CH 13

CHAPTER 13 SOLUTIONS
Note: In most cases, ROI is used in place of "return on investment."
Solutions to Questions for Review and Discussion
1. The major advantages of decentralization are to (1) provide motivation for managers to be
committed to their work and to be more willing to accept the consequences of their actions; (2)
encourage front-line decision making on a timely basis by those closest to the operations; (3)
delegate authority to managers to enhance specialization; (4) develop future leaders of the firm;
and (5) reduce the span of control for more effective operations.
The primary problems of decentralization are the difficulties associated with (1) developing
competent personnel; (2) identifying, implementing, and maintaining the same measurement.
system for all organizational units; and (3) reducing the division managers' tendencies toward
suboptimization.
2. A cost center is a responsibility center that controls only the incurrence of cost and is usually
found at lower levels of the organization. A profit center is a responsibility center that controls
both costs and revenues. It tends to be a segment in the middle of the organizational structure
and is characterized by its focus on operating and marketing decisions. An, investment center is
a responsibility center that has control over costs, revenues, and investments in assets used by
that responsibility center. It is usually found at the top levels of an organization. The basic
distinction between a profit center and an investment center is the level at which the investment
decisions are made.
3. Performance in a cost center is generally measured on the basis of some cost index, such as
the comparison of budgeted costs with actual costs. A profit center will use one of several profit
indices available, depending on the purpose for the performance evaluation. These indices
include segment or direct contribution margin. An investment center will relate one of the many
profit indices to the investment base. This relationship may be viewed in terms of either ROI or
residual income.
4. If a division manager has decision-making authority over prices and marketing products, a cost
budget as the control index is too narrow. That is, the decision-making responsibility
encompasses the revenue aspect of profit because the division manager has the ability to
change prices and marketing campaigns. Consequently, profit, or profit as related to investment,
would be a more appropriate index. This index encompasses more of the variables over which
the division manager has authority.
5. The main disadvantage of using "division profit" as an evaluation measure is that it is a difficult
quantity to define and calculate. First, it is necessary to decide whether profit will be defined as
variable contribution margin, controllable contribution margin, direct contribution margin, or net
profit. Thus, the disadvantage of using the general term 'division profit" is that different profit
measures are determined for different purposes.
6. In computing division controllable profit, only those direct costs of the division which are
controllable by division management are deducted from the total division revenue. In computing
division direct profit, all direct costs of the division are deducted from the total division revenue.
Thus, the fixed non-controllable costs that can be traced directly to the division are included in
Managerial Accounting Solutions, Schneider/Sollenberger, 4th Edition, Chapter 13, Page 13-1
the calculation of division direct profit but are not included in the calculation of division
controllable profit.
7. If division net income is selected as the numerator in the ROI measure, it includes an allocation
of the common home office costs. Whatever method is chosen to allocate home office costs to
divisions, it is likely to be arbitrary and open to question by the division managers.
The allocation problem involving the investment base is concerned with how to assign assets to
divisions. Many assets can be traced directly to the division, while some assets are common to
several divisions. In allocating this common investment, it is necessary to establish an
appropriate relationship between the investment and the division. In general, the amount of
common investment allocated to a division would be that part of the total common investment
which could be avoided if the division did not exist. This is a difficult concept to apply.
8. When comparing various divisions, it is important that the divisions have utilized the same or
similar accounting methods. Otherwise, comparability does not exist. Divisions that do not have
the same or similar accounting methods cannot be compared without some distortion of results.
Accounting methods could differ in areas such as depreciation methods, inventory pricing, and
capitalization/expense decisions.
9. ROI is profit divided by investment. This ratio is actually made up of two components whose
characteristics allow better control and evaluation: (1) rate of return on sales and (2) asset
turnover. The rate of return on sales is a measure of the relationship between sales and
expenses, volume, or profit. Asset turnover is a measure of how efficiently an investment is
used in generating sales.
A manager can improve the ROI by controlling either component and by taking action in any or
all of the following areas: (1) increasing sales relative to assets, (2) reducing expenses relative to
revenues, or (3) reducing the investment base relative to sales.
10. Residual income is defined as the operating profit of a division less an imputed charge for the
operating capital used by that division. It is viewed as an alternative to a ROI calculation.
Residual income is advantageous because it focuses the attention of the division manager on a
dollar amount instead of a ratio. Maximization of the dollar amount tends to be in the best
interest of both the division manager and the company as a whole.
11. A profit center manager in a decentralized organization must be responsible for costs as well as
revenues of the responsibility center. This means that if the profit center needs a part
manufactured in another division of the organization, it should be free to purchase this part from
the other division or to go to the outside market, whichever provides the better price to the profit
center. The upper management cannot dictate to the profit center that it must purchase from the
internal division; otherwise, the organization is not really decentralized. In addition, the profit
center-must be free to set the quantities and prices of the products it produces. Even if another
division of the organization needs a product from the profit center, the profit center is free to sell
to or not to sell to that division at whatever price it feels maximizes its own performance and
enhances its return.
12. A transfer price is any price used to measure a value for the goods or services transferred
between divisions (or any other segment) of a company. Transfer prices are necessary if the
company's operation is decentralized in decision-making and performance evaluation senses.
An input price is needed by the buying segment, and an output price is needed by the selling
segment.
13. The four criteria that are useful in evaluating transfer prices for intra-company transactions are:
Goal congruence. Does the transfer price promote the common goal of financial success for
the entire firm?
Performance evaluation. Will the transfer price allow corporate-level managers to measure the
financial performance of sub-unit managers?
Autonomy. Will the transfer price policy allow sub-unit managers to operate their segments as if
they are independent businesses?
Administrative cost. Is the transfer pricing system easy and inexpensive to operate?
14. Goal Performance Administrative

Congruence Evaluation Autonomy Cost
(a) Market price Good Very strong Very strong Low, if available
(b) Actual cost......... Poor Very poor Poor Low
(c) Standard full cost Poor Poor Poor Very low
(d) Cost plus profit... Poor Average Average Low
(e) Variable cost....... Strong Very poor Poor Often low
(f) Negotiated price Strong Strong Strong to poor High
15. A pseudo-profit center artificially creates a market for a product or service passing from one unit
to another unit in an organization. A natural market does not exist. Finding a "fair" price is a
major problem. Buying and selling units will strive to have the price set low or high to benefit
themselves. Lack of a market test often allows the center to use costs and cost allocations to
justify prices. Both buyer and seller may take actions which make their own performance look
better but which actually may hurt the overall firm's performance. Examples are internal data
processing, repairs and maintenance, and industrial engineering services.
16. Usually the use of a decentralized organization arrangement is largely motivated by a desire to
create smaller, more autonomous operating divisions that will conduct their business as separate
entities. The use of a market transfer price, whenever possible, will parallel the actual market
conditions under which these divisions would operate if they were actually separate companies.
If a market price can be determined, the problems of determining which costs to use and of
deciding upon cost allocation can be avoided. In addition, market prices cannot be manipulated
by the individuals who have an interest in the resulting profit calculation.
17. A dual transfer pricing system is one in which the selling division transfers out at one price and
the buying division transfers in at another price. For example, the buying division might buy at
variable cost while the selling division sells (and calculates revenues) at a synthetic market price.
The advantages of a dual transfer pricing system are twofold: The selling division is motivated to
sell because profit will be increased; and the buying division will buy internally unless the outside
price is less than the variable costs plus opportunity costs. As a result, the utilization of such a
system will cause the buying and selling divisions to be motivated to make decisions that are
consistent with the interests of the company as a whole.
The primary disadvantage of a dual transfer pricing system is the administrative costs incurred
by the corporate office. The corporate accounting office must be involved in all transactions, act
as a clearing agent, and record the two prices and the difference. The difference and duplicate
profits must then be deducted along with other intra-company sales and profits before total
company profit can be determined. This complication often results in creating a new accounting
process to account for the differences in prices recognized by the selling and buying divisions.
18. Even if the intermediate market is competitive, a market-based transfer price can lead to sub-
optimization. If the buying unit could buy internally or externally at the same price, the internal
supplier could generate additional contribution margin for the firm as a whole over the external
supplier. But the buying unit may not be aware of or be concerned about the-firm-wide impacts.
19. If no intermediate market exists, it is very difficult to use a negotiated transfer price because the
producing division is a captive division. That is, the producing division has no power that can be
used as a negotiating advantage, particularly if the purchasing division takes all of the producing
division's output.
When no intermediate market exists, the other disadvantage of using a negotiated transfer price
is that no outside market price exists to guide negotiations. The negotiation will then have to
depend largely on cost. Thus, if no intermediate market exists, and particularly if the buying
division takes all of the producing division's output, it is probably better to recognize the
producing division as a cost center and evaluate this division on the basis of a controllable cost
budget or standard costs.
20. In spite of not producing an optimal profit level for the firm, a full-cost transfer pricing system is
popular because cost-based transfer prices are the cheapest and easiest prices to obtain: they
are outputs of the cost accounting system. Management does not have to spend much time and
money to determine a full-cost transfer price. It is important to remember, however, that other
transfer pricing systems can increase overall firm profits and could very well be worth the extra
time and money spent on them.
21. Cost-based transfer prices can include, at management's discretion, more or fewer costs.
Transfer prices for a multinational company are more complex because conditions differ in each
country in which the company does business. Naturally, firms want managers to make decisions
that enhance company goal congruence. However, international transfer pricing goes beyond
domestic needs to include:
(1) Minimization of world-wide income taxes and import duties.

