CHAPTER 12

FINANCIAL PERFORMANCE
REPORTS AND TRANSFER PRICING

ANSWERS TO TUTORIAL QUESTIONS

EXERCISE 12.26 Business unit profit statement: service company
1
Profit Statement: Sparky Electrical Services
Business units
Total Metro Suburban Regional
services
Service revenue $2 050 000 $950 000 $750 000 $350 000
Variable expenses 300 000 150 000 100 000 50 000
Unit contribution margin 1 750 000 800 000 650 000 $300 000
Less: fixed expenses
controllable by unit
manager 720 000 350 000 270 000 100 000
Profit margin controllable by
unit manager $1 030 000 450 000 380 000 200 000
Less: fixed expenses,
traceable to unit, but
controllable by others 370 000 180 000 150 000 40 000
Profit margin traceable to
unit 660 000 $270 000 $230 000 $160 000

Less: common fixed expenses 45 000

Profit before taxes 615 000
Less: income tax expense 245 000
Net profit $370 000

2
Profit Statement: Sparky Electrical Services
Business units
Total Metro Suburban Regional
services
Service revenue $2 090 000 $960 000 $780 000 $350 000
Variable expenses 300 000 150 000 100 000 50 000
Unit contribution margin 1 790 000 810 000 680 000 $300 000
Less: fixed expenses
controllable by unit
manager 720 000 350 000 270 000 100 000
Profit margin controllable by
unit manager $1 070 000 460 000 410 000 200 000
Less: fixed expenses,
traceable to unit, but
controllable by others 370 000 180 000 150 000 40 000
Profit margin traceable to
unit 700 000 $280 000 $260 000 $160 000

Less: common fixed expenses 45 000

Profit before taxes 655 000
Less: income tax expense 245 000
Net profit $410 000
EXERCISE 12.28 Performance report: hotel

The performance report of the Byron Bay Hotel is as follows:

Flexible budget Actual results Variance Variance

March Year to date March Year to date March Yr to date
Food and Beverage Dept
Banquets and catering $650 $1910 $658 $1 923 $8 F $13 F
Restaurants 1800 $5550 1794 5 534 $6 U $16 U
Kitchen (1065) $(3233) (1069) (3242) $4 U $9 U
Total profit $1385 $4227 1383 4215
Kitchen $1 U $2 U
Kitchen staff wages $(85) $(253) $(86) $(255) $0 - $1 U
Food (690) (2110) (690) (2111) $3 F $5 F
Paper products (125) (375) (122) (370) $3 U $7 U
Variable overhead (75) (225) (78) (232) $3 U $4 U
Fixed overhead (90) (270) (93) (274) $4 U $9 U
Total costs (1065) (3233) (1069) (3242) $8 F $13 F

EXERCISE 12.29 General transfer pricing rule: manufacturer

1 If the Assembly Division has spare capacity, there is no opportunity cost associated with a transfer.
Therefore:
outlay opportunity
Transfer price = +
cost cost
= $300 + 0 = $300

2 outlay opportunity
Transfer price = +
cost cost
= $300 + $80† = $380

† Opportunity cost = forgone contribution margin

= $380 – $300 = $80

3 If the Assembly Division has spare capacity and no outside market exists for the transferred component,
the transfer price should be based on the variable cost per unit, $300, plus a small profit margin to
provide an incentive for the Assembly Division to manufacture and transfer the component to the
Electrical Division.
EXERCISE 12.30 Cost-based transfer pricing: manufacturer

1 The Electrical Division’s manager is likely to reject the special offer because the Electrical Division’s
incremental cost on the special order exceeds the division’s incremental revenue:
Incremental revenue per unit of the special order $465
Incremental cost per unit to the Electrical Division per unit for the special
order:
Transfer price $374
Additional variable cost 100
Total incremental cost 474
Loss per unit in special order for the Electrical Division $(9)
2
The Electrical Division manager’s decision to reject the special order is not in the best interests of the
company as a whole, since the company’s incremental revenue on the special order exceeds the company’s
incremental cost.
Incremental revenue per unit in special order $465
Incremental cost to company per unit in special order:
Unit variable cost incurred in Assembly Division $300
Unit variable cost incurred in Electrical Division 100
Total unit variable cost 400
Profit per unit in special order for the company as a whole $65
3 The transfer price could be set in accordance with the general rule, as follows:
Transfer price = outlay cost + opportunity cost
= $300 + 0*
= $300
* Opportunity cost is zero, since the Assembly Division has spare capacity.
The Assembly Division will want to make a profit on the transfer, so that transfer price will be $300 plus a
profit margin. The Electrical Division manager will have an incentive to accept the special order since the
Electrical Division’s incremental revenue on the special order exceeds the incremental cost. Any transfer price
that is between $300 and $365 will allow the Electrical Division to make a profit.
PROBLEM 12.35 Preparation of performance reports including variances from budget:
hospital

