BOR CPAs, Inc. is a closely held corporation owned by three stockholders who used the initials of their last names to form the corporations name: Cyrus Bailey, John Ogden, and Samuel Rogers. The firms Certified Public Accountants (CPAs) perform audits of both public companies and privately owned companies. BORs CPAs also provide tax services to both individuals and businesses. The corporation is divided into two profit centers: the Audit Division and the Tax Division. Each division is composed of two cost centers. The Audit Division is composed of two cost-center departments: Public Company Audits and Private Company Audits. The Tax Division is composed of two cost-center departments also: Individual Tax and Business Tax. BOR, a decentralized organization, is interested in evaluating the performance of the two divisions. The stockholders are responsible for deciding on investment in the two divisions. Cyrus Bailey is in charge of the performance evaluation, and turns to you for assistance. Mr. Bailey is only interested in evaluating operations at the profit center (division) level, and not at the cost center (department) level. Mr. Bailey is considering temporarily using some of the staff from the Tax Division to assist the Audit Division during the upcoming busy audit season, and would like to evaluate the effect of this on net income. The Tax Division is estimated to have 800 hours of excess capacity. The unit for determining sales revenue in both divisions is the "engagement," which means the total agreed-upon work for a given client in either audit or tax for a given year. The company charges on average a fee of $75,000 per audit engagement, and $15,750 per tax engagement. The company has its own Payroll Office, which provides payroll services to both divisions and will allocate its total expenses to the two divisions as service department charges. The following chart shows some basic data for the company: Hourly market rate for staff (the price the company would have to pay from an outside contractor for staff services) $100.00 Average hourly cost rate for staff (the average price the company pays to its staff) $50.00 Number of paychecks issued by Audit Division 110 Number of paychecks issued by Tax Division 340 Total expense for Payroll Office $29,250 Amount of assets invested in Audit Division by BOR CPAs, Inc. $10,000,000 Amount of assets invested in Tax Division by BOR CPAs, Inc. $4,000,000 Mr. Bailey would like you to start by analyzing the Payroll Office expenses, and allocating the total expenses to each division. He has decided to use the number of payroll checks as the activity base for the allocation. Fill in the following blanks, allocating the total expense for the Payroll Office to each of the two divisions. Payroll Charge Rate $ per payroll check. Division Allocated Service Department Charges Audit Division $ Tax Division $ BOR CPAs, Inc. is a closely held corporation owned by three stockholders who used the initials of their last names to form the corporations name: Cyrus Bailey, John Ogden, and Samuel Rogers. The firms Certified Public Accountants (CPAs) perform audits of both public companies and privately owned companies. BORs CPAs also provide tax services to both individuals and businesses. The corporation is divided into two profit centers: the Audit Division and the Tax Division. Each division is composed of two cost centers. The Audit Division is composed of two cost-center departments: Public Company Audits and Private Company Audits. The Tax Division is composed of two cost-center departments also: Individual Tax and Business Tax. BOR, a decentralized organization, is interested in evaluating the performance of the two divisions. The stockholders are responsible for deciding on investment in the two divisions. Cyrus Bailey is in charge of the performance evaluation, and turns to you for assistance. Mr. Bailey is only interested in evaluating operations at the profit center (division) level, and not at the cost center (department) level. Mr. Bailey is considering temporarily using some of the staff from the Tax Division to assist the Audit Division during the upcoming busy audit season, and would like to evaluate the effect of this on net income. The Tax Division is estimated to have 800 hours of excess capacity. The unit for determining sales revenue in both divisions is the "engagement," which means the total agreed-upon work for a given client in either audit or tax for a given year. The company charges on average a fee of $75,000 per audit engagement, and $15,750 per tax engagement. The company has its own Payroll Office, which provides payroll services to both divisions and will allocate its total expenses to the two divisions as service department charges. The following chart shows some basic data for the company: Hourly market rate for staff (the price the company would have to pay from an outside contractor for staff services) $100.00 Average hourly cost rate for staff (the average price the company pays to its staff) $50.00 Number of paychecks