(2) Avoidance of financial restrictions, including the movement of cash.
(3) Management of currency exchange fluctuations.
(4) Approvals from the host country.
22. Cost-based transfer prices can include, at management's discretion, more or fewer costs. If the
desire is to have lower profits in the exporting country, fewer costs can be attached to those
products exported, resulting in lower prices and therefore lower profits. Costs such as
distribution costs, certain fixed administrative overheads, and costs allocated in terms favorable
to the exported products can be shifted to other segments or products. The costs have been
incurred but not included in the price charged to the international buying division. The reverse is
also true.
If prices are based on market or negotiation, artificially higher or lower prices can be used to
increase or decrease the margins earned on the products exported.
23. Assume that Firm A in Country A and Firm B in Country B are subsidiaries of the same holding
company. The following cases could exist:
(a) If income tax rates are high in Country A and low in Country B, use a low transfer price for
sales from Firm A to Firm B. More profits will be shifted to Firm B, lowering total tax
payments.
(b) If import duties are high for imports in Country B, use a low transfer price for sales from Firm
A to Firm B. Lower duties are paid; profits are higher.
(c) If Country B restricts cash withdrawals from the country or imposes a tax on dividends paid
to the holding company, use a high transfer price on sales from Firm A to Firm B. This allows
a greater cash outflow from Country B through payments for purchases.
Solutions to Exercises
13-1. Division Division Division

Variable Controllable Direct Division
Contribution Contribution Contribution Net
Margin Margin Margin Profit
Revenue $95,000 $95,000 $ 95,000 $95,000
Direct cost:
Variable cost 48,000 48,000 48,000 48,000
$47,000
Fixed controllable costs 5,000 5,000 5,000
$42,000
Fixed noncontrollable costs 15,000 15,000
$27,000
Indirect cost:
Allocated home office overhead 7,000
$20,000
13-2. Electricity Division:
Current ROI:
$2,400,000 operating income ÷ $12,000,000 investment = 20%
Current residual income:

Operating income $2,400,000
Minus capital charge (15% x $12,000,000) 1,800,000
Residual income $600,000
If the division manager accepts the investment, the ROI will decrease to 19.375%:
New ROI: ($2,400,000 + $700,000) ÷ ($12,000,000 + $4,000,000) = 19.375%
Since the return on incremental investment of 17.5 percent ($700,000 / $4,000,000) is above the
15 percent standard, the investment should probably be accepted. However, since it will lower
the current rate of return, the division manager may reject it.
The residual income, on the other hand, will be increased by the incremental investment:
New residual income:

Operating income $ 3,100,000
Minus capital charge (15% x $16,000,000) 2,400,000
Residual income $700,000
Using residual income as an evaluation measure, the division manager will be motivated to
accept the investment. Hence, in this case, residual income may be a better evaluation measure
than ROI.
13-3. All of these terms relate to purchasing and/or using assets. They could be used to evaluate
the performance of an investment center only since cost and profit centers have no control over
investment decisions. Define each and its relation to division performance as follows:
Market value. This is an asset's current value if a division were to sell it on the open market. In
some cases, a ready market value exists. In many others, market value can only be estimated.
The market value is compared to- an asset's book value when an asset is considered for sale.
The difference between market value and book value is a gain or loss on the sale of the asset.
Gains on the sale of an asset require a cash outflow for the taxes on the gain, which may
detract from a division's performance. However, the gain is reported on the income statement
as additional profit which may make the statement appear more attractive to shareholders. A
loss will decrease profits.
Replacement value. This is the cost to a division of purchasing another similar asset with the
same basic future benefits as the asset being replaced. A division may not be willing to replace
an asset that has too high a replacement value because it will detract from the divisional
performance. However, if an asset will require more maintenance costs to keep it running than
a new asset, the new asset could improve earnings.
Economic value. This is the future benefits a division hopes to attain from using an asset-its
earning power. Division managers will look for assets with high economic values to enhance
their division's performance.
Present value. This is the value today of the future cash costs and benefits, discounted at
some interest rate, that will be realized from using an asset. Division managers should use the
capital budgeting techniques discussed in Chapters 12 and 13 to determine the best ways to
spend their capital funds available. Division performance should include an evaluation of how
well the division spends its capital budget.
Opportunity value. This is the value of the next best alternative not chosen. Often managers
will have a choice among many alternatives and can only choose one. The manager should
choose the alternative with the greatest benefit to the division, and the opportunity value is the
benefit of the second best alternative not selected by management.
Disposal value. This is the value of an asset after the costs associated with removing the
asset from a division are subtracted from the asset's market value. This is often called salvage
value.
Entry value. This is the value at which a division records the purchase of an asset on its
books. Most of the time, assets are recorded on the books at historical cost at the time of
purchase or entry into the system.
13-4. The missing data are double-underlined and bolded:
Un: Residual income C$15,000

Plus capital charge (6% x $1,500,000) 90,000
Net income C$105,000
ROI: C$105,000 ÷ C$1,500,000 = 7%
Deux: Investment base = Net income  ROI = C$500,000  20% = C$2,500,000
Minus capital charge (18% x $2,500,000) 450,000
Residual income C$50,000
Trois: Net income = Investment base x ROI = C$2,000,000 x 12.5% = C$250,000

Plus negative residual income 50,000
Capital charge C$300,000
Divided by investment base  2,000,000
Imputed rate 15%
Quatre: ROI: C$300,000  C$3,000,000 = 10%
Since the residual income is zero, the imputed rate must be equal to the ROI of 10%:

Minus residual income 0
Capital charge C$300,000
Divided by investment base  3,000,000
Imputed rate 10%
13-5. Residential Insurance Division (amounts in euros):
(1) 90,000 = Profit – 0.15 (700,000)

Profit = 105,000 + 90,000 = 195,000
ROI = 195,000  700,000 = 27.86%
(2) 0.08 = 195,000  Sales

Sales = 2,437,500
Asset turnover = 2,437,500  700,000 = 3.48
13-6. Southeast Division:

(1) ROI for proposed investment = ($1,000,000 – $600,000 – $300,000)  $500,000
= $100,000  $500,000 = 20%
Projected ROI without the investment = $400,000  $1,200,000 = 33%
Since 20 percent is well below Malcolm 's projected ROI of 33 percent, he is not likely to
undertake the investment.
(2) Donald Malcolm faces conflicting interests here. The overall firm interests would be best served
if Malcolm undertakes the investment since its ROI of 20 percent is above the minimum
requirement of 15 percent. On the other hand, his own interests are best served if the
investment is rejected, as indicated in Part 1. The ethical issue here is whose interests come
first? Although Malcolm should be loyal to the firm, the firm is promoting autonomous decision
making, and Malcolm would be conforming to the firm's incentive structure even if he rejects the
investment.
13-7. ROI and divisional charges:
(a) This charge is not consistent with responsibility accounting and managerial performance
evaluation. The division manager cannot control the general corporation administration costs;
therefore, a charge for such administration costs should not be included on the division's
monthly report.
(b) If the division manager has control over the amount of corporate computer time the division
uses, then this charge is probably acceptable for the monthly divisional reports. However, if
corporate computer time is utilized for such operations as running payroll, then the division
manager won't have any control over the amount of time the division uses; and the charge
should not appear on divisional performance reports. This is a gray area that is assessed
according to many factors including traceability of division hours, variability, and importance of
computer services in the division's operations.
(c) This charge is definitely consistent with responsibility accounting and managerial performance
evaluation since the charge is based on a competitive market price. Market prices cannot be
manipulated by the division manager who has an interest in the profit calculation. Market prices
also eliminate the negotiations and squabbling over costs and definitions of fairness between
divisions and provide an excellent transfer price for evaluating division manager performance.
13-8.
(1) ROI for the third year:
($480,000 – $40,000)  [$800,000 – 2 ($40,000)] = $440,000  $720,000 = 61.1%
(2) Residual income for the seventh year:
($480,000 – $40,000) – 0.14[$800,000 – 6 ($40,000)] = $440,000 – 0.14 (560,000)

= $440,000 – $78,400
= $361,600
13-9. Adjusted accounting profit:
$5,000,000 = x – 0.15 ($20,000,000)

$5,000,000 = x – $3,000,000
x = $8,000,000
13-10. From the perspective of the Division X manager, the lowest price that should be accepted for
units transferred to Division Y is $60. This is the variable cost for Division X and since there is
excess capacity, anything above $60 will contribute towards covering fixed costs and profits.
13-11. If Division A refuses to accept the $28 price for transfers to Division B, the annual profit of
the corporation would be reduced by $40,000 [($28 - $20)(5,000)].
13-12. The Shomovic Company:
Since the current level of production covers the fixed costs, profit will result by using the excess
capacity for units with a price higher than variable cost. Since the full-cost transfer price of $18
exceeds the variable cost, profit will be increased by the difference between the price and the
variable cost ($18 – $14 = $4 per unit; $4 x 20,000 units = $80,000). The following profit
calculations show the $80,000 increase in profit:
Profit Calculations
Internal Internal
Order Not Order
Accepted Accepted
Sales to outside markets (100,000 units x $26) $2,600,000 $2,600,000
Sales to division (20,000 units x $18) 360,000
Total sales $2,600,000 $ 2,960,000
Variable cost ($14) 1,400,000 1,680,000
Contribution margin $1,200,000 $1,280,000
Fixed cost 400,000 400,000
Net profit $800,000 $880,000
13-13. The 100,000 units should be sold by Division 2. If the units are sold by Division 2, the
company earns $4 in additional revenue per unit ($14 – $10) and only incurs $1.50 of additional
variable cost per unit. Since Division 2 has excess capacity, its fixed costs are irrelevant.
Therefore, allowing Division 2 to sell the units is worth an additional $2.50 per unit to the
company as a whole.
A transfer price based on market price might discourage Division 2 from buying from Division 1
since the market price would lower the average return Division 2 could achieve. This transfer
price would mean Division 2 would only earn $2.50 per unit ($14 – $10 – $1.50).
A transfer price based on variable cost would not provide Division 1 with any incentive to sell
units to Division 2 since its total profits would remain unchanged. However, Division 2 would be
very excited about the opportunity to purchase units at variable cost since its total profits would
increase to $7.50 per unit ($14 – $5 – $1.50).
13-14.
(1) Average sales price to earn 20 percent rate of return on assets:
Net income = Average direct assets x Desired rate of return = 600,000 x 20% = R120,000
The selling price must be enough to cover the variable costs, fixed costs, and the net income:
Variable costs (100,000 grams x R1) R100,000