1 The performance report of the Richmond General Hospital is as follows:

Flexible Budget Actual Results Variance*

Year Year Year
to to to
August Date August Date August Date
Richmond General Hospital $1 165 400 $9 323 200 $1 162 300 $9 316 600 $3 100 F $6 600 F

General Medicine Division $420 000 $3 360 000 $408 000 $3 341 800 $12 000 F $18 200 F
Surgical Division 280 000 2 240 000 282 000 2 231 600 2 000 U 8 400 F
Medical Support Division 365 400 2 923 200 365 300 2 931 200 100 F 8 000 U
Administrative Division 100 000 800 000 107 000 812 000 7 000 U 12,000 U
Total cost $1 165 400 $9 323 200 $1 162 300 $9 316 600 $3 100 F $6 600 F
Medical Support Division
Nursing Department $140 000 $1 120 000 $150 000 $1 160 000 $10 000 U $40 000 U
Radiology Department 36 000 288 000 36 200 288 000 200 U –
Nutrition Department 143 400 1 147 200 143 900 1 157 200 500 U 10 000 U
Housekeeping Department 20 000 160 000 23 200 172 000 3 200 U 12 000 U
Maintenance Department 26 000 208 000 12 000 154 000 14 000 F 54 000 F
Total cost $365 400 $2 923 200 $365 300 $2 931 200 $100 F $8 000 U
Nutrition Department
Dietitian Department $15 000 $120 000 $15 000 $120 000 – –
Food Service Section 66 400 531 200 70 100 545 200 $3 700 U $14 000 U
Kitchen 62 000 496 000 58 800 492 000 3 200 F 4 000 F
Total cost $143 400 $1 147 200 $143 900 $1 157 200 500 U $10 000 U
Food Service Section
Patient Food Service $34 000 $272 000 $37 000 $274 000 $3 000 U $2 000 U
Cafeteria 32 400 259 200 33 100 271 200 700 U 12 000 U
Total cost $66 400 $531 200 $70 100 $545 200 $3 700 U $14 000 U
Cafeteria
Wages $16 000 $128 000 $18 000 $144 000 $2 000 U $16 000 U
Paper products 9 000 72 000 8 800 72 400 200 F 400 U
Utilities 2 000 16 000 2 100 16 200 100 U 200 U
Maintenance 800 6 400 200 2 200 600 F 4 200 F
Security 2 200 17 600 2 200 17 200 – 400 F
Supplies 2 400 19 200 1 800 19 200 600 F –
Total cost $32 400 $259 200 $33 100 $271 200 $700 U $12 000 U

*F denotes favourable variance; U denotes unfavourable variance.

2 Arrows are included on the performance report to show the cost relationships.
3 A variety of responses are reasonable for this question. Since the data given in the problem do not include the
individual variances over several months, it is not possible to condition the investigation on trends. The largest
variances in the performance report are the most likely to warrant an investigation. The following variances
for August would likely catch the attention of the hospital administrator:

General Medicine Division $12 000 F

Administrative Division 7 000 U
Nursing Department 10 000 U
Maintenance Department 14 000 F
Cafeteria wages 2 000 U

The $2000 variance for wages in the cafeteria is smaller than some of the variances not listed above. However,
it is a relatively large variance for only one cost item in the subunit. In contrast, the $3200 variance for the
kitchen is for an entire subunit of the hospital.

