To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER INTRODUCTION: THE ROLE, HISTORY, AND DIRECTION OF MANAGEMENT ACCOUNTING QUESTIONS FOR WRITING AND DISCUSSION A management accounting information system is an information system that produces outputs using inputs and processes needed to satisfy specific managerial objectives Continuous improvement means searching for ways of increasing overall efficiency and productivity of activities by reducing waste, increasing quality, and reducing costs The inputs of a management accounting information system are economic events The processes transform the inputs into outputs and are such things as collecting, measuring, storing, analyzing, reporting, and managing Typical outputs include special reports, product costs, customer costs, performance reports, budgets, and personal communication Employee empowerment is allowing operational workers to plan, control, and make decisions without explicit authorization from middle- and higher-level managers The three objectives of a management accounting information system are as follows: To provide information for costing out services, products, and other objects of interest to management; to provide information for planning, controlling, evaluation, and continuous improvement; and to provide information for decision making All organizations — manufacturing, merchandising, and services — must have a good management accounting information system Management accounting concepts and procedures are not restricted to any one type of organization The users of management accounting information are managers and workers within the organization Anyone internal to an organization is a potential user of management accounting information Management accounting information is used to cost out objects (for example, services and products) and to aid in planning, controlling, evaluation, continuous improvement, and decision making Both financial and nonfinancial information should be provided by the management accounting information system Nonfinancial information provides insights useful for controlling operations — it is easily used by operational workers Financial information is critical for evaluating the success of operational control 10 Operational workers must be informed so that they can evaluate and monitor the effectiveness of their decisions 11 Planning establishes performance standards, feedback compares actual performance with planned performance, and controlling uses feedback to evaluate deviations from plans 12 Performance reports are formal reports that compare actual data with planned data or benchmarks and thus provide signals to managers that allow them to take corrective actions 13 Management accounting differs from financial accounting in the following major ways: (1) internally focused, (2) no mandated rules, (3) financial and nonfinancial; subjective information possible, (4) emphasis on the future, (5) internal evaluation and decisions based on very detailed information, (6) broad, multidisciplinary 14 The requirement to prepare reports for external users created a demand for a particular accounting information system This system was geared to produce inventory costs Aggregate average cost information apparently was sufficient for most internal decisions Thus, management accounting became an extension of the financial accounting system This outcome was probably due to a favorable cost-benefit tradeoff The incremental cost of producing To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com more accurate product costs was not offset by the incremental benefits of improved decision making However, significant changes in the competitive environment have increased the cost of making bad decisions, thus increasing the benefits of more accurate information Also, information technology has decreased the cost of processing data These two events have led to a demand for an improved management accounting information system 15 16 17 18 19 Activity-based management is an important approach that focuses management’s attention on activities with the objective of improving the value received by the customer and the profit achieved by providing this value It is important because it is the heart of the contemporary management accounting system, offering increased accuracy in product costing (through the use of activity-based costing) and the ability to evaluate and control activities (through process value analysis) Customer value is the difference between customer realization (what a customer receives) and customer sacrifice (what a customer gives up) Focusing on customer value forces managers to consider the entire set of value-chain activities, including what happens after a product is sold This creates a demand for a broader set of information than that found in a traditional system The internal value chain is the set of activities required to design, develop, produce, market, distribute, and service a product (the product can be a service) To increase customer value, managers must assess the effect each activity in the chain has on customer value, keeping those that add value and eliminating those that not Industrial value chain is the linked set of value-creating activities from raw materials through the end-use customer Understanding the industrial value chain is important because it enables a manager to identify the important internal and external linkages and use these linkages to create a competitive advantage Supply chain management is concerned with managing material flows