Fixed costs 200,000
Net income 120,000
Sales R420,000
Divided by grams  100,000 grams
Average selling price R4.20 per gram
(2) No. The R2.25 per gram offered price for the 30,000 grams from the other division is not enough
to cover the opportunity cost. The opportunity cost is the return earned on the eliminated assets
and the avoidable variable and fixed costs:
Eliminated assets:
Inventory R40,000
Plant and equipment 60,000
Total eliminated assets R100,000
Times rate of return x 0.20
Return on assets R20,000
Plus avoidable costs:
Variable costs (30,000 grams x R1) 30,000
Fixed costs 20,000
Total opportunity cost R70,000
Opportunity cost per gram R2.33 per gram
In addition, the average selling price on the remaining 70,000 grams would have to increase
from R4.20 to R5.00:
Average sales price to earn 20 percent rate of return on assets:
Net income = Average direct assets x Desired rate of return

= (R600,000 – R100,000) x 20% = R100,000
The selling price must be enough to cover the variable costs, fixed costs, and the net income:
Variable costs (70,000 grams x R1) R70,000

Fixed costs 180,000
Net income 100,000
Sales R350,000
Average selling price R5.00 per gram
For these two reasons, the manager of the selling division should not accept the R2.25 offer
from the other division manager.
13-15.
(1) The Production Division manager should not accept the argument of the Sales Division
manager. The additional units will lower the fixed cost per unit, but the total fixed cost will not be
affected. This is the critical point. The following calculation demonstrates that profit for the
Production Division will be lower with the order than without it. In fact, the decrease in profit will
be $40,000, which is $1 per unit (the amount by which the variable cost exceeds the transfer
price) times 40,000 units.
Profit at Profit at
120,000 160,000
Units Units
Existing sales (120,000 units x $30) $3,600,000 $3,600,000
Additional sales (40,000 units x $21) 840,000
Total sales $3,600,000 $ 4,440,000
Variable cost ($22) 2,640,000 3,520,000
Contribution margin $960,000 $920,000
Fixed cost 720,000 720,000
Net income $240,000 $200,000
(2) The order should be accepted. If the variable cost in the Production Division is $22 and the
additional cost in the Sales Division is $2.25, the company will earn $2.75 on each unit sold
($27.00 outside selling price – $24.25 cost), or a total of $110,000 of IBT on the 40,000 units.
13-16. Profit centers and transfer prices:
(a) The minimum price that the Parts and Service Department should charge the other departments
is the variable cost, and the maximum price should be the market price. Any price in-between
will allow the Parts and Service Department to make a positive contribution margin and the other
departments to save costs over outside market prices. The dealership would not want the Parts
and Service Department charging too high a price for its services because it would not be in the
best interest of the dealership for the Used Vehicle Department to take its cars down the road to
"Joe's Fix-lt Station." Also, outside service facilities may not provide the quality of service that
the dealership demands.
(b) The Used Vehicle Department's major source of cars is from the New Vehicle Department, and
the most convenient market for the used cars accepted in trade by the New Vehicle Department
is the Used Vehicle Department. The Used Vehicle Department will want to purchase the cars at
the lowest possible price to boost its profits when it sells the car. However, the New Vehicle
Department will want to offer the new car buyer a premium price for the used car to ensure the
sale of the new car. It would be in the best interests of the dealership for the two departments to
negotiate fair transfer prices for these cars. The Used Vehicle Department should base its price
on some sort of wholesale price for the cars. If the New Vehicle Department does not like the
Used Vehicle Department's offered price, it should be free to go outside to sell the used car at a
wholesale car auction. Given the amount of information available today on the current market
values of used cars, the two departments should be able to come to an agreement that is in their
mutual best interest.
13-17.
(a) A transfer pricing rule based on variable costs will lead to the maximization of corporate profits,
provided the variable costs of production are less than any outside market price available.
When only variable costs are passed between divisions, the corporation can make production
and pricing decisions based on cost/volume/profit relationships. However, the producing
divisions are left holding all of their fixed costs and cannot be evaluated as profit centers with a
variable cost transfer price.
(b) A division manager may reject a cost reduction proposal with a positive net present value and
decide to keep an inefficient old asset because the return on the new investment may lower the
divisional ROI (ROI). If a division manager's performance is based on ROI, the manager will not
want to invest in any asset that has a lower ROI than the current one, even if the asset has a
positive net present value and would benefit the division if it were purchased. Also, if the
manager is evaluated using a ROI where the investment base is the book value of assets, old
assets will keep the investment base low and the ROI high, in spite of losing profitable
opportunities.
(c) Many firms use cost-plus or negotiated transfer prices even though they do not lead to optimal
firm-wide results for individual products because cost-based prices are easily found and used.
Negotiated prices can be arbitrarily set. Neither will necessarily encourage managers to make
decisions in the best interests of the firm as a whole.
(d) If a company is decentralized and wants divisions acting as if they are independent companies,
separate from the company as a whole, then market transfer prices could be considered "ideal."
Market prices, if available, meet the autonomy, administrative cost, and performance evaluation
criteria. They may, but will not always, encourage goal congruency. The performance of a
division can be better evaluated using a market transfer price because the division manager
cannot manipulate the price to enhance the division's profits.
(e) This statement indicates that division managers should not only be trying to achieve the highest
level of profitability for their divisions but should also be attempting to achieve the highest total
firm profits simultaneously. Often, transfer pricing rules can create negative results-lost sales,
greater costs, gamesmanship, internal fights, and lost opportunities. One division should not try
to achieve higher profits at the expense of another division in the same company. Divisions
should realize they are members of the same team and therefore should work toward common
goals. Transfer prices can be either positive or negative forces. The "least dysfunctional
behavior" is intended to minimize the negative and in turn create a positive influence. However,
this limits the amount of decentralization a firm can achieve.
13-18. Princeton Enterprises:
$3.00, the current price. This transfer price generates a profit of $9,000 for the ice cream
business, as shown in the problem. However, this price is above the market price of $2.40 and
may cause the ice cream business to lose sales because of the high costs to the drive-ins.
$2.40, the market price. This transfer price will cause the profits of the ice cream business to
fall by $6,000 [($3.00 - $2.40) x 1 0,000 gallons] to $3,000. At this price, the drive-ins are on
competitive footing with the ice cream business. However, this price may not maximize firm-wide
profits.
$2.10, the average full cost. This is the full cost based on 10,000 gallons of ice cream. This
price would allow the ice cream business to only break even, with no opportunity to make a
profit. It is important to note that if the volume increases, the average full cost decreases as the
fixed costs are spread over more units. This reduction still does not allow the ice cream
business to make a profit, but it does lower the cost to the drive-ins. But, since the drive-ins are
evaluated as profit centers, they may "use" this cost savings to enhance their own profits and not
pass the "savings" back to the firm.
$1.60, the variable cost. This transfer price will cause the ice cream business to lose $ 5,000,
its fixed costs. This price will give the drive-ins the most discretion and competitive advantage at
the expense of the ice cream business. The ice cream business must find some way to recoup
its fixed costs before it can break even. In most circumstances, a transfer price based on
variable cost will optimize firm-wide profits. However, the selling division can no longer be
evaluated as a profit center.
All three lower prices would probably generate more sales. Would higher profits result? It
depends on retail prices, volumes, incentives, and cost controls.
13-19.
(1) Income statement:
Sales:
In the intermediate market (600,000 units) $6,000,000
In the final market (400,000 units) 7,200,000
Total sales $13,200,000
Costs:
Division M manufacturing $7,200,000
Division S processing 1,300,000
Total division costs $8,500,000
Minus unprocessed units held in inventory by S:
[(200,000 units  1,200,000 units) x $7,200,000] 1,200,000
Total costs $7,300,000
Net income $5,900,000
(2) Cost-based transfer price:

Division M income statement:
Sales:
600,000 units sold in outside market $ 6,000,000
600,000 units transferred to Division S 3,600,000
Manufacturing costs 7,200,000
Division S income statement:

Sales in final market (400,000 units) $7,200,000
Costs:
Processing cost $1,300,000
Cost of goods received from Division M 3,600,000 $4,900,000
Minus unprocessed units held in inventory by S
[(200,000 units  1,200,000 units) x $7,200,000] 1,200,000
Since the units transferred between divisions are transferred at cost, the total of the two
divisional income statements, $5,900,000 ($2,400,000 + $3,500,000), equals the total income
on the company income statement.
(3) Market-value transfer price:

Division M income statement:
Sales:
600,000 units sold in intermediate market $6,000,000
600,000 units transferred to Division S 6,000,000
Manufacturing costs 7,200,000
Division S income statement:

Sales in final market (400,000 units) $7,200,000
Costs:
Processing cost $1,300,000
Cost of goods received from Division M 6,000,000 $7,300,000
Minus unprocessed units in inventory at
market price (200,000 units) 2,000,000
The net income shown on the company income statement is $5,900,000. The total net income
shown on the two division statements is $6,700,000 ($4,800,000 + $1,900,000). The difference
of $800,000 resulted from Division M transferring the 200,000 unsold units (ending inventory) at
market value rather than cost:
Market value of 200,000 units $2,000,000