PROBLEM 12.36 Business unit profit statement; responsibility accounting: retailer

1 Business unit profit statement for Modern Music Malaysia:

Modern
Music
Malaysia KL Malacca Sunway
Sales revenue RM1 998 000 RM 666 000 RM 676 500 RM 655 500
Variable operating expenses:
Cost of goods sold RM 1 057 500 RM 305 250 RM 338 250 RM 414 000
Sales commissions 119 880 39 960 40 590 39 330
Total RM 1 177 380 RM 345 210 RM 378 840 RM 453 330
Unit contribution margin RM 820 620 RM 320 790 RM 297 660 RM 202 170
Less: fixed expenses controllable by unit manager:
Local advertising 121 500 16 500 33 000 72 000
Sales manager salary 48 000 – – 48 000
Total 169 500 16 500 33 000 120 000
Profit margin controllable by unit manager
RM 651 120 RM 304 290 RM 264 660 RM 82 170
Less: fixed expenses traceable to unit, but
controllable by others:
Local property taxes RM18 750 RM 6 750 RM3 000 RM
9 000
Store manager salaries 162 000 46 500 58 500 57 000
Other 42 300 8 700 6 900 26 700
Total RM 223 050 RM 61 950 RM 68 400 RM 92 700
Unit profit margin RM 428 070 RM 242 340 RM 196 260 RM (10 530)
Less: common fixed expenses 288 450
Net profit RM 139 620

Supporting calculations:
Sales revenue: KL, 37 000 units  RM 18.00; Malacca, 41 000 units  RM 16.50; Sunway, 46 000 units  RM
14.25
Cost of goods sold: KL, 37 000 units  RM 8.25; Malacca, 41 000 units  RM 8.25; Sunway, 46 000 units  RM
9.00
Sales commissions: KL, RM 666 000  6%; Malacca, RM 676 500  6%; Sunway, RM 655 500  6%

As shown in the table above, KL has the highest profit margin, followed by Malacca.
2 Sunway is the weakest unit because of several factors:
  KL and Malacca have a much higher unit contribution margin: 118% (RM9.75/RM8.25) and 100%
(RM8.25/RM8.25). However, Sunway’s contribution margin is only 58% (RM5.25/RM9.00). The
company might want to consider increasing the selling prices at Sunway or find ways of reducing
costs.
 Despite being the only store that has a sales manager, and spending considerably more on
advertising than KL and Malacca, Sunway has the lowest gross dollar sales of the three stores.
Sunway’s return from these outlays appears to be low. However, it may be that these activities will
increase sales in the next period.
 Sunway’s ‘other’ non-controllable costs are much higher than those of KL and Malacca. More
information is needed about the composition of these costs.

3 Modern Music Malaysia uses a responsibility accounting system, meaning that managers and centres
should be evaluated on the basis of activities under their control or influence. The decision should be
made by reviewing the profit margin controllable by the store manager. However, some would argue that
the profit margin of each store should still be considered, even if it is not entirely under the manager’s
control. It would also be useful to know how long each of the store managers has been in their current
positions and to know how effective their performance has been compared to their budget/plan.

PROBLEM 12.37 Transfer pricing problem: manufacturer

1 (a) Transfer price = outlay cost + opportunity cost

= $130 + $30 = $160
(b) Transfer price = standard variable cost + (10%)(standard variable cost)
= $130 + (10%)($130) = $143
Note that the Frame Division manager would be likely to refuse to transfer at this price.
2 (a) Transfer price = outlay cost + opportunity cost
= $130 + 0 = $130
(b) When there is no spare capacity, the opportunity cost is the forgone contribution margin on an
external sale when a frame is transferred to the Glass Division. The contribution margin equals
$30 (i.e. $160 – $130). When there is spare capacity in the Frame Division, there is no opportunity
cost associated with a transfer. Students should not be formula bound here but understand the
rationale: when there is no spare capacity this manager can sell all output for $160. Hence, they
would not be willing to transfer at $143. When there is spare capacity anything over $130 will
increase their profit. This argument is reflected in the use of the opportunity cost.
(c) Fixed overhead per frame (125%)($80) = $100
Transfer price = variable cost + fixed overhead per frame
+ (10%)(variable cost + fixed overhead per frame)
= $130 + $50 + [(10%)($130 + $50)]
= $198

(d) Incremental revenue per window $310

Incremental cost per window
Direct material (Frame Division) $30
Direct labour (Frame Division) 40
Variable overhead (Frame Division) 60
Direct material (Glass Division) 60
Direct labour (Glass Division) 30
Variable overhead (Glass Division) 60
Total variable (incremental) cost 280
Incremental contribution per window in special order
for Clear Water Company $30
 From the perspective of the company as a whole, the special order should be accepted because the
incremental revenue exceeds the incremental cost.

(e) Incremental revenue per window $310

Incremental cost per window, for the Glass Division:
Transfer price for frame [from requirement 2(c)] $198
Direct material (Glass Division) 60
Direct labour (Glass Division) 30
Variable overhead (Glass Division) 60
Total incremental cost 348
Incremental loss per window in special order
for Glass Division $ (38)
The Glass Division manager has an incentive to reject the special order because the Glass Division’s
reported net profit would be reduced by $38 for every window in the order.