starting with suppliers and upstream suppliers, moving to production, and finishing with the distribution of finished goods to customers and down- stream customers Supply chain management focuses on the entire industrial value chain because potential benefits may be reaped by understanding upstream suppliers and downstream customers 20 E-business is any business transaction or information exchange that is executed using information and communication technology Management accountants provide information for e-business settings, e.g., the cost of processing an electronic transaction versus the cost of a paper transaction 21 Managing the value chain requires a crossfunctional perspective Because of the interrelationships that exist in the value chain, a decision can affect many different functions Information must be gathered and reported so that these effects can be assessed and decision making improved 22 Decreasing the time required to perform activities may increase quality and decrease costs The management accounting system should be able to document the relationship between time reductions and such things as quality and cost both on a projected or before-the-fact basis and on an after-the-fact basis This enhances planning, controlling, and decision making 23 A line position has direct responsibility for carrying out the basic missions of an organization A staff position has indirect responsibility for the basic missions and provides a supportive role for line activities 24 Yes For most organizations, the controller should be a member of the top management staff The controller is the financial expert of an organization and can provide critical advice and insights 25 The controller is responsible for both internal and external accounting These responsibilities usually include diverse activities such as taxes, SEC reports, cost accounting, budgeting, internal auditing, financial accounting, and systems accounting 26 Ethical behavior is concerned with making right choices and usually involves sacrificing individual self-interest for the well-being of others It is possible to teach ethical behavior in virtually any course By being introduced to ethical dilemmas in management accounting, students can be made aware of To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com needs The CPA has a public-accounting orientation, and the CIA has an internalauditing orientation Only the CMA specifically addresses the professional requirements of a management accountant the behavior that is expected in the business world and, in particular, for management accountants 27 28 Yes There is some evidence that ethical behavior actually is good business In other words, the market and consumers appreciate ethical behavior and are willing to reward those who adopt it In addition, a company with higher ethical standards would experience less exposure to manipulation of financial data for gain Yes As management accountants become more informed about what behavior is acceptable and what is not, we should expect a favorable response This response can be reinforced by the IMA imposing sanctions for serious violations of the code 29 The three forms of certification are the CMA, the CPA, and the CIA Although each certification can be valuable for management accountants, the CMA is tailored to fit their 30 The Sarbanes-Oxley Act (SOX) established stronger government control and regulation of publicly-traded companies in the United States Major sections of SOX include: establishment of the Public Company Accounting Oversight Board, enhanced auditor independence, tightened regulation of corporate governance, control over management, and management/auditor assessment of the firm’s internal controls SOX also requires public companies to state whether or not the top corporate officers are bound to the company code of ethics To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com EXERCISES 1–1 Inputs: a, d, f, j Processes: b, g, m Outputs: c, i, l System objectives: e, h, k, n 1–2 a b c d e f g Management Financial Management Financial Financial Management Management h i j k l m n Management Financial Management Management Financial Financial Management 10 11 j c b e d 1–3 b c f 1–4 e b c 1–5 k g a f i h To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1–6 Penny is staff She is in a support role—she prepares reports and helps explain and interpret them Her role is to help the line managers more effectively carry out their responsibilities Karol is line She is responsible for selling product A basic objective for the existence of a manufacturing firm is to sell product Karol has direct responsibility for a basic objective and therefore holds a line position Porter is staff He is in a support role to production He does not make the products himself Instead, he ensures that the appropriate production equipment is in place for manufacturing Joe is a line manager He has direct responsibility for producing a garden hose Clearly, one of the basic objectives for the existence of a manufacturing firm is to make a product Thus, Joe has direct responsibility for a basic objective and therefore holds a line position 1–7 A manager has a responsibility to the company as well as society If he/she lays off the employees, he/she ignores both of these responsibilities In effect, the manager would be pursuing his/her self-interest at the expense of the company and the salespeople While pursuit of self-interest is not necessarily unethical, it can be if it harms others In this case, the manager’s action could