Tutorial 3

Question 1 Performance Evaluation

Daniel Merrill & Co. Is a stock brokerage firm that evaluates its employees on sales
activity generated. Recently, the firm also began evaluating its stockbrokers on the
number of new accounts generated.

(a) Discuss how these two performance measures are consistent and how they may
conflict.
(b) Do you believe that these measures are appropriate for the long-term goal of
profitability?

Question 2 Responsiblity Accounting, Profit Centers, and Contribution Approach

Bloomington Honda had the following data for the year’s operation:
Sales of vehicles $2,400,000
Sales of parts and service 600,000
Cost of vehicle sales 1,920,000
Parts and service materials 180,000
Parts and service labour 240,000
Parts and service overhead 60,000
General dealership overhead 200,000
Advertising of vehicles 120,000
Sales commissions, vehicles 48,000
Sales salaries, vehicles 60,000
The president of the dealership has long regarded the markup on material and labour
for the parts and service activity as the amount that is supposed to cover all parts and
service overhead plus some general overhead of the dealership. In other words, the
parts and service department is viewed as a cost recovery operation, while the sales of
vehicles is viewed as the income-producing activity.
1. Prepare a departmentalised operating statement that harmonizes with the views
of the president.
2. Prepare an alternative operating statement that would reflect a different view of
the dealership operations. Assume that $24,000 and $120,000 of the $200,000
general overhead can be allocated with confidence to the parts and service
department and to sales of vehicles, respectively. The remaining $56,000 cannot
be allocated except in some highly arbitrary manner.
3. Comment on the relative merits of numbers 1 and 2.
Question 3 Simple ROI Calculation

You are given the following data:

Sales $120,000,000
Invested capital $ 60,000,000
Net income $ 6,000,000
Compute the following:
(a) Turnover of capital
(b) Return on sales
(c) Return on investment (ROI)

Question 4 Simple ROI Calculation

Fill in the blanks

Division
A B C
Return on sales 7% 3% _%
Capital turnover 3 _ 4
Rate of return on invested capital _% 18% 20%

Question 5 Simple ROI and Economic Profit Calculations

Consider the following data:

Division
X Y Z
Invested capital $1,000,000 $ $1,250,000
Income $ $182,000 $162,500
Revenue $2,500,000 $3,640,000 $
Return on sales 4% % %
Capital turnover 3
Rate of return on invested capital % 14% %

1. Prepare a simple tabular presentation, filling in all blanks

2. Suppose each division is assessed a capital charge based on a cost of capital of
12% of invested capital. Compute the economic profit for each division.
3. Which division is the best performer? Explain.
Question 6 EVA at Briggs & Stratton

Briggs & Stratton Corporation is the world’s largest maker of air-cooled gasoline
engines for outdoor powered equipment. The company’s engines are used by the lawn
and garden equipment industry. According to the company’s annual report,
“management subscribes to the premise that the value of Briggs & Stratton is enhanced
if capital invested in its operations yield a cash return that is greater than that expected
by the providers of capital.”

The following data are from Briggs & Stratton’s 2008 annual report with the operating
profit and average invested capital adjusted to reflect the capitalization of R&D and the
use of FIFO inventories (thousands of dollars):

2018 2017

Adjusted before tax operating profit $ 71,460 $ 52,190

Cash taxes 10,853 30,424
Adjusted average invested capital 1,687,082 1,652,321
Cost of capital 9.40% 9.90%

1. Compute the EVA for Griggs & Stratton for 2017 and 2018.
2. Did Briggs & Stratton’s overall performance improve from 2017 to 2018? Explain.

Question 7 Comparison of Assets and Equity Bases

Laurel Company has assets of $2 million and long-term, 10% debt of $1,200,000. Hardy
Company has assets of $2 million and no-long term debt. The annual operating income
(before interest) of both companies is $400,000. Ignore taxes.
1. Compute the rate of return on
a. Assets, and
b. Stockholders’ equity
2. Evaluate the relative merits of each base for appraising operating management.
Question 8 Variable Cost as a Transfer Price

A chair’s variable cost is $50 and its market value as a piece of unfinished furniture is
$63 at a transfer point from the assembly division to the finishing division. The finishing
division’s variable cost of sanding and finishing the chair is $28, and the selling price of
the finished chair is $85.
1. Prepare a tabulation of the contribution margin per unit for the finishing division’s
performance and the overall company’s performance under two alternatives of
(a) selling to outsiders at the transfer point and (b) sanding and finishing the chair
and then sell to outsiders.
2. As finishing manager, which alternative would you choose? Explain.