3 The price to transfer 200 units from the Frame Division to the Glass Division is $380 per unit.
Minimum transfer price = incremental cost per unit + opportunity cost per unit
= [(200 x $130) + (150 x $80)]/200
= $38 000 / 200
= $190 per unit

This transfer price will not change the profits of the Frame Division. If the units are transferred then the
Frame Division may also add a profit margin to make the transfer worthwhile. Note that the Frame
Division only has sufficient capacity to manufacture 100 of the total 200 units required by the Glass
Division. The opportunity cost in this calculation relates to the forgone profit of $80 per unit for the 150
units that could not be manufactured and sold to external customers if the extra 100 units are
manufactured and transferred to the Glass Division. The Frame Division must consider any impact on
regular external customers if the Frame Division cannot supply them with their usual product. This could
result in lead to a decrease in the company’s reputation, and loss of future external sales as disappointed
customers seek out other suppliers.

The manager of the Frame Division could transfer the 200 units at an average price of $190 per unit, or it
could transfer 100 units at anything above the variable cost of $130 per unit to utilise its spare capacity.
The manager of the Glass Division will not find the price of $190 per unit for 200 units attractive as it is
higher than the market prices of $160 per unit. Thus, the manager would prefer to purchase 100 units at a
price less than the market price of $160 from the Frame Division and the remaining 100 units at $160
from the external market. If the manager of the Glass Division does not want to manage two suppliers or
if the Glass Division insist on charging market price, then the Glass Division may end up purchasing all
of the 200 units from the outside supplier.

PROBLEM 12.39 Multiple interdivisional transfers; accept or reject outside contract:

manufacturer

1 In order to maximise short-run contribution margin, the Crater Division should accept the contract from
Eros Company. This conclusion is supported by the following calculations:

(a) Crater transfer to Dollar:

Transfer price (3000 units @ $2250 each) $6 750 000
Variable cost:
Purchase from Brentwood (3000 units @ $900 each) $2 700 000
Processing by Crater (3000 units @ $750 each) 2 250 000
Total variable cost 4 950 000
Contribution margin for Crater Division $1 800 000
(b) Crater accepts Eros contract:
Selling price (3500 units @ $1875 each) $6 562 500
Variable cost:
Purchase from Brentwood (3500 units @ $750 each) $2 625 000
Processing by Crater (3500 units @ $600 each) 2 100 000
Total variable cost 4 725 000
Contribution margin to Crater Division $1 837 500

Conclusion:
Contribution margin from Eros contract $1 837 500
Contribution margin from Dollar sale 1 800 000
Difference in favour of Eros contract $37 500

2 Crater Division’s decision to accept the contract from Eros Company is in the best interest of Rabbid
Industries Ltd as the decision increases the overall contribution margin of the company. This conclusion
is supported by the following calculations.
Revenues and cost savings to Rabbid Industries Ltd:
Sales by Crater to Eros (3500 units @ $1875 each) $6 562 500
Sales by Brentwood to Frantic (3000 units @ $600 each) 1 800 000
Cost savings (variable costs avoided by not accepting the Dollar order)
Brentwood’s savings (3000 units @ $450) 1350 000
Crater’s savings (3000 units @ $750) 2 250 000
Total revenue and cost savings $11 962 500

Expenditures incurred by Rabbid Industries Ltd:

Variable cost incurred for the Eros order:
Crater (3500 units @ $600 each) $2 100 000
Brentwood (3500 units @ $375 each) 1 312 500
Variable cost incurred for purchase:
Dollar from Frantic (3000 units @ $2250 each) 6 750 000
Frantic from Brentwood (3000 units @ $300 each) 900 000
Total expenditures incurred 11 062 500
Additional contribution margin to Rabbid Industries Ltd $900 000

CASE 12.43 Business unit profit statement: manufacturer

1 Business unit profit statement by geographic areas:

Asian Style Industries

Business unit profit statement by geographic area
for the year ended 30 June
Geographic areas
Australia New Singapore Un- Total
Zealand allocated
Sales in unitsa
Furniture 32 000 8 000 40 000 80 000
Sports 36 000 36 000 18 000 90 000
Housewares 16 000 16 000 48 000 80 000
Total unit sales 84 000 60 000 106 000 250 000