result in lower profits for the company because sales may decrease and unnecessary training costs will be incurred when the positions are refilled the following year Similarly, it is unjust to penalize productive employees simply to earn a bonus The right choice is to retain the three salespeople Although the manager is not a management accountant, he/she is violating the ethical standard that requires the refusal of “any gift or favor (bonus) that would influence or appear to influence their actions.” The reward system, in part, encouraged this behavior Apparently, the manager is paid a bonus if profits exceed 10 percent of planned profits By basing reward on a short-run measure such as profits, the manager has the incentive to manipulate earnings in the short run One way of manipulating annual earnings is to reduce discretionary expenditures This type of behavior can be discouraged by expanding the performance mea-sures to include long-run factors like market share, productivity, and personnel development The accounting system can also be used to track trends (e.g., training costs over time) Moreover, managers can be required to provide extensive justification for significant changes in discretionary expenses To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1–8 a By the time most students graduate from high school, they have not had much exposure to business Therefore, they not have full knowledge of acceptable behavior for the business environment Students may not know that certain practices are unethical because they may not be familiar with the behavioral norms associated with these practices Once students begin to learn business practices, they begin to see what ethical dilemmas can arise in a business context They then are able to apply the moral training they have had to deal with the situations Furthermore, evidence exists that ethical reasoning can be changed for the better Thus, instruction in ethics can be a vital part of a student’s education b Sacrificing self-interest is a choice that each person must make Others may be influenced by those individuals who behave ethically Individuals committed to ethical behavior produce societies committed to ethical behavior (not vice versa) c While this sounds noble, many would disagree that managers are first seeking to serve others and accept personal financial rewards as a by-product of a good job Pursuit of self-interest and personal financial well-being is not necessarily unethical It is only when this pursuit is done at the expense of the collective good that the behavior becomes questionable d It is often true that unethical firms and individuals suffer financially In the long run, there is some evidence that ethical behavior pays off It is doubtful, however, that every unethical firm or individual is wiped out financially There are too many notable exceptions (for example, the selling of drugs by organized crime) 1-9 No, it is not ethical for Steve to demand a kickback from Dave Dave should not agree to this This brief situation actually happened to Dave, a friend of the author The author advised Dave not to accept the deal Dave then checked with his lawyer, who bluntly told him the deal was illegal Dave did not accept 1–10 a b c d e f g h CPA CIA CMA CPA CPA CMA CMA, CPA, CIA CMA, CPA, CIA To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROBLEMS 1–11 Excellence teams and minicompanies both have the objective of involving production line personnel more fully in the management process so that the company can take advantage of the direct contact and knowledge that operating workers have about production and their work environment This will hopefully translate into continuous improvement of operating performance The objectives seem to be realized Duffy has increased profits and reduced costs, attributing much of the change to the contributions of the excellence teams The same is true for the minicompanies—much of the success in quality improvements appears to be grounded in this organizational change Employee empowerment is a key element of continuous improvement Operating workers have tremendous skills, knowledge, and firsthand contact with the operating environment, all of which can be exploited to discover new and more efficient ways of producing As employees are allowed more input, their self-esteem grows and their commitment to the company increases Morale also increases, making for a more pleasant and productive environment There are potential disadvantages Too much latitude in employee empowerment might sidetrack employees to the point where they begin to attack personalities; discuss and argue about wage and hour considerations (or other grievances); or try to become involved in hiring, firing, and disciplinary matters Many of these matters are best left centralized, and some skillful management is needed to ensure that operating employees are primarily involved in improving efficiency Management accounting information should be used to inform empowered employees so that they can identify problems and monitor and evaluate the effects of decisions they make This information will only be valuable if it is delivered on a timely basis Quality culture means that the employees of the organization have an internal commitment to producing high-quality products and services A learning organization means that the employees are always seeking new and better ways of doing things—they have a commitment to continuous improvement To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1–12 A Decision