Chapter 10 Guided Practice

10GP.1 Service Department Cost Allocations

10GP.1.E1 Direct Method

A firm has two service departments (A and B) and two production departments (X and Y). The various departments consume service department services as follows. Department A has incurred costs of $900,000 this period. Department B has incurred costs of $750,000 this period.

Dept. A (driver is labor hours):

  • Dept. B consumes 200 labor hours.
  • Dept. X consumes 2,000 labor hours.
  • Dept. Y consumes 1,000 labor hours.

Dept. B (driver is work orders):

  • Dept. A consumes 300 work orders.
  • Dept. X consumes 350 work orders.
  • Dept. Y consumes 350 work orders.

Required

If the firm uses the direct method to allocate service department costs to production departments, how much with the allocations be to Departments X and Y?

10GP.1.M2 Step-Down Method

A firm has two service departments (A and B) and two production departments (X and Y). The various departments consume service department services as follows. Department A has incurred costs of $900,000 this period. Department B has incurred costs of $750,000 this period.

Dept. A (driver is labor hours):

  • Dept. B consumes 200 labor hours.
  • Dept. X consumes 2,000 labor hours.
  • Dept. Y consumes 1,000 labor hours.

Dept. B (driver is work orders):

  • Dept. A consumes 300 work orders.
  • Dept. X consumes 350 work orders.
  • Dept. Y consumes 350 work orders.

Required

If the firm uses the step-down method to allocate service department costs to production departments, how much with the allocations be to Departments X and Y? Assume that Department B’s costs are allocated first and then Department A’s costs are allocated.

10GP.2 Transfer Pricing

10GP.2.E1 Negotiated Price: Ceiling and Floor

A firm has two departments, C and D. Department D uses an important gasket produced by Department C. Department D can obtain a comparable gasket on the external market for the price of $25 per unit.

Department C produces 200,000 gaskets each period. It incurs fixed costs of $2,000,000 per period. It also incurs, per gasket, $5 of direct material cost and $3 of direct labor cost. Department C does not sell these gaskets in an external market.

Required

If the firm has a policy of negotiating transfer prices, what would be the ceiling and floor for this gasket’s negotiated transfer price?

10GP.2.M1 Negotiated Price: Floor (Complex)

A firm has two departments, C and D. Department D uses an important gasket produced by Department C. Department D can obtain a comparable gasket on the external market for the price of $25 per unit.

Per gasket, Department C incurs $5 of fixed overhead cost, $5 of variable overhead cost, $5 of direct material cost, and $3 of direct labor cost. Department C sells gaskets externally for $27 each. Department C incurs $4 per gasket in shipping and transportation costs on external sales only (Department D is housed in an adjacent building and there would be negligible shipping and handling costs).

Department C only has 10,000 of excess capacity, wheras Department D requires 15,000 gaskets per period. (Thus Department C would lose 5,000 gaskets’ worth of external sales by supplying Department D with gaskets.)

Required

If the firm has a policy of negotiating transfer prices, what would be the ceiling and floor for this gasket’s negotiated transfer price?

10GP.3 ROI and Residual Income

10GP.3.E1

Three department managers at a firm–Able, Baker, and Charlie–are compensated using ROI (i.e. when department ROI is at or above the firm’s hurdle rate, 12%, the manager earns a bonus). They are each considering whether to upgrade their departments’ information technology systems. The three departments and upgrades have the following fact patterns.

Able’s department:

  • $11,000,000 in assets
  • $1,650,000 in profit annually
  • Upgrade expected to cost $500,000.
  • Upgrade expected to save $100,000 in costs annually.

Baker’s department:

  • $1,000,000 in assets
  • $250,000 in profit annually
  • Upgrade expected to cost $750,000.
  • Upgrade expected to save $70,000 in costs annually.

Charlie’s department:

  • $2,750,000 in assets
  • $350,000 in profit annually
  • Upgrade expected to cost $1,300,000.
  • Upgrade expected to save $162,500 in costs annually.

Required

(A) What are the three departments’ ROI (without the upgrade)?

(B) What is the ROI for each of department’s upgrade?

(C) Which department managers are likely to be motivated by their ROI-based contract to accept the upgrade project?

10GP.3.M1

Three department managers at a firm–Able, Baker, and Charlie–are compensated using both ROI and residual income (i.e. manager earns a bonus equal to a percentage of residual income). The firm’s hurdle rate is 12%. Each manager is considering whether to upgrade their departments’ information technology systems. The three departments and upgrades have the following fact patterns.

Able’s department:

  • $11,000,000 in assets
  • $1,650,000 in profit annually
  • Upgrade expected to cost $500,000.
  • Upgrade expected to save $100,000 in costs annually.

Baker’s department:

  • $1,000,000 in assets
  • $250,000 in profit annually
  • Upgrade expected to cost $750,000.
  • Upgrade expected to save $70,000 in costs annually.

Charlie’s department:

  • $2,750,000 in assets
  • $350,000 in profit annually
  • Upgrade expected to cost $1,300,000.
  • Upgrade expected to save $162,500 in costs annually.

Required

(A) What is the residual income for each of department’s upgrade?

(B) Which department managers are likely to be motivated by their residual income-based contract to accept the upgrade project?