10 Sep After reading information on business unit performance measurement in Chapter 14 of the Fundamentals

After reading information on business unit performance measurement in Chapter 14 of the Fundamentals of Cost Accounting text, complete the problems listed below. The problems will help you apply your knowledge of performance measures for investment centers and business units.

Complete the following problems:

· Problem 14-40, “Comparing Business Units Using Divisional Income, ROI, and Residual Income,” page 569.

· Problem 14-51, “Economic Value Added,” page 573.

14-40. Comparing Business Units Using Divisional Income, ROI, and Residual Income

Colonial Pharmaceuticals is a small firm specializing in new products. It is organized into two divisions, which are based on the products they produce. AC Division is smaller and the life of the products it produces tend to be shorter than those produced by the larger SO Division. Selected financial data for the past year is shown below. Divisional investment is as of the beginning of the year. Colonial Pharmaceuticals uses a 9 percent cost of capital and uses beginning-of-the-year investment when computing ROI and residual income. Ignore income taxes.

Required

a. Compute divisional income for the two divisions.

b. Calculate the operating margin, which is equivalent to the return on sales, for the two divisions.

c. Calculate ROI for the two divisions.

d. Compute residual income for the two divisions.

e. Assess the financial performance of the two divisions based on your analysis.

14-51. Economic Value Added

Bisbee Health Products invests heavily in research and development (R&D), although it must currently treat its R&D expenditures as expenses for financial accounting purposes. To encourage investment in R&D, Bisbee evaluates its division managers using EVA. The company adjusts accounting income for R&D expenditures by assuming these expenditures create assets with a two-year life. That is, the R&D expenditures are capitalized and then amortized over two years.

Western Division of Bisbee shows after-tax income of $7.5 million for year 2. R&D expenditures in year 1 amounted to $3 million and in year 2, R&D expenditures were $4.8 million. For purposes of computing EVA, Bisbee assumes all R&D expenditures are made at the beginning of the year. Before adjusting for R&D, Western Division shows assets of $30 million at the beginning of year 2 and current liabilities of $600,000. Bisbee computes EVA using divisional investment at the beginning of the year and a 14 percent cost of capital.

Required

Compute EVA for Western Division for year 2.

After reading information on transfer pricing in Chapter 15 of the Fundamentals of Cost Accounting text, complete the problems listed below. The problems will help you apply your knowledge of transfer pricing rules and segment reporting.

Complete the following problems:

· Problem 15-20, “Apply Transfer Pricing Rules,” page 604.

· Problem 15-44, “Segment Reporting,” page 613.

15-20. Apply Transfer Pricing Rules

Best Practices, Inc., is a management consulting firm. Its Corporate Division advises private firms on the adoption and use of cost management systems. Government Division consults with state and local governments. Government Division has a client that is interested in implementing an activity-based costing system in its public works department. The division’s head approached the head of Corporate Division about using one of its associates. Corporate Division charges clients $600 per hour for associate services, the same rate other consulting companies charge. The Government Division head complained that it could hire its own associate at an estimated variable cost of $200 per hour, which is what Corporate pays its associates.

Required

a. What is the minimum transfer price that Corporate Division should obtain for its services, assuming that it is operating at capacity?

b. What is the maximum price that Government Division should pay?

c. Would your answers in requirement (a) or (b) change if Corporate Division had idle capacity? If so, which answer would change, and what would the new amount be?

5-44. Segment Reporting

Midwest Entertainment has four operating divisions: Bus Charters, Lodging, Concerts, and Ticket Services. Each division is a separate segment for financial reporting purposes. Revenues and costs related to outside transactions were as follows for the past year (dollars in thousands):

Bus Charters Division participates in a frequent guest program with Lodging Division. During the past year, Bus Charters reported that it traded lodging award coupons for travel that had a retail value of $1.3 million, assuming that the travel was redeemed at full fares. Concerts Division offered 20 percent discounts to Midwest’s bus passengers and lodging guests. These discounts to bus passengers were estimated to have a retail value of $350,000. Midwest’s lodging guests redeemed $150,000 in concert discount coupons. Midwest’s hotels also provided rooms for Bus Charters’s employees (drivers and guides). The value of the rooms for the year was $650,000.

Ticket Services Division sold chartered tours for Bus Charters valued at $200,000 for the year. This service for intracompany lodging was valued at $100,000. It also sold concert tickets for Concerts; tickets for intracompany concert admission were valued at $50,000.

While preparing all of these data for financial statement presentation, Lodging Division’s controller stated that the value of the bus coupons should be based on their differential and opportunity costs, not on the full fare. This argument was supported because travel coupons are usually allocated to seats that would otherwise be empty or that are restricted similar to those on discount tickets. If the differential and opportunity costs were used for this transfer price, the value would be $250,000 instead of $1.3 million. Bus Charters’s controller made a similar argument concerning the concert discount coupons. If the differential cost basis were used for the concert coupons, the transfer price would be $50,000 instead of the $350,000.

Midwest reports assets in each division as follows (dollars in thousands):

Required

a. Using the retail values for transfer pricing for segment reporting purposes, what are the operating profits for each Midwest division?

b. What are the operating profits for each Midwest division using the differential cost basis for pricing transfers?

c. Rank each division by ROI using the transfer pricing methods in requir