making; Role: Information about the cost of performing the various tests B Planning and controlling; Role: Feedback about the actual defective rate versus the planned rate C Planning; Role: Pro forma income statement and cash budget D Decision making; Role: Projection of future cash flows and analysis of the effects on unit cost and cycle time E Planning; Role: Providing unit prices and costs so that a cost-volume-profit analysis can be done F Decision making; Role: Identifying avoidable costs 1–13 The total product is the product and its features (processing speed, disk drives, software packages, and so on), the service, the operating and maintenance requirements, and the delivery speed One company is emphasizing low costs, and the other is attempting to differentiate its PC by offering faster delivery and higher-quality service The Confiar’s service component and its delivery time appear to be better than Drantex’s Thus, the realization of these features appears to outweigh the additional sacrifice (the additional operating and maintenance cost) associated with the Confiar PC The implications for management accounting are straightforward The management accounting information system should collect and report information about customer realization and sacrifice Much of this information is external to the firm but clearly needed by management Better quality and shorter delivery time increase customer realization, while lowering the price decreases customer sacrifice In total, customer value has increased and presumably this should make the Drantex PC much more competitive This example illustrates how quality, time, and costs are essential competitive weapons It also illustrates how critical it is that the management accounting system collect and report data concerning these three dimensions To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 1–14 Planning The management accountant gains an understanding of the impact on the organization of planned transactions (i.e., analyzing strengths and weaknesses) and economic events, both strategic and tactical, and sets obtainable goals for the organization The development of budgets is an example of planning Controlling The management accountant ensures the integrity of financial information, monitors performance against budgets and goals, and provides information internally for decision making Comparing actual performance against budgeted performance and taking corrective action where necessary is an example of controlling Internal auditing is another example Evaluating Performance The management accountant judges and analyzes the implications of various past and expected events and then chooses the optimum course of action The management accountant also translates data and communicates the conclusions Graphical analysis (such as trend, bar charts, or regression) and reports comparing actual costs with budgeted costs are examples of evaluating performance Ensuring Accountability of Resources The management accountant implements a reporting system closely aligned to organizational goals that contributes to the measurement of the effective use of resources and safeguarding of assets Internal reporting such as comparison of actual to budget is an example of accountability External Reporting The management accountant prepares reports in accordance with generally accepted accounting principles and then disseminates this information to shareholders, creditors, and regulatory and tax agencies An annual report or a credit application are examples of external reporting (CMA adapted) 1–15 The changes that are being proposed violate the following ethical standards: Competence Top management’s request of Roger Deerling to account for the company’s information in a manner that is not in accordance with generally accepted accounting principles is in violation of the standard to “perform professional duties in accordance with relevant laws, regulations, and technical standards.” To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Mexican labor cheaper As the controller, you will revise your estimates of labor costs in the maquiladora downward The proposed new production facility will be more attractive As a local labor union leader, you would be displeased by the potential devaluation If Mexican wages go down relative to U.S wages, Mexican labor will be relatively more attractive, and more jobs may be outsourced to Mexico 11 Hedging is a way of insuring against gains and losses on foreign currency exchange The company that imports the material may be afraid that the exchange rate will change in 90 days and that the home currency will weaken against the foreign currency In that case, the company may hedge by purchasing a forward contract for the foreign currency, thereby locking in the exchange rate and 614 insuring against adverse exchange rate fluctuations 12 Disagree The manager of a subsidiary should not be evaluated on the basis of factors over which he or she has no control These factors may include transfer prices, currency fluctuations, local taxes, and so on The subsidiary manager should be evaluated on the basis of revenues and costs 13 Environmental factors that may affect the performance of divisional managers include economic, legal, political, social, and educational variables 14 Internal Revenue Code Section 482 outlines the transfer pricing methods acceptable for income tax purposes The four acceptable methods are the comparable uncontrolled price method, the resale price method, the cost-plus method, and any method