Cost of units in Division M (1/6 of $7,200,000) 1,200,000
Increased income from using market value $800,000
13-20. Since the fixed refining costs remain the same, the impact on profits can be measured by
the contribution margin (price minus variable costs).
(a) Variable-cost transfer price: Refining Marketing Porath Oil

Final selling price - $1.20 $1.20
Transfer price $0.30 (0.30) -
Variable refining costs (0.30) - (0.30)
Transportation costs (0.10) (0.10)
Contribution margin 0.00 $0.80 $0.80
(b) Market price: Refining Marketing Porath Oil

(c) Full-cost transfer price: Refining Marketing Porath Oil

* Full cost equals $0.30 variable refining costs plus $0.40 fixed refining costs ($160,000 
400,000 gallons).
Conclusion: When all products are transferred internally, the transfer price determines how
each division shares in the profits of the company, since in each case the company's contribution
margin is $0.80.
13-21. Transfer pricing problem:
(1) Ordinarily, if the price of a service increases, the user of the service will decrease the quantity
purchased. Hence, this scheme may work. Evidence exists that this method is actually used by
firms as a means of motivating managers to conserve on services. However, the danger exists
that the operating managers may cut back by failing to make adjustments that should be made.
The customer may then be dissatisfied with the results. Whether a student agrees or disagrees
with such a scheme will probably depend on the extent to which he or she thinks a cost figure
should be used as a motivating device.
(2) If the selling departments are not required to use the tailor shop, they would search for outside
tailor time at a cost of less than $24 per hour. If lower-cost outside services can be purchased,
then the $24 price is a poor one to use since it is not a good guide to decision making. The
problem that then arises is the loss of quality control. Outside tailors at lower costs may also do
poorer quality work and may not be aware of or be trained in the store's fitting standards.
13-22.
The allocation is a type of transfer price for the services of the central corporate office. In this
case then, the cost allocation can be viewed as a transfer price.
From the division manager's point of view, every time sales dollars are increased, the division will
be allocated more central corporate office cost. Such an allocation may well affect the decisions
of the division manager even though it is viewed as "just a cost allocation."
In assessing whether to introduce a new product, a division manager may ignore the cost
allocation and recognize the contribution of $2.50 per unit ($8 – $5.50). On the other hand, if
the cost allocation is considered, the division manager might not introduce the new product. The
$2.50 contribution margin is needed to cover fixed costs and provide an adequate profit margin.
This "additional variable" cost of $0.32 per unit may drive the contribution margin below an
acceptable percentage. That is, the manager may feel that the introduction of the new product
will cause more central corporate office cost to be added to the division.
The problem is that to the division manager the cost appears to be a variable cost – $0.04 per
dollar of sales – even though it actually is not. If the company insists on allocating fixed central
corporate office cost, it may be preferable to allocate a lump sum to each division rather than to
base the allocation on sales thereby making the charge appear as a variable cost. However,
since the cost is not controllable by the division managers, the central corporate office cost
should not be considered in divisional or divisional manager performance evaluations.
13-23.
(1) The minimum price should be $11.25 ($12 – $0.75).
(2) The minimum price should be $4.25 ($5 – $0.75).
13-24.
(1) If the product is transferred to the German subsidiary, the additional contribution margin is (in
euros):
Selling price 34.0

Costs:
Additional processing costs in Germany 6.0
Market price in Swiss market (SFr26 x 0.90) 23.4 29.4
Additional contribution margin per unit 4.6
Therefore, the units should be transferred to the German subsidiary for processing and sale.
(2) Cash could be transferred through the use of a low transfer price, such as variable cost, that
would minimize the cash payments from Germany to Switzerland.
13-25.
Goal congruent transfer price = $30 + {[12,000 x ($42 - $30)]  15,000} = $30 + $9.60 = $39.60
Solutions to Problems
13-26.
(1) Apartment Division:
ROI before investment = $4,000,000  $12,000,000 = 33.3%
ROI of investment:
Net income = $11,000,000 – 0.7 ($11,000,000) – $2,500,000 = $800,000
ROI = $800,000  $3,500,000 = 22.9%
Since 22.9% is less than 33.3%, the division manager would reject the investment.
(2) The president would want the investment because the ROI of 22.9% exceeds 17%.
(3) Residual income = $800,000 – 0.13 ($3,500,000) = $800,000 – $455,000 = $345,000
Since the residual income is positive, the division manager would accept the investment.
13-27. Capital budgeting and ROI:
(1) After allocation of fixed cost, the division earns a rate of 10 percent on historical investment.
This rate of return, of course, is not comparable to the rate of return on additional investment
that is being imposed as a standard. The division is producing a positive cash flow which must
be compared with the cost savings of liquidating the division. This can be handled like a capital
budgeting problem of Chapter 11. Assuming the facility is not sold (in thousands):
Investment Life of the Project

Year: 0 1 ........
Disposal value of facility foregone ($8,000)

Revenues $17,000 $17,000
Variable cost (12,000) (12,000)
Contribution margin $5,000 $5,000
Avoidable fixed costs (2,000) (2,000)
Maintenance cost (1,000) (1,000)
Net annual cash flow ($8,000) $2,000 $2,000
PV-Years 1-10 8,384
(20%, 10 years): $2,000 x 4.192
NPV $384
Since keeping the division has a positive net present value at the 20 percent minimum rate of
return, the division should be kept. Solving for the internal rate of return on keeping the division:
PV factor (IRR) = Disposal value  Net annual cash flow

= $8,000  $2,000
= 4.000 (corresponds to between 20 and 22 percent, 21.4 percent on a
business calculator.)
(2) If the performance report is going to be used to decide whether or not to keep the division, the
'profit" should be converted to estimated net cash flow; the investment should be based on the
selling value of the assets; and the rate of return should be an internal rate of return, since that
is the standard being used. The following report is an example:
Telemarketing Division, Statement of ROI (in thousands):
Revenues $17,000
Variable cost 12,000
Contribution margin $5,000
Avoidable fixed costs 2,000
Maintenance cost 1,000
Net annual cash flow $2,000
Estimated selling value of assets $8,000
Internal rate of return 21.4%
When the internal rate of return drops below 20 percent, management should consider selling
the division.
13-28. The Skokie Company:
(1) The allocation of the central office overhead is a transfer price, since the central office provides
services for the operating departments. Therefore, the manager of the Engineering Research
Department is charged for the services supposedly received from the central office.
(2) If the manager hires through the Personnel Department, the Engineering Research Department
will be charged a total of $4,500 per month (two employees each at a $1,500 per month plus
$0.50 per dollar of payroll cost) as its share of the overhead:
2 employees at $1,500 each $3,000

$0.50 x $3,000 1,500
Total cost $4,500
If the additional staff is hired through the outside firm, the manager will pay $4,000 per month
(two people at $2,000 each). The manager is likely to choose this alternative since the cost to
the department will be less. Obviously, the additional cost to the company will be $ 1,000 per
month ($4,000 – $3,000), since the $1,500 charge is the allocation of a cost which is fixed.
This is an increasingly common situation in many industries. The hiring firm can add talent when
needed (perhaps at a premium rate) and avoids the heavy overhead costs of health and
employer taxes. The other impact is that a large industry of systems, engineering, and design
contract firms are ballooning near every industrial city. Others areas are also using this concept
for office cleaning services, office equipment maintenance, and lawn care.
(3) As long as the central office overhead allocation is based on payroll cost, the managers will
receive a signal to minimize payroll cost. If this is the message received, then the company
might consider allocating central office overhead as a flat rate per year so that the allocation will
not lead managers to make poor hiring decisions.
13-29.
(1) Since no alternative use for HD's internal facilities exists, its fixed costs are irrelevant to the
decision to purchase the units internally or in the outside market. Only HD's variable costs are
relevant to this "make or buy" decision:
Make Costs Buy Costs
HD's variable costs Purchase cost
(2,000 x $220) $440,000 (2,000 units x $260) $520,000
______ Die charge 20,000
Total make costs $440,000 Total buy costs $540,000
Net make advantage $100,000
Therefore, the company as a whole would be worse off by $100,000 if ISD purchases the
subassembly from the outside supplier.
(2) If HD's internal facilities would not otherwise be idle, then its transfer price would be the variable
cost per unit plus $20 per unit. The $20 per unit represents the opportunity cost to HD of
producing the 2,000 units for ISD ($40,000 ÷ 2,000 units).
Make Costs Buy Costs

HD's variable costs Purchase cost:
(2,000 x $220) $440,000 (2,000 units x $260) $520,000
Opportunity cost 40,000 Die charge 20,000
Total make costs $480,000 Total buy costs $540,000
Net make advantage $60,000
It is still in the best interests of the firm for ISD to purchase the 2,000 units from HD.
(3) The answer to Part 1 would not change if the outside supplier drops its price by $20 per unit
since the total buy costs would only fall by $40,000 (2,000 units x $20). The net make advantage
is $60,000, instead of $100,000.
The answer to Part 2 would also not change since the total buy costs would fall to $500,000,
down from $540,000. The net make advantage is $20,000, instead of $60,000.
13-30. Morris Company:
Transfer price Pros Cons

Cost plus Forces users to pay for use. No incentives to control costs.
Could increase the level of Other departments may avoid
preventative maintenance maintenance to save costs. This
in the other departments. could lead to more machinery break-
downs and additional repair costs.
Market price Forces Maintenance May not get quality maintenance.

minus a Department to be efficient. May also be hard to get accurate
cost saving Is based on a market price. market price.
percentage
Don’t do it Easy to do nothing. Hard to accurate performance

Some cost control. evaluations. No “pay as you use”
program. No incentive to do preventative
maintenance.
(2) Students could pick any one of these or even create others. In any case, the solution prepared
should be measured against expected management behavior and the four transfer pricing
criteria.
13-31. Cinnamon Corporation:

(1) The minimum bid Jay should make to Ray would be one that covers all of its variable costs as
well as the contribution margin of its lost outside sales. Jay's outside sales have a contribution
margin of $3 per unit:
Selling price ($600,000 100,000 units) $6

Variable cost ($300,000  100,000 units) 3
Contribution margin $3
Minimum bid:
Variable cost (30,000 units x $3) $90,000
Lost outside contribution margin (10,000 units x $3) 30,000
Total costs to cover by bid $120,000
Divided by 30,000 units  30,000 units
Minimum bid $ 4.00 per unit
This bid of $4.00 per unit would leave Jay's profit unchanged, but Ray's profit would increase
by $30,000:
Jay Ray
Sales: Division Division
90,000 units x $6 $540,000
30,000 units x $4 120,000
30,000 units x $9 $270,000
Total sales $660,000 $270,000
Costs:
Variable cost:
120,000 units x $3 $360,000
30,000 units x $4 $120,000
Cost of units transferred: 30,000 units x $4 120,000
Fixed cost 200,000
Total cost $560,000 $240,000
Net income $100,000 $30,000
This bid would meet the transfer pricing criterion of goal congruency. The price maximizes total
firm profits, even though Jay's profit remains unchanged.
(2) The preferred alternative for the maximum bid Jay should make to Ray is normal selling price. If
Jay chooses its normal selling price of $6 per unit, Jay's profit would increase; but it would force
Ray into a loss position:
Jay Ray
120,000 units x $6 $720,000
30,000 units x $9 $270,000
Total sales $720,000 $270,000
Costs:
Variable cost:
120,000 units x $3 $360,000
30,000 units x $4 $120,000
Cost of units transferred: 30,000 units x $6 180,000
Fixed cost 200,000
Total cost $560,000 $300,000
Net income $160,000 ($30,000)
A transfer price based on outside selling price would meet the transfer pricing goal of autonomy.
Jay Division would be looking to maximize its own profits, even at the expense of Ray Division.
Total firm profits are the same $130,000, regardless of which of the above transfer prices is
chosen. However, if Jay sets the price at $6 per unit, Ray is not likely to purchase from Jay
since it can go outside and purchase the part for $4.50 per unit.
(3) Ray purchases from outside supplier for $4.50 per unit:
Jay Ray
100,000 units x $6 $600,000
30,000 units x $9 $270,000
Total sales $600,000 $270,000
Costs:
Variable cost:
100,000 units x $3 $300,000
30,000 units x $4 $120,000
Cost of units purchased outside: 30,000 units x $4.50 135,000
Fixed cost 200,000
Total cost $500,000 $255,000
Net income $100,000 $15,000
Total firm profits are only $115,000, down from $130,000, if Ray purchases the units from
outside. Therefore, Cinnamon Corporation loses $15,000 from Ray purchasing outside. To
maximize overall firm profits, Jay should set the transfer price between $4.00 and $4.50 per unit.
In this range, total firm profits will be $130,000, but profits will be split between Jay and Ray
Divisions. At $4.00 per unit, Ray will show higher profits at the expense of Jay. And at $4.50,
Jay will show higher profits at the expense of Ray. However, total firm profits will stay constant
at $130,000. If Jay decides to set the transfer price above $4.50 per unit, Ray Division will go
outside to purchase the units; and overall company profits will be hurt. If Jay forces Ray to
purchase outside, it loses the opportunity to sell 20,000 additional units; and total company
profits are hurt.
13-32. Baltic National Bank:
(1) First, solve for the variable cost per computer time unit:
Miscellaneous supplies 120,000 litas

Utilities 250,000
Total variable cost 370,000
Divided by time units available  20,000 time units
Variable cost per time unit 18.50 litas per time unit
If this was a one-time run, it is not in the best interest of the bank to spend 300 litas to save two
computer time units whose variable cost is only 37 litas (2 x 18.50). But, if this program is run
weekly or monthly, the savings can become significant. The program would have to be run more
than eight times (300  37) before the 300 litas of outside programming would be justified. If this
is done across many programs, rentals and other step-fixed costs can be controlled or kept from
rising.
Also, as the price of the product or service is raised, less will be consumed. The operating
managers will probably find ways to reduce usage and may use unprofitable schemes. It
appears that the price does affect the behavior of the operating managers. In this sense, the
associate director is right.
(2) Perhaps. As pointed out in Part (1), the 300 litas cash outlay for outside programming saved
only 37 litas of variable operating cost each time it was run. So the answer depends on the
frequency of use. Often, yes. Once a year, no.
(3) The variable cost of computer time is 18.50 litas per time unit times the frequency of use. This is
the maximum rate that should have been paid.
13-33. Blech Packing Company:

(1) Divisional income statements:
Division 1:
Sales:
To outsiders $600,000
To Division 2 at market ($1,800,000 + $300,000) 2,100,000
Cost of goods sold:
Beginning inventory $0
Livestock costs 600,000
Labor 400,000
Overhead 500,000
Cost of goods available for sale $1,500,000
Minus ending inventory 0 1,500,000
Gross margin $1,200,000
Selling and administrative expense 120,000
Division 2:
Sales:
To outsiders $2,000,000
Cost of goods sold:
Beginning inventory $0
Unprocessed meat from Division 1 2,100,000
Processing supplies 200,000
Labor 300,000
Overhead 100,000
Cost of goods available for sale $2,700,000
Minus ending inventory (market value) 300,000 2,400,000
Gross margin ($400,000)
Selling and administrative expense (100,000)
Net loss ($500,000)
Reconciliation of net income:
Divisional net income (loss):
Division 1 $1,080,000
Division 2 (500,000)
Total divisional net income $580,000
Minus central office overhead 100,000
$480,000
Minus intradivision profits in ending inventory shown on
Division 2 income statement 100,000
Net income per company income statement $380,000
(2) The transfer price used in preparing the statements is the market price. This is appropriate since
the intermediate market is competitive.
(3) The intermediate market is competitive in that Division 1 can sell all of its output and Division 2
can buy all the meat it needs at the market price. Hence, no conflict should arise. The
unprocessed market price is the opportunity cost of processing the meat. It does mean, given
the current prices, that resources will go to Division 1 and not to Division 2.
13-34.
(1) Partial income statements: Central Electronics Communications
Revenues $80,000,000 $25,000,000 $18,000,000
Costs:
Electronics (25,000,000) (20,000,000)
Communications (18,000,000) (14,000,000)
Central (8,000,000)
Contribution Margin $29,000,000 $5,000,000 $4,000,000
(2) If the offer is accepted, the company has an incremental cost of $300 ($2,300 – $2,000).
Hence, the offer should not be accepted. Electronics should meet the price.
(3) Incremental revenues ($3,000 x 10,000) $30,000,000

Incremental costs ($500 + $2,300) x 10,000 28,000,000
Incremental contribution margin $2,000,000
Another way:
Central Electronics Communications
Revenues $80,000,000 $30,000,000 $18,000,000
Costs:
Electronics (25,000,000)
Communications (18,000,000) (14,000,000)
Central (8,000,000)
Purchase (23,000,000)
Contribution Margin $31,000,000 $5,000,000 $4,000,000
While Electronics and Communications have the same contribution margins as before, Central
has increased by $2,000,000 ($31,000,000 – $29,000,000).
13-35.
(1) Component Variable Cost Fixed Cost Full Cost
Number Per Unit Per Unit Per Unit
2 $15 $7.201 $22.20
4 5 7.20 12.20
1
$360,000  50,000 units = $7.20 per unit
The reallocation of fixed costs causes the cost for all components to exceed the outside price;
and, therefore the manager will order these components from outside the company. This action
will then price Division 1 out of the market, and it will have no production.
(2) A transfer price based on full cost is higher than one based on variable cost. With a higher
price, Division 2 will tend to use outside suppliers; thus, creating unused capacity in Division 1.
The question may be raised as to whether Division 1 should be eliminated altogether. Even
assuming that the out-of-pocket fixed cost could be eliminated, it would still be better to keep the
division. The following illustrates this:
Costs of buying parts internally:
Component Quantity Variable

Number Produced Per Unit Total
1 25,000 $11.00 $275,000
2 35,000 15.00 525,000
3 15,000 7.00 150,000
4 15,000 5.00 75,000
Total variable cost $980,000
Total fixed cost 360,000
Total cost $1,340,000
Costs of buying parts outside:
Component Quantity Outside Price

Number Produced Per Unit Total
1 25,000 $14.50 $362,500
2 35,000 19.20 672,000
3 15,000 9.40 141,000
4 15,000 9.60 144,000
Total purchase cost $1,319,500
Unavoidable fixed cost 90,000
Total cost $1,409,500
(3) One method is to charge Division 2 a flat rate of $360,000 for the period, regardless of the
number of units purchased, plus a rate per unit purchased that is based on the variable cost of
each component. Under this system, the manager of Division 2 will most likely buy from Division
1 as long as the outside price is higher than the variable cost. Division 1's manager should be
allowed to meet external competition. This decision might force cost reductions and production
efficiency improvements.
(4) If the items transferred to Division 2 are only 4 percent of Division 1's total business, then
Division 1 should charge Division 2 a flat rate of only $14,400 (4 percent of $360,000) and then
charge a rate per unit based on variable cost. More likely, Division 2 would bid the items it wants
both internally and externally. Perhaps a corporate policy could give the internal bidder a small
profit percentage advantage to retain internal business. Strong external bids can then be
accepted by Division 2, but Division 1 is not downwardly spiraling into the ground as happened
in the text problem description when going from four products to no products.
13-36.
(1) Present system transfer prices:
Order 1:
Labor:
Section 1 (3 hours x $15) $45.00
Section 2 (3 hours x $10) 30.00
Total labor $75.00
Overhead ($75 x 150%) 112.50
Materials 500.00
Transfer price $687.50
Order 2:
Labor:
Section 2 (1 hour x $10) 10.00
Total labor. $100.00
Overhead ($100 x 150%) 150.00
Materials 200.00
Proposed system transfer prices: Direct Labor

