Quiz 22: Responsibility Accounting and Transfer Pricing

Business

Contribution margin is a best tool to evaluating the effects of short term decisions on profitability. These decisions do not include the fixed cost as they are for the short run. While on the other side long run decisions include the fixed cost, so responsibility margin is consider in the long run. So if the company decided to expense $10000 in advertizing which will increase the sale either in both the departments by $50000. So in short run Department B is beneficial as it has high Contribution margin and in long run Department A is beneficial as it has high responsibility margin.

(a) Evaluation of Chamberlain's comments: A basic purpose of a responsibility accounting system is to measure the performance of specific responsibility centers. This means that the revenue and costs upon which a center is evaluated should be traceable directly to that center and, ideally, be under the center manager's control. Chamberlain is correct that allocating all fixed costs of the hotel (many of which are common costs) on the basis of gross revenue penalizes a successful profit center. Not only is the profit center charged with more costs as its revenue rises, but also it can be charged with more costs merely because the revenue in other profit centers declines. Thus, center performance may be obscured; the performance of strong profit centers may beunderstated, and the performance of weaker centers may be overstated since these centers are charged with less costs. In summary, Chamberlain's criticisms of the existing approach to assigning costs to profit centers are valid. His suggestion that fixed costs should instead be allocated in proportion to square feet of space is discussed below. Evaluation of Mettenburg's comments: Mettenburg is also correct in her criticism of Chamberlain's suggestion that fixed costs should be allocated on a basis of square feet of occupied space. Many fixed costs, such as salaries, may bear little or no relationship to square feet of space. Further, space occupied by a department may be a matter of circumstances not under the center's manager's direct control. Mettenburg, for example, does not have the option of "shrinking" the Sunset Lounge. The criticisms of the two managers point out that any allocation of common costs is necessarily arbitrary, rewarding some profit centers, but penalizing others. (b) The revenue of a center should be offset only by the related variable costs and by those fixed costs that are directly traceable to the center. Common fixed costs-those that jointly benefit several profit centers-should not be allocated among the centers deriving benefit. Thus, the responsibility income statement includes only those costs directly traceable to the center's activities. Furthermore, traceable fixed costs may be divided into the subcategories of controllable fixed costs and committed fixed costs. This enables the responsibility income statement to show as a subtotal (performance margin) those aspects of the center's operations that are readily controllable by the center manager.

Management makes use of accounting information about individual responsibility centers of the business in many ways, including (1) planning and allocating resources, (2) evaluating the performance of responsibility centers, (3) controlling costs, and (4) evaluating the performance of center managers.