jointly acceptable to the IRS and the company To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com EXERCISES 18–1 Your friend will take the traditional accounting and business courses required for a major in accounting Naturally, these would include international business courses, such as international accounting and international finance In addition, she/he would be well advised to take classes relating to other cultures, including history, philosophy, literature, and foreign language(s) No individual class is critical; instead, it is the sum of the classes that is important In other words, your friend will learn a little about other countries in each class Over time, that little bit will add up, giving your friend the background to understand business practices overseas and to fit business transactions into a cultural context Suppose your friend is just about to graduate and cannot afford to spend more time in college? Then she/he should what all management accountants need to do—stay up to date by reading books and articles in a variety of international business areas, including information systems, marketing, management, politics, and economics Note to Instructors: Your students may want to read Daniel M Hrisak’s “Global Challenges Call for More CMAs and CFMs,” Strategic Finance (June 2001): pp 44–49 18–2 e b d c a 18–3 e c d b a 615 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–4 $14,200,000 × 0.30 = $4,260,000 $4,260,000 × 9/12 × 0.10 = $319,500 18–5 $14,200,000 × 0.85 × 0.30 = $3,621,000 Savings = ($4,260,000 – $3,621,000) + $319,500 = $639,000 + $319,500 = $958,500 18–6 Tariff savings = ($3,750,000 × 0.06 × 0.25) = $56,250 per year Because broken items will never be sold outside the foreign trade zone, Bulwar will not owe a tariff on them 18–7 70,100 pesos/10.9 = $6,431 70,100 pesos/11.4 = $6,149 There is an exchange gain of $282 ($6,431 – $6,149) 616 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–8 75,000/10.9 = $6,881 75,000/11.4 = $6,579 Exchange loss = $6,881 – $6,579 = $302 Hedging contract = 75,000/11.1 = $6,757 Premium expense = $6,881 – $6,757 = $124 Net savings = $302 – $124 = $178 18–9 The dollar weakened against the euro (€) from June to September On June 1, one dollar would buy €0.833 (1/1.20) On September 1, one dollar would buy €0.794 (1/1.26) On June 1, Basu would need $720,000 to pay for the purchase €600,000 × 1.20 = $720,000 On September 1, Basu would need $756,000 to pay for the purchase €600,000 × 1.26 = $756,000 18–10 There was an exchange loss of $36,000, calculated as follows: Liability in dollars on June Payment in dollars on September Exchange loss $ 720,000 (756,000) $ 36,000 617 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–11 Persephone Company engaged in a forward contract to buy Canadian dollars for U.S dollars In other words, on September 30, Persephone expects to pay 120,000 Canadian dollars Therefore, it needs to exchange U.S dollars for Canadian dollars on September 30 The forward contract allows it to buy the 120,000 Canadian dollars at a specified forward rate of Canadian dollars for U.S dollars Had Persephone Company expected to receive Canadian dollars from the Canadian company, it would have engaged in a forward contract to sell Canadian dollars on September 30 instead Because Persephone hedges all currency exchanges, the forward rate is the applicable exchange rate Persephone will buy 120,000 Canadian dollars on September 30 for $92,308 120,000/1.30 = Canadian $ 92,308 18–12 You are delighted—the dollar has appreciated and now buys more euros than it did before The car costs € 90,000, which translates to $107,143 at the € 0.84 to $1 rate (90,000/0.84 = $107,143) At the new exchange rate, only $102,273 (90,000/0.88) is required to purchase € 90,000 Have a good trip! 18–13 Market price Add: Shipping, duties Less: Marketing costs Transfer price $45.00 12.20 (4.50) $52.70 618 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–14 $80 = Cost + 0.25 Cost $80 = 1.25 Cost Cost = $64 Therefore, the transfer price is $64 18–15 Mexican division’s ROI = $150,000/$1,500,000 = 10.0% British division’s ROI = $230,000/$2,000,000 = 11.5% No, we cannot directly compare the two divisions’ ROIs without knowing more about the cultural and environmental factors faced by each 18–16 The maximum transfer price is $200, because the Singapore plant could purchase the motor externally for that price The minimum transfer price is $195, because that is equal to the total variable cost of $195 The environmental factor most important to this decision is the governmental prohibition against layoffs This could turn direct labor into a strictly fixed cost This particular prohibition is a serious one Some Spanish plants have been virtually closed for years, yet the firms must continue to pay the workers because the government has refused permission to lay off the workers 619 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–17 The comparable uncontrolled price method should be used because a market price exists Market price Add: Shipping, duties Less: Marketing costs Transfer price $30.00 5.05 (4.00) $31.05 18–18 d e e c a b a 620 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROBLEMS 18–19 a Factors that generally determine the degree of decentralization in an organization include the following: • Physical proximity of the organization’s divisions • Philosophy of top-level management to commit to delegating authority and allowing decentralized decision making • Importance, materiality, time constraints, and