Question 9 Maximum and Minimum Transfer Price

Sherwin Company makes bicycles. Various divisions make components and transfer
them to the Dayton Division for assembly into the final product. The Dayton division can
also buy components from external suppliers. The Toledo divisions make wheels, and it
also sell wheels to external customers. All divisions are profit centres, and managers
are free to negotiate transfer prices. Prices and cost for Toledo and Dayton divisions are
as follows:

Toledo Division
Sales price to external customers $ 14
Internal transfer price ?
Costs
Variable costs per wheel $ 10
Total fixed costs $ 320,000
Budgeted production 64,000 wheels*
*Include production for transfer to Dayton

Dayton Division
Sales price to external customers $ 170
Costs
Wheels, per bicycle ?
Othe components, per bicycle $ 85
Other variable costs, per bicycle $ 45
Total fixed costs $ 640,000
Budgeted production 16,000 bicycles

Fixed costs in both divisions will be unaffected by the transfer of wheels from Toledo to
Dayton.
 1. Compute the maximum transfer price per wheel the Dayton division would be
willing to pay to buy wheels from the Toledo division.
2. Compute the minimum transfer price per wheel at which the Toledo division
would be willing to produce and sell wheels to the Dayton division. Assume that
Toledo has excess capacity.

Question 10 Transfer Pricing

The shocks and struts division of Transnational Motors Company produces strut
assemblies for automobiles. It has been the sole supplier of strut assemblies to the
automotive division and charges $45 per unit, the current market price for very large
wholesale lots. The shocks and strut division also sells to outside retail outlets at $57
per unit. Normally outside sales amount to 25% of a total sales volume of 1 million strut
assemblies per year. Typical combined annual data for the division follow:

Sales $ 48,000,000
Variable costs at $37.50 per strut assembly $ 37,500,000
Fixed costs 4,500,000
Total costs $ 42,000,000
Gross margin $ 6,000,000

Flint Auto Parts Company, an entirely separate entity, has offered the automotive
division comparable strut assemblies at a firm price of $42 per unit. The shocks and
strut division of Transnational Motors claims that it cannot possibly match this price
because it could not earn any margin at $42.

1. Assume that you are the manager of the automotive division of Transnational
Motors. Comment on the shocks and strut division’s claim. Assume that normal
outside volume cannot be increased.
2. Now assume the shocks and strut division believes that it can increase outside
sales by 750,000 strut assemblies per year by increasing fixed costs by $3
million and variable costs by $4.50 per unit while reducing the selling price to
$54. Assume the maximum capacity is 1 million strut assemblies per year.
Should the division reject intracompany business and concentrate on outside
sales?
Question 11 Negotiated Transfer Prices

The Lighting division of Ibex Office Furniture needs 1,200 units of a leaded-glass lamp
shade from the fabricating division. The company has a policy of negotiated transfer
prices.
The fabricating division has enough excess capacity to produce 2,000 units of lamp
shades. Its variable cost of production is $23. The market price of lamp shade to
external customers is $39.
What is the natural bargaining range for a transfer price between the two divisions?
Explain why no price below your range would be acceptable. Also explain why no price
above your range would be acceptable.

Question 12 Transfer price

Food Technology Ltd (FTL) has two divisions: A and B. B currently sells a sambal powder
to manufacturers of chilli sauce for £23 per packet. Variable costs amount to £15, and
demand for this product currently exceeds the division’s ability to supply the marketplace.

Despite this situation, FTL’s head office management is considering another use for the
sambal powder, namely, integration into a Korean noodle that would be manufactured by
A. The noodle has an anticipated selling price of £42 per packet and requires an additional
£22 of variable manufacturing costs. A transfer price of £22 has been established for the
sambal powder.
Head Office management is anxious to introduce the new noodle. However, unless the
transfer is made, an introduction will not be possible because of the difficulty of obtaining
the needed sambal powders from the external market. The B and A divisions are in the
process of recovering from financial problems, and neither division can afford any further
losses. The company uses return on investment (ROI) to measure divisional performance
and awards bonuses to divisional management based on their division’s performance.
Required:
(a) How might B’s divisional manager react to the decision to transfer sambal powders to
A? Show calculations to support your answer.
(b) How might A’s divisional manager react to the £22 transfer price? Show calculations
to support your answer.
(c) Assume a lower transfer price is desired. Should head office management lower the
price or should the price be lowered by another means? Explain.
(d) From a contribution margin perspective, does FTL benefit more if it sells the sambal
powders externally or transfers the sambal powders to A? By how much?