternative 2: Sell as finished lumber for $275 per 100 board feet: Revenue Variable costs: Raw lumber Finished lumber Contribution margin

$275 $100 125

225 $ 50 per 100 board feet

British Columbia Lumber will maximize its total contribution margin by selling lumber in its raw form. An alternative approach is to examine the incremental revenues and incremental costs in the Finished Lumber Division: Incremental revenues, $275 – $200 Incremental costs Incremental loss 2.

$ 75 125 $ (50) per 100 board feet

Transfer price at 110% of variable costs: = $100 + ($100 0.10) = $110 per 100 board feet Sell as Raw Lumber

Raw Lumber Division Division revenues Division variable costs Division operating income Finished Lumber Division Division revenues Transferred-in costs Division variable costs Division operating income

Sell as Finished Lumber

$200 100 $100

$110 100 $ 10

$ 0 —

$275 110 125 $ 40

$

0

The Raw Lumber Division will maximize reported division operating income by selling raw lumber, which is the action preferred by the company as a whole. The Finished Lumber Division will maximize division operating income by selling finished lumber, which is contrary to the action preferred by the company as a whole.

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3.

Transfer price at market price = $200 per 100 board feet. Sell as Raw Lumber

Sell as Finished Lumber

Raw Lumber Division Division revenues Division variable costs Division operating income

$200 100 $100

$200 100 $100

Finished Lumber Division Division revenues Transferred-in costs Division variable costs Division operating income

$ 0 — — $ 0

$275 200 125 $ (50)

Since the Raw Lumber Division will be indifferent between selling the lumber in raw or finished form, it would be willing to maximize division operating income by selling raw lumber, which is the action preferred by the company as a whole. The Finished Lumber Division will maximize division operating income by not further processing raw lumber and this is preferred by the company as a whole. Thus, transfer at market price will result in division actions that are also in the best interest of the company as a whole.

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22-21 (30 min.) Effect of alternative transfer-pricing methods on division operating income. Method A Internal Transfers at Market Prices 1. Mining Division Revenues: $90, $661 400,000 units Costs: Division variable costs: $522 400,000 units Division fixed costs: $83 400,000 units Total division costs Division operating income Metals Division Revenues: $150 400,000 units Costs: Transferred-in costs: $90, $66 400,000 units Division variable costs: $364 400,000 units Division fixed costs: $155 400,000 units Total division costs Division operating income

Method B Internal Transfers at 110% of Full Costs

$36,000,000

$26,400,000

20,800,000

20,800,000

3,200,000 24,000,000 $12,000,000

3,200,000 24,000,000 $ 2,400,000

$60,000,000

$60,000,000

36,000,000

26,400,000

14,400,000

14,400,000

6,000,000 56,400,000 $ 3,600,000

6,000,000 46,800,000 $13,200,000

1

$66 = Full manufacturing cost per unit in the Mining Division, $60 110% Variable cost per unit in Mining Division = Direct materials + Direct manufacturing labor + 75% of manufacturing overhead = $12 + $16 + (75% $32) = $52 3 Fixed cost per unit = 25% of manufacturing overhead = 25% $32 = $8 4 Variable cost per unit in Metals Division = Direct materials + Direct manufacturing labor + 40% of manufacturing overhead = $6 + $20 + (40% $25) = $36 5 Fixed cost per unit in Metals Division = 60% of manufacturing overhead = 60% $25 = $15 2

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2.

Bonus paid to division managers at 1% of division operating income will be as follows: Method A Internal Transfers at Market Prices

Mining Division manager’s bonus (1% $12,000,000; 1% $2,400,000) Metals Division manager’s bonus (1% $3,600,000; 1% $13,200,000)

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