risk level of decisions b Benefits to be derived from decentralization include: • Increased growth of the organization because decisions can be made by more individuals closer to the operations, thus reducing pressure on and allowing ample time for top-level management to deal with strategic and long-range planning issues • More flexibility and timelier decision making in a rapidly changing environment c Disadvantages of decentralization include: • More control features required at company headquarters to monitor divisions/subsidiaries • Loss of some control as central authority is reduced • Greater pressure in allocating pooled resources • Duplication of support functions The factory currently owned and operated by LSI in Nuevo Laredo is a maquiladora LSI is already well acquainted with the customs of doing business in Mexico and should have relatively little difficulty expanding its operations The passage of the North American Free Trade Agreement makes LSI’s expansion simpler by further easing Mexican laws governing foreign ownership It also means that the current special U.S customs treatment of reimported goods would continue In general, NAFTA creates a more hospitable environment for U.S companies expanding production in Mexico 621 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–20 Alternative 1: Advantages: This alternative involves working with a well-understood process in a well-understood environment Beryl is completely familiar with the legal and social environment in Minnesota Morale may increase because all workers will receive the higher wages The factory is already set up, suppliers are in line, and the company knows just how long it takes to produce the fax machines Disadvantages: Additional workers who are not trained in Paladin’s process would need to be hired Heavier use of plant facilities will wear out plant and equipment faster The addition of a second shift may cause labor problems because those workers assigned to the second shift may want to work on the more desirable first shift Alternative 2: Advantages: Wages are much lower in Mexico The burgeoning Mexican market would provide demand for Paladin’s product Production in Mexico would satisfy Mexican demands for locally produced goods Disadvantages: Paladin has no experience in Mexico There is considerable uncertainty regarding the training of Mexican workers and the start-up costs of building a new plant Language and cultural differences may cause difficulties Alternative 3: Advantages: Location of a new plant in a foreign trade zone would save on duty-related costs There is no language difference in Dallas The opening of a plant in the Southwest would give Paladin easier access to markets in the southern and southwestern United States Wages would be lower than those in Minnesota Disadvantages: The Dallas plant is a considerable distance from the Minnesota plant, requiring another layer of management Beryl may find it difficult to run both plants herself 622 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–21 Using the spot rates in effect on July 1, the following prices can be set in francs and yen: Swiss order: $64,000 × 1.2360 = 79,104 Swiss francs Japanese order: $124,000 × 117.70 = 14,594,800 yen On October 1, the Swiss customer should pay Custom Shutters 79,104 Swiss francs If the 90-day forward rate anticipated on July holds, Custom Shutters will receive $62,831 (79,104/1.2590) On October 1, the Japanese customer should pay Custom Shutters 14,594,800 yen If the 90-day forward rate anticipated on July holds, Custom Shutters will receive $124,000 Will Lee actually receive $186,831 ($62,831 + $124,000) on October 1? We don’t know It depends on the exchange rates in effect on October Currently, it is expected that the dollar will weaken against the Swiss franc and stay unchanged against the yen However, this could change If Lee is bothered by the uncertainty, he could hedge by locking in the exchange rates now That would guarantee the $186,831 on October He might want to that since the anticipated trend is steadily upward for Swiss francs and the Swiss customer could very well pay late 623 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–22 Your objective in meeting with the IRS representative is to demonstrate that the $10 transfer price negotiated between the European and U.S divisions is acceptable under Internal Revenue Code Section 482 Comparable uncontrolled price method: Market price (U.S.) Add: Landing costs Less: Variable marketing costs Transfer price $14.00 2.50 (1.80) $14.70 Clearly, your problem is that the comparable uncontrolled price method gives a higher transfer price than the one negotiated The problem with the above computation, of course, is that it assumes that you can sell additional units of the component for $14 within the United States You can’t If there were a buyer for additional units at $14 per unit, the U.S division would gladly sell them As it is, the U.S division has substantial excess capacity The $10 transfer price covers all incremental costs of production plus the landing costs Thus, a more valuable computation would be the following: Negotiated transfer price Less: Variable costs of production Landing costs Profit per unit $ 10.00 (7.00) (2.50) $ 0.50 You can also point out that there is a market for this component in Europe, and that given this fact, the negotiated transfer price has the feel of an arm’s-length transaction That is, both the U.S and the European divisions are acting in their own best interests 624 