Revenueb
Furniture $512 000 $128 000 $640 000 $1 280 000
Sports 1 440 000 1 440 000 720 000 3 600 000
Housewares 480 000 480 000 1 440 000 2 400 000
 Total revenue $2 432 000 $2 048 000 $2 800 000 $7 280 000

Variable costsc
Furniture $384 000 $96 000 $480 000 $960 000
Sports 864 000 864 000 432 000 2 160 000
Housewares 336 000 336 000 1 008 000 1 680 000
Total variable costs $1 584 000 $1 296 000 $1 920 000 $4 800 000
Contribution margin $848 000 $752 000 $880 000 $2 480 000

Fixed costs
Manufacturing
overheadd $165 000 $135 000 $200 000 $500 000
Depreciatione 134 400 96 000 169 600 400 000
Administrative and
selling expenses 60 000 100 000 250 000 $750 000 1 160 000
Total fixed costs $359 400 $331 000 $619 600 $750 000 $2 060 000
Operating profit
(loss) $488 600 $421 000 $260 400 $(750 000) $420 000

Supporting Calculations:

Sales in unitsa
Total units  % of sales = Units sold
Australia
Furniture 80 000 0.40 32 000
Sports 90 000 0.40 36 000
Housewares 80 000 0.20 16 000

New Zealand
Furniture 80 000 0.10 8 000
Sports 90 000 0.40 36 000
Housewares 80 000 0.20 16 000

Singapore
Furniture 80 000 0.50 40 000
Sports 90 000 0.20 18 000
Housewares 80 000 0.60 48 000

Revenueb
Units Sold Unit Price Revenue
Australia
Furniture 32 000 $16.00 $512 000
Sports 36 000 40.00 1 440 000
Housewares 16 000 30.00 480 000

New Zealand
Furniture 8 000 16.00 128 000
Sports 36 000 40.00 1 440 000
 Housewares 16 000 30.00 480 000

Singapore
Furniture 40 000 16.00 640 000
Sports 18 000 40.00 720 000
Housewares 48 000 30.00 1 440 000

Variable costsc
Units sold Variable mfg Variable selling Total variable
cost/unit cost/unit cost
(1) (2) (3) (1)  [(2) + (3)]
Australia
Furniture 32 000 $8.00 $4.00 $384 000
Sports 36 000 19.00 5.00 864 000
Housewares 16 000 16.50 4.50 336 000

New Zealand
Furniture 8 000 8.00 4.00 96 000
Sports 36 000 19.00 5.00 864 000
Housewares 16 000 16.50 4.50 336 000

Singapore
Furniture 40 000 8.00 4.00 480 000
Sports 18 000 19.00 5.00 432 000
Housewares 48 000 16.50 4.50 1 008 000

Manufacturing overheadd
Total Area Proportion Allocated
manufacturing variable of total manufacturing
overhead costs cost
Australia $500 000 $1 584 000 33% $165 000
New Zealand 500 000 1 296 000 27% 135 000
Singapore 500 000 1 920 000 40% 200 000
Total $4 800 000 $500 000
Depreciation expensee
Total Area units Proportion Allocated
depreciation sold of total depreciation
Australia $400 000 84 000 33.6% $134 400
New Zealand 400 000 60 000 24.0% 96 000
Singapore 400 000 106 000 42.4% 169 600
Total 250 000 $400 000

2 Areas where the company’s management should focus its attention in order to improve corporate
profitability include the following:
 The profit statement by product line shows that the furniture product line may not be profitable.
The furniture product line does have a positive contribution. However, the fixed costs assigned to
the product line result in a loss. Management should investigate:
 the possibility of increasing the selling price of these products
 the possibility of increasing volume by cutting prices or increasing advertising, resulting in
a larger total contribution margin
 the potential for reducing variable costs associated with this product line
  discontinuing the manufacture of furniture and concentrating on the other product lines that
are more profitable
 determining how much of the fixed costs allocated to furniture are avoidable if the product
line is discontinued.

 The profit statement by geographic area shows that the Singapore market is the least profitable
sales area, despite having the highest unit sales volume and the highest total revenue. In order to
improve the profit margin in the Singapore market, management should:
 investigate the selling and administrative expenses in this area, as they are considerably
higher than those in other areas
 consider increasing the sales of product lines other than furniture as this product line makes
the smallest contribution to profit.

 Management should review the unallocated expenses in an attempt to reduce these costs and
improve overall profitability.