Overhead Payroll Rate
Section overhead rates:
Section 1 $900,000 $200,000 450%
Section 2 300,000 600,000 50%
Order 1:
Labor:
Section 2 (3 hours x $10) 30.00 $75.00
Overhead:
Section 1 ($45 x 450%) $202.50
Section 2 ($30 x 50%) 15.00 217.50
Materials 500.00
Order 2:
Labor:
Section 2 (1 hour x $10) 10.00 $100.00
Overhead:
Section 1 ($90 x 450%) $405.00
Section 2 ($10 x 50%) 5.00 410.00
Materials 200.00
(2) The transfer price for Order 1 is higher under the proposed system than under the present
system because the overhead is $217.50 under the proposed system, as opposed to $112.50
under the present system.
The transfer price under Order 2 is also higher under the proposed system because the
overhead, which is $150.00 under the present system, is $410.00 under the proposed system.
This increase occurs because the order spends 6/7 of its total manufacturing time in Section 1,
the higher overhead section.
If the market price is $700 for Order 1 and $600 for Order 2, the proposed system produces
transfer prices above the market prices. The buying division would then go outside to purchase
the orders, and the selling division would lose the business.
(3) Transfer prices based on variable cost:

Divisional variable overhead rates:
Section 1: ($900,000 x 1/3)  $200,000 = 150%

Section 2: ($300,000 x 1/3)  $600,000 = 16.67%
Order 1:
Labor:
Section 2 (3 hours x $10) 30.00 $75.00
Overhead:
Section 1 ($45 x 150%) $67.50
Section 2 ($30 x 16.67%) 5.00 72.50
Materials 500.00
Order 2:
Labor:
Section 2 (1 hour x $10) 10.00 $100.00
Overhead:
Section 1 ($90 x 150%) $135.00
Section 2 ($10 x 16.67 %) 1.67 136.67
Materials 200.00
(4) The system based on variable cost is the best one for decision purposes. Since both divisions
are operating at less than full capacity, a price based on variable cost should be quoted to
encourage other divisions to purchase from within the company. If, on the other hand, the
division is near full capacity, a price based on variable cost plus a profit should be quoted to
other divisions. The profit should be based on the contribution margin that could be earned by
devoting the same number of hours required for the inside order to the production and sale of
shafts outside the company. That is, a market-based transfer price should be used if it will not
create more excess capacity in the producing division.
13-37.
(1) The circuit boards should be transferred within the company, provided the selling division has the
capacity to handle the demand and the variable cost is below the outside price. The savings to
the company is the difference between the outside price of $7.50 and the variable cost of
Metropolis. With idle capacity, Metropolis can handle the internal business. Even though
Metropolis may not realize a profit if internal sales are priced at variable cost, Reeves will
recognize a saving which benefits the whole company. The superintendent fails to see the total
company situation.
(2) Variable unit cost:
Total unit cost $6.50
Minus unit fixed cost ($175,000 100,000 units) 1.75
Variable unit cost $4.75
(3) The selling division can show increased contribution margin at any price above $4.75, given no
other use of the capacity. The buying division will benefit at any price below $7.50, its market
price.
The key facts are the unused capacity in Metropolis and the need for units by Reeves.
Metropolis' unabsorbed fixed overhead is its problem; it selected 100,000 units as the basis for
absorbing overhead.
Several possibilities exist:
(a) Allow the two division managers to negotiate a price between $4.75 and $7.50. A midpoint
price of about $6.00 to $6.25 would give Metropolis a positive contributionmargin and save
Reeves a similar amount from its current price.
(b) Use a dual pricing that would allow Metropolis price at market or slightly below and allow
Reeves to benefit from a variable cost transfer price. The dual price arrangement motivates
the seller by allowing the division to operate as a profit center. The buying division is
encouraged to buy at the best price, i.e., buying inside when the variable cost is less than the
outside selling price.
13-38. Arnold Phillips Corporation:

(1) Unit variable cost:
Direct materials and direct labor $16.20
Variable overhead ($8.40  4) 2.10
Unit variable cost $18.30
(2) First, does the international sale represent a commitment? If so, then only 50,000 hours of
capacity remain. And only 200,000 units can be made for Jessop. If the foreign sale can be
subcontracted, those 200,000 units for Jessop must be priced no lower than the subcontract
price. If the contract can be canceled or partly eliminated, the Jessop sales should be made but
at a price no lower than variable cost plus the opportunity cost of the international business.
In that case, the Sterling Division should supply the Jessop Division because the cost savings on
the internal sale will increase the overall profits of the company. The amount of the cost savings
is the difference between what the Jessop Division would pay on the outside and the variable
costs plus opportunity costs of the Sterling Division, perhaps $6.00 per unit ($32 - $26.00) for
200,000 units and $13.70 per unit ($32 - $18.30) for the other 200,000 units.
(3) An argument could be made that variable cost should be the price to the Jessop Division as the
Sterling Division had excess capacity. Under the circumstances, however, the new contract
gives the Sterling Division the opportunity to operate nearer to capacity. The Jessop Division
should pick up the opportunity cost of $26 per unit. This should be the price to the Jessop
Division. To optimize the company-wide profits, the variable cost plus opportunity cost should be
the minimum; and the market price should be the maximum transfer price.
13-39. Dessler Company:
(1) It is appropriate for the vice-president to advise the manager of the Cody Division that it is not in
the best interest of the company to acquire the machinery. Acquisition of the machinery would
create excess capacity in the Trimming-Polishing Department of the Casper Division. A cash-
flow analysis will substantiate that this excess capacity exists. The variable cost of the trimming-
polishing operation in the Casper Division is $12 per unit or $600,000 based on current
production. This cost would not change as a result of purchasing the machinery. The annual
cash cost associated with the rental of the machinery by the Cody Division is $200,000; hence,
the profit for the firm as a whole would decrease by that amount. The problem is that the $6 per
unit overhead cost, while it appears to be a variable cost to the Cody Division manager, is really
a noncash allocated cost and unavoidable. The outside vendor might be sent to the Casper
Division manager since the new machinery might be used to replace the existing equipment at
some future date.
(2) Yes, the transfer pricing system might be modified by charging the Cody Division with only the
variable cost; thus, the manager of the Cody Division would not be led to make erroneous
decisions. If the Casper Division's fixed cost is assigned to the Cody Division, it may be better to
charge this fixed cost as a lump sum per year rather than as a per-unit amount.
13-40.
(1) Peter Blair would not be likely to agree to the $40 rate. Since the Bondi Division is operating at
full capacity and can receive a rate of $50 per hour, Blair would be forfeiting revenue (and
contribution margin) of $10 per hour by agreeing to Helen Richard's request.
Blair's decision to reject Richard's proposal is reinforced by the corporate policy of evaluating
performance using ROI. The reduction in revenue and contribution margin will decrease Bondi
Division's ROI.
(2) The introductory order would benefit Olga Industries to the tune of $8,750, which represents the
incremental profit from the introductory order, as follows:
Manley revenues: $38,000 x 5 pools = $190,000

Bondi revenues lost: $50/hr. x $5,000/$40 hours x 5 pools = $31,250
Incremental revenues: $158,750
Incremental costs: $30,000 x 5 pools = $150,000
Another way to obtain the $8,750 is as follows:
Manley incremental profit: $3,000 x 5 pools = $15,000