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–23 Comparable uncontrolled price method: Belgium $430 30 (40) $420 Market price Add: Shipping Less: Avoidable marketing cost Transfer price Canada $430 25 (40) $415 No, the IRS will have no problem with the $430 charged to the Belgian and Canadian divisions This price exceeds the comparable uncontrolled price One might wonder why Audio-Tech has set such a high transfer price to the foreign divisions The reason is that both Canada and Belgium have higher corporate income tax rates than the United States Therefore, Audio-Tech wants to take as much profit as possible in the United States and as little profit as possible in the two foreign countries Currently, the tax departments in Canada and Belgium have not targeted transfer pricing as an important problem 625 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com MANAGERIAL DECISION CASES 18–24 Some might argue that the company has an obligation to pay no more than its minimum legal tax The actions taken by the company were clearly intended to escape taxation Avoidance of taxes is acceptable, evasion is not And perhaps auditors would not find anything that would signal any deviation from the legal guidelines After all, this had been done in the past with great success Nonetheless, the propriety of the actions taken by the firm is questionable It was made quite clear that under normal operating conditions, transfer prices were set by divisional managers Thus, the incentive for tampering with the transfer prices appears to be motivated by expected losses for the U.S operations The only purpose of increasing the transfer prices was to reduce European taxes that normally would be owed and paid This creates some suspicion about the ethical content of the transfer pricing decision This suspicion is strengthened by the act of reassigning so-called legitimate costs to support the planned increase in transfer prices If the costs are really that legitimate, why were they not discovered until the prospect of losses appeared? The behavior displayed by the top executives is not ethical Debbie is not directly involved in the decision but should consider whether she wants to continue working for a company that engages in this kind of manipulation Accountants have a responsibility to “perform professional duties in accordance with relevant laws, regulations, and technical standards.” (I-2) Furthermore, they have a responsibility to “abstain from engaging in or supporting any activity that would discredit the profession.” (III-3) Finally, they must “disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations presented.” (IV-2) One wonders how willing and how comfortable the management and accountants responsible for the scheme would be in revealing the reassignment of costs and the reasons thereof If tax accountants are asked to be involved in a questionable scheme, they should clearly refuse to so 626 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 18–25 The price is unacceptable because it is less than the adjusted market price of $12.00 ($10 + $2.50 – $0.50) By setting a transfer price lower than the IRS guideline, revenues recognized in the United States are lower than they should be, and less taxes are paid than required The IRS could reallocate income (by requiring a transfer price of $12) If the transfer price were greater than $12, the IRS would have no concern, since the company would be paying more taxes than expected Resale price – Cost = 0.25(Resale price) $8.00 – Cost = 0.25($8.00) Cost = $6.00 Thus, if the normal markup is 25 percent, the allowable cost without adjustment is $6.00 Adding to this the landing cost of $1.20, the allowable transfer price is $7.20 Thus, the price of $4.50 is certainly unacceptable as far as the U.S taxing authorities would be concerned The transfer price should be increased to $7.20 Minimum: $6.00 + $2.00 – $1.25 = $6.75 Maximum: $12.00 (local price for the European division) The maximum transfer price is less than the Internal Revenue Code Section 482 comparable uncontrolled price ($12.75 = $12.00 + $2.00 – $1.25) If the joint benefit of $5.25 ($12.00 – $6.75) is split equally, the transfer price would be $9.38 ($2.63 + $6.75) The company could justify the $9.38 transfer price by arguing that the company has idle capacity, which would otherwise produce no revenues This argument would be strengthened if the buying division does not normally buy this component from the selling division or if the price concession is necessary to induce the internal acquisition The presence of decentralized decision making could also strengthen the argument If divisional managers are free to set prices and free to buy from whichever source is best and evidence exists that they both, then the company could argue that the negotiated outcome is an arm’s-length transaction RESEARCH ASSIGNMENT 18–26 Answers will vary 627 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 628 ... external accounting These responsibilities usually include diverse activities such as taxes, SEC reports, cost accounting, budgeting, internal auditing, financial accounting, and systems accounting. .. information should be provided by the management accounting information system Nonfinancial information provides insights useful for controlling operations — it is easily used by operational workers... improving the value received by the customer and the profit achieved by providing this value It is important because it is the heart of the contemporary management accounting system, offering