Bondi profits foregone: ($15/hr. - $5/hr.) x $5,000/$40 hours x 5 pools = $6,250
(3) The $40 per hour transfer price is not reasonable. It would not be fair to Bondi Division, since
they are operating at full capacity and would stand to lose $10 per hour. Moreover, Manley could
pay the full $50 rate and still show a profit on the introductory order. A transfer price of $50 per
hour would result in a profit of $1,750, as follows:
Price $38,000
Costs:
Heating System Installation $6,250
Other Incremental Cost 30,000
Total Cost $36,250
Profit $1,750
Just because Manley's normal profit margin has been reduced by this introductory offer does not
mean that other divisions should also be expected share in the reduced profits. Richard has no
real justification for insisting on a $40 per hour transfer price because they should undertake the
introductory offer even at $50 per hour and will still be showing some profit.
(4) If Bondi was not operating at full capacity and could service Manley without affecting other
revenues, then any transfer price above the variable cost of $35 would benefit Bondi. So, in that
case, $40 would be a reasonable transfer price.
(5) Service-oriented divisions like Bondi typically do not have the amount of invested capital that a
manufacturing division would have. Rather, a service division is labor intensive, and these
"people assets" are not reflected in the balance sheet. Hence, a service division's ROI may not
be comparable to that of a manufacturing division. So, while a 42 percent ROI might be
impressive in most settings, it may not be all that great for a division like Bondi, which has
invested capital in equipment, but not in manufacturing facilities.
13-41.
(1) Divisional income statements:
Producing Division:
Revenue at market:
First crop (1,900,000 x M$l0) M$19,000,000
Second crop (1,900,000 x M$12) 22,800,000
Third crop (1,900,000 x M$8)
15,200,000
Total revenue M$57,000,000
Costs:
Labor and materials ($13,200,000  $0.33) M$40,000,000
Division overhead ($5,610,000  $0.33) 17,000,000
Total division costs 57,000,000
Division net income M$0
Selling Division:
Revenue $22,300,000
Costs:
Grain at market transfer price:
First crop (1,900,000 x M$10 x $0.34) $6,460,000
Second crop (1,900,000 x M$12 x $0.35) 7,980,000
Third crop (1,900,000 x M$8 x $0.33) 5,016,000
Total cost of grain $19,456,000
Labor 900,000
Division overhead 900,000
Total division costs $21,256,000
Division net income $1,044,000
Clearly, the producing division is merely breaking even. The sales division is able to manage
sales of the grain to earn a higher return than merely selling when each crop is ready for market.
The question that must be asked is what advantage exists for the company to grow its own
grain. Could the sales division buy grain in the open market at the same prices? If so, all the
effort put into production, which earns no net income, could be focused on the speculation
activities. Perhaps this year is an aberration, with profits shifting between the production and
sales divisions each year-when one is down, the other is up.
(2) Market price is the appropriate transfer price since the grain can be sold immediately on either
the domestic or international market rather than be held for speculation.
13-42.
This problem can be analyzed in several ways. One is conceptual with arguments presented to
support a transfer pricing strategy A second approach is to use the quantitative data to calculate
various solutions using different transfer prices. The following logical arguments can be used to
develop a transfer price policy. The following numerical analysis makes certain assumptions and
shows the implementation of the policy given the data in the problem. This problem does,
however, ignore governmental attempts to prevent the loss of tax revenue and laws and
regulations that define what transfer prices must include.
The data show that Country A has low import duties and high income tax rates. The goal would
be to use high transfer prices for goods moved into Country A. This would reduce taxable income
and lower income taxes. Country B has very high import duties and low income tax rates. By
using variable cost plus 10 percent as a transfer price, duties are minimized and high profits are
generated. These profits are taxed at lower rates. Country C has equal income tax and duty
rates.
The basic theme is to attempt to reduce total taxes for the total firm and, therefore, maximize
profits for the total firm. A question that is not addressed in the problem is whether transfer
prices specific for each country can be used. If not, a global study should be done to evaluate
the impact of various policies. The first set of columns in the following analysis uses sales prices
as the transfer price globally. The second set of columns uses variable cost plus 10 percent as
the global transfer price. Clearly, the variable cost version reduces total taxes paid (duties and
income tax). Other transfer price policies could be defined and tested. For example, in the third
set of columns, a full-cost transfer price is used for one country. Higher markups to obtain higher
prices might be tried. But the sales price and the variable cost-based transfer prices can be
considered extremes for policy evaluation purposes.
If country specific transfer prices can be used, the third set of columns presents the results of
using the following combinations:
Country A: Sales price transfer prices to take advantage of low duties and to reduce
taxable net income.
Country B: Variable cost-based transfer prices to take advantage of low income tax rates
and to reduce import duties.
Country C: Full-cost transfer prices because of the balance between income tax and
import duty rates.
The result is that the combination of transfer prices minimizes taxes and maximizes net income
after taxes.
Many other combinations could be tested in a simulation. Based on this data, the suggested
policy would be to develop a country specific strategy to take advantage of the different rate
situations in each country. Remember that country laws and regulations may prevent
implementing such a policy.
Reisman Company analysis of transfer prices at sales value, variable cost plus 10 percent, and
full cost (in thousands) :
Sales, Var. Cost,
Sales Price Transfer Variable Cost Plus Transfer & Full Cost Transfer
A B C A B C A B C
Sales – Outside $50.00 $100.0 $200.00 $50.000 $100.000 $200.000 $50.000 $100.000 $200.000
To A 10.0 9.00 3.520 3.168 10.000 9.000
To B 10.00 3.00 3.520 1.056 3.520 1.056
To C 5.00 28.0 1.760 9.856 4.000 2.400
Total sales $65.00 $138.0 $212.00 $55.280 $113.376 $204.224 $57.520 $132.400 $210.056
Cost of sales – Outside $40.00 $80.0 $160.00 $40.000 $80.000 $160.000 $40.000 $80.000 $160.000
To A 8.0 7.20 8.000 7.200 8.000 7.200
To B 8.00 2.40 8.000 2.400 8.000 2.400
To C 4.00 22.4 4.000 22.400 4.000 22.400
Total cost of sales $52.00 $110.4 $169.60 $52.000 $110.400 $169.600 $52.000 $110.400 $169.600
Cost of sales adjust:
Trans In – sales price $19.00 $13.0 $33.00 $19.000 $13.000 $33.000 $19.000 $13.000 $33.000
Trans Price – A (10.0) (5.00) (3.520) (1.760) (3.520) (4.000)
–B (10.00) (28.00) (3.520) (9.856) (10.000) (22.400)
–C (9.00) (3.0) (3.168) (1.056) (9.000) (1.056)
Minus adj to COS $0.00 $0.0 $0.00 $12.312 $8.424 $21.384 $0.000 $8.424 $6.600
Adj. cost of sales $52.00 $110.4 $169.60 $39.688 $101.976 $148.216 $52.000 $101.976 $163.000
Duties on Imports:
A – 10% 1.9 0.669 1.9
B – 70% 9.1 3.203 3.203
C – 40% 13.20 4.646 10.560
Total costs $53.90 $119.5 $182.80 $40.357 $105.179 $152.862 $53.900 $105.179 $173.560
Net income before tax $11.10 $18.5 $29.20 $14.923 $8.197 $51.362 $3.620 $27.221 $36.496
Income taxes 6.66 3.7 11.68 8.954 1.637 20.545 2.172 5.444 14.598
Net income after tax $4.44 $14.8 $17.52 $5.969 $6.560 $30.817 $1.448 $21.777 $21.898
Duties plus inc. taxes $8.56 $12.8 $24.88 $9.623 $4.840 $25.191 $4.072 $8.647 $25.158
Total taxes paid $46.24 $39.654 $37.877
Total net income $36.76 $43.346 $45.123
Solutions to Cases
CASE 13A – Meisels Corporation
(1) ROI can be an appropriate measure of a manager's performance if its limitations are clearly
understood. The basic issue is whether or not the manager controls the components of ROI.
For example, a profit figure must be defined such that it includes only those revenues and
expenses over which the manager can exercise control. The investment base should include
only those assets under the control of the manager. In this particular problem, managers
apparently control revenues, expenses, and investment in assets. Therefore, the measure may
be appropriate for managers.
(2) Improving the division ROI does not automatically result in an improved corporate ROI. Because
a manager's performance is evaluated by division ROI, the manager is motivated to maximize
the division ROI, regardless of the impact on corporate ROI. In other words, there is
suboptimum behavior from the company's point of view. For example, a division manager will
reject an investment yielding a return below its divisional ROI but above the corporate ROI. This
action keeps a high division ROI at the expense of depressing the corporate ROI. This whole
issue is one of goal congruence.
(3) Some comparative ratios:
Apparel Division Sports Gear Division
2007 2008 2009 2007 2008 2009
Market Share' 12.0% 12.5% 13.1% 10.0% 10.4% 10.4%
Contribution margin
percentage 2 70.0% 71.3% 70.5% 68.0% 72.0% 74.0%
Return on sales3 9.2% 14.1% 15.4% 2.0% 6.6% 9.9%
Asset turnover4 1.09 1.15 1.22 4.00 3.33 2.79
1
Division sales  Industry sales
2
Contribution margin  Division sales
3
Net income  Division sales
4
Division sales  Investment base
Apparel Division has:
1. Increased market share percentage.

2. Held contribution margin percentage constant while keeping fixed costs from growing much.
3. Slightly increased asset turnover by holding down investment.
4. Increased return on sales to an impressive level.
Sports Gear Division has:
1. Increased contribution margin but also increased fixed costs. (Variable costs acted more like
fixed costs, and fixed costs grew like variable costs.)
2 Increased sales.
3. Caused asset turnover to drop dramatically because the investment base has grown rapidly.
4. Improved dramatically the return on sales from a low 2.0% to 9.9%.
(4) (000s omitted) Apparel Division Sports Gear Division

2007 2008 2009 2007 2008 2009
Division net profit $110 $194 $245 $10 $43 $77
Investment base $1,100 $1,200 $1,300 $125 $195 $280
Minimum desired rate
of return 0.12 0.12 0.12 0.15 0.15 0.15
Capital charge $132 $144 $156 $19 $29 $42
Residual income ($22) $50 $89 ($9) $14 $35
Residual income
percentage (residual
income  investment
base) (2.00%) 4.20% 6.85% (7.20%) 7.18% 12.5%
(5) First, see Part (3) answers. Judging which manager is better is subjective. Both Gabor and Kiva
are apparently good performers, as reflected in the improvements in ROI. Other factors must be
reviewed in making the appropriate assessment. Factors to consider include the following:
(a) The Sports Gear Division is a newer division in relatively early stages of development. Kiva
has obtained a steady increase in sales and profit without many of the problems
encountered by startup operations.
(b) ROI has increased faster in the Sports Gear Division.
(c) The residual income percentage shows the Sports Gear Division is generating a higher rate
of residual income per dollar invested over time than is the Apparel Division. This increase is
in spite of the higher expected minimum rate of return that corporate management has
anticipated for the Sports Gear Division.
(d) Both divisions are able to promote sales growth in excess of the market growth, but the
Apparel Division is increasing its share of the market more rapidly than the Sports Gear
Division.
(e) Both divisions have been able to reduce costs as a percentage of sales, thereby increasing
the rate of return on sales. The Apparel Division has the lower cost to sales ratio over the
three-year period.
(f) Profit improvement from 2007 has been more dramatic for the Sports Gear Division than the
Apparel Division
CASE 13B – ERCULEAN ELECTRONICS
This is a very complex case conceived around very real-world issues. The following solution is
meant to be used as a guideline for generating discussions and grading student solutions. No exact
answers exist in the real world, and student solutions should be graded with this fact in mind.
Answers should be evaluated based on clarity of responses and justification of logic.
(1) Due to the differences between plants, Erculean Electronics has a very complex cost structure.
These differences should be kept in mind for incorporating these costs into the bidding and pricing
procedures for external business. First of all, each external sales opportunity should be evaluated
before the bidding is done. Issues to examine include: (1) Who is the customer and where is it
located? (2) When does the customer need the component? (3) What is the complexity of the
components? and, (4) How large is the order and how often will this order be placed? Only once or
on a repeating basis? Management must keep these issues in mind as it prepares a bidding policy.
Many differences exist among plants that could be critical in preparing bids. For instance, the labor
at the Jackson, Michigan, plant works under a guaranteed employment contract requiring the
company to pay each employee for 2,000 hours, regardless of whether or not the employee worked
the hours. Therefore, labor at this plant is a free good. This plant is highly automated, and the em-
ployees are highly skilled in using robotics and technical equipment. Jobs with high engineering
requirements and adaptable to computer integrated manufacturing (CIM) should be built in this
plant. If the company is looking for low labor costs in labor intensive jobs, then the Mexican plants
are probably the answer due to the low labor cost at those facilities. Unfortunately, these plants are
not located near the customers as are other plants. This consideration could present a problem in
meeting customers just-in-time delivery requirements. The location of the customer is very critical in
meeting just-in-time constraints, as 40 percent of Erculean's customers are located within 200 miles
of the Jackson plant. That plant could be very attractive in meeting stringent customer delivery
schedules.
One of Erculean's keys to success is its ability to adapt to a customer's needs quickly. If a customer
requires a custom part very quickly, the automated plants may or may not be able to adjust to the
customer's new needs. Ideally, the CIM environment will have much flexibility and be able to move
quickly to produce new designs. Yet, if a part is truly unique to the customer's needs, it may not be
possible to configure the machines to the specifications in time to meet the customer's time
requirements. A customized part may be made less expensively at one of the more labor-intensive
facilities, possibly one of the Mexican plants.
Management should also examine whether the bid in question is a one-time order or one that will
become repeat business. A highly specialized order that could become repeat business might justify
the time spent reconfiguring the robotics for the component. The time and efforts initially spent
could pay off in the long run. However, if the order will only be produced once, reconfiguring highly
automated machinery could price Erculean out of the bidding process. In addition, truly customized
orders usually are for smaller volumes. This fact makes the labor intensive Mexican plants more
attractive for these orders.
Finally, Erculean's management should never lose sight of the quality factor. Properly configured
and maintained robotics can often turn out a higher quality product than can human hands. It is
stated in the case, however, that the facilities with little automation and high labor intensity have a
history of producing high-quality components.
These are just a few of the issues management must consider in developing a bidding policy. While
a standard bidding policy could be constructed, every bid should be examined carefully to determine
the optimal bid price to maximize company profits.
(2) To develop a policy for pricing intracompany transfers, the logical place to start is with the basic
guidelines discussed in this chapter: The minimum price should be variable cost or variable cost plus
opportunity costs, and the maximum price should be market price. Then a negotiated price between
the maximum and minimum will allow the selling division to earn a positive contribution margin. In
turn, the buying division can save costs by purchasing internally at a lower cost than the outside
market price.
Unfortunately, the differences among the numerous plants at Erculean make determining the
variable costs of production very difficult. For instance, as mentioned earlier, the labor at the
Jackson, Michigan, plant is a free good and, therefore, not a variable cost. This could conceivably
make the variable costs at this plant only the direct materials and variable overhead. However,
determining the variable overhead rate at this highly automated plant could be very difficult. The
plant probably has very high fixed overhead due to the robotics. Basing a transfer price on variable
costs could force this plant into a loss center if it cannot recover its fixed costs.
Determining variable cost at the other plants will also present a problem. For example, at the Tulsa,
Oklahoma, facility, labor is not a free good; and the fully loaded labor rate is only about half of the
Jackson plant. Few worker classifications exist at this plant so defining labor at this plant could be
very difficult. Also, the labor rate in the Mexican plants is extremely low, making it very difficult to
compare this labor rate with the U.S. labor rates. The Mexican plants are also very labor intensive;
so, while the cost per hour may be very low, the high number of hours used may make up for the low
labor rate.
When plants are operating at full capacity or producing specific products, the company outsources
production. Erculean purchases the materials for the outside contractors, thus the direct materials
cost is known. However, the contractors have different cost structures; therefore, the price at which
Erculean purchases the finished component may differ among contractors. This variable throws
another wrench into determining the variable cost transfer price. Sending business to the outside
contractor does send possible contribution margin outside Erculean. Thus, special requirements or
meeting other corporate goals would be the only reasons for going outside.
Since Erculean is not the only manufacturer of these electronic components, an outside market
price should be available. However, since Erculean is in a very specialized market, the market
prices could vary considerably among manufacturers.
(3) To maximize Erculean's profits, management must consider carefully the decision of location
when producing different orders. Trying to match cost functions, types of production, volumes,
sources of business, and sales revenues among plants can be very difficult as previously outlined.
We will mention a few of the important characteristics of each of the facilities that students should
be considering in their answers to this section:
Jackson, Michigan. Labor is a free good at this plant due to the guaranteed labor contract. The
plant is highly automated which makes it attractive for higher volume production runs. Also, it is
within 200 miles of 40 percent of the customers. Plant location could be a critical factor if an order
must meet stringent customer just-in-time requirements.
Tulsa, Oklahoma. This is also a highly automated plant with very few worker classifications.
Definition of labor is unique to this plant due to the low number of worker classifications. This
means that workers have the training to do very different functions in the plant, and workers can be
moved around the production line to maximize the worker output.
Mexican plants. These are very labor intensive plants with low labor rates and very little
automation. These plants should be very attractive for producing low volume, very customized
components. Workers produce very high quality which is symbol of the company's success.
Outside contractors. These are used for certain components or when the other plants are
operating at full capacity. These contractors should not be disregarded. While using these
contractors may cost the company more than producing internally, they could be very critical in
meeting customer delivery requirements if Erculean's plants do not have the capacity. Erculean
should continue to 'throw a little work" to the contractors even when the other plants are not at
capacity to show the contractors that Erculean is committed to the work they do for them. In this
way, the contractors may be more willing to help Erculean meet tight schedule requirements when it
is at full capacity. In meeting other corporate goals, these contractors are often minority owned
businesses and are part of major corporations' affirmative action programs.
European plant. Currently, the company does not have a plant in Europe, although its European
customers are demanding a facility close to their plants. Erculean should evaluate each of its
existing plants, as well as the labor situation in Europe, to determine the best type of plant to
construct, a highly automated facility or a labor intensive one. The company should also consider
whether a facility is actually necessary before starting construction. It is possible that the existing
facilities can meet the international needs without any problems. Just-in-time needs may force a
positive decision to expand.
As mentioned at the beginning of this solution, no perfect answers to this case exist. It is a very
involved case and students' responses should be evaluated with these complexities in mind.

CH 13

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CHAPTER 13 SOLUTIONS

Note: In most cases, ROI is used in place of "return on investment."

Solutions to Questions for Review and Discussion

14. Goal Performance Administrative

(1) Minimization of world-wide income taxes and import duties.

13-1. Division Division Division

13-2. Electricity Division:

Current residual income:

New ROI: ($2,400,000 + $700,000) ÷ ($12,000,000 + $4,000,000) = 19.375%

New residual income:

13-4. The missing data are double-underlined and bolded:

Un: Residual income C$15,000

ROI: C$105,000 ÷ C$1,500,000 = 7%

Deux: Investment base = Net income  ROI = C$500,000  20% = C$2,500,000

Net income C$500,000

Trois: Net income = Investment base x ROI = C$2,000,000 x 12.5% = C$250,000

Net income C$250,000

Quatre: ROI: C$300,000  C$3,000,000 = 10%

Net income C$300,000

13-5. Residential Insurance Division (amounts in euros):

(1) 90,000 = Profit – 0.15 (700,000)

ROI = 195,000  700,000 = 27.86%

(2) 0.08 = 195,000  Sales

Asset turnover = 2,437,500  700,000 = 3.48

13-6. Southeast Division:

Projected ROI without the investment = $400,000  $1,200,000 = 33%

($480,000 – $40,000)  [$800,000 – 2 ($40,000)] = $440,000  $720,000 = 61.1%

(2) Residual income for the seventh year:

($480,000 – $40,000) – 0.14[$800,000 – 6 ($40,000)] = $440,000 – 0.14 (560,000)

13-9. Adjusted accounting profit:

$5,000,000 = x – 0.15 ($20,000,000)

13-12. The Shomovic Company:

Variable costs (100,000 grams x R1) R100,000

Average sales price to earn 20 percent rate of return on assets:

Net income = Average direct assets x Desired rate of return

Variable costs (70,000 grams x R1) R70,000

13-16. Profit centers and transfer prices:

13-18. Princeton Enterprises:

(2) Cost-based transfer price:

Division S income statement:

(3) Market-value transfer price:

Division S income statement:

Market value of 200,000 units $2,000,000

(a) Variable-cost transfer price: Refining Marketing Porath Oil

(b) Market price: Refining Marketing Porath Oil

(c) Full-cost transfer price: Refining Marketing Porath Oil

13-21. Transfer pricing problem:

(2) The minimum price should be $4.25 ($5 – $0.75).

Selling price 34.0

(3) Residual income = $800,000 – 0.13 ($3,500,000) = $800,000 – $455,000 = $345,000

13-27. Capital budgeting and ROI:

Investment Life of the Project

Disposal value of facility foregone ($8,000)

PV factor (IRR) = Disposal value  Net annual cash flow

13-28. The Skokie Company:

2 employees at $1,500 each $3,000

Make Costs Buy Costs

13-30. Morris Company:

Transfer price Pros Cons

Market price Forces Maintenance May not get quality maintenance.

Don’t do it Easy to do nothing. Hard to accurate performance

13-31. Cinnamon Corporation:

Selling price ($600,000 100,000 units) $6