issued by Audit Division 110 Number of paychecks issued by Tax Division 340 Total expense for Payroll Office $29,250 Amount of assets invested in Audit Division by BOR CPAs, Inc. $10,000,000 Amount of assets invested in Tax Division by BOR CPAs, Inc. $4,000,000 Mr. Bailey would like you to start by analyzing the Payroll Office expenses, and allocating the total expenses to each division. He has decided to use the number of payroll checks as the activity base for the allocation. Fill in the following blanks, allocating the total expense for the Payroll Office to each of the two divisions. Payroll Charge Rate $ per payroll check. Division Allocated Service Department Charges Audit Division $ Tax Division $ A profit center manager has the responsibility and authority for making decisions that affect revenues and costs and, thus, profits. The manager of a profit center does not make decisions concerning the fixed assets invested in the center. Responsibility accounting for profit centers such as the Audit Division and Tax Division take the form of income statements, which should include only controllable revenues and controllable expenses. Although it is not technically a decentralized unit, BOR CPAs, Inc. as a whole may be considered as an investment center. Thus, Mr. Bailey is also interested in evaluating the performance of the company as a whole. Two performance measures that are used at the investment center level are return on investment and residual income. Mr. Bailey would like to use the DuPont formula, composed of profit margin and investment turnover, to break down the return on investment, in order to evaluate each division. At the company level, Mr. Bailey would like to use return on investment to evaluate the overall performance of the company and its investment decisions with regard to each division. Answer the following questions (1) and (2). 1. What is the most likely reason Mr. Bailey chose the DuPont formula to evaluate the divisions? Mr. Bailey wants to focus on whether the profit centers are spending in accordance with their budgets. Mr. Bailey would like to analyze differences in the return on investment across divisions. Mr. Bailey believes that the investment turnover will provide a good assessment of each divisions profitability. 2. What is the most likely reason Mr. Bailey chose return on investment to evaluate the company as a whole? Return on investment will allow Mr. Bailey to measure the income (return) on each dollar invested in the divisions, and decide where to invest additional assets or expand operations. Mr. Bailey would like to determine which division has the highest net income. Mr. Bailey is using non-financial performance measures. Mr. Bailey has prepared the following divisional income statement for you to review, assuming no transfer of excess capacity hours occurs. He has also included the total amounts for BOR CPAs, Inc. in the rightmost column. Complete the following Income Statements with your data from the Payroll panel. Enter all amounts as positive numbers. BOR CPAs, Inc. Income Statements For the Year Ended December 31, 20Y1 1 Audit Division Tax Division Total Company 2 Fees earned: 3 Audit fees (12 engagements) $900,000.00 $900,000.00 4 Tax fees (45 engagements) $708,750.00 708,750.00 5 Transfer-pricing fees 0.00 6 Expenses: 7 Variable: 8 Audit hours provided by Audit Division 180,000.00 180,000.00 9 Tax hours provided by Tax Division 236,250.00 236,250.00 10 Excess capacity hours paid to salaried staff 40,000.00 40,000.00 11 Audit hours provided by Tax Division 0.00 0.00 12 Fixed 50,000.00 65,500.00 115,500.00 13 Income from operations before service department charges $670,000.00 $367,000.00 $1,037,000.00 14 Less service department charges for payroll 15 Income from operations Mr. Bailey asks that you prepare Divisional Income Statements showing what 20Y1 results would have been had the Audit Division purchased all the excess capacity of the Tax Division, using a market transfer price. The divisional managers tell you that, with the excess capacity of the Tax Division of 800 hours, the Audit Division can perform 4 more audits during the year, and the Tax Division would charge the Audit Division the market rate of $100.00 per hour for the additional hours required, selling all its excess capacity to the Audit Division. The Tax Division would still be responsible for paying the salaries of their employees. Complete the following Income Statements. Enter all amounts as positive numbers. If there is no amount or an amount is zero, enter 0. BOR CPAs, Inc. Income Statements For the Year Ended December 31, 20Y1 1 Audit Division Tax Division Total Company 2 Fees earned: 3 Audit fees (16 engagements) $1,200,000.00 $1,200,000.00 4 Tax fees (45 engagements) $708,750.00 708,750.00 5 Transfer-pricing fees 6 Expenses: 7 Variable: 8 Audit hours provided by Audit Division 180,000.00 180,000.00 9 Tax hours provided by Tax Division 236,250.00 236,250.00 10 Excess capacity hours paid to salaried staff 11 Audit hours provided by Tax Division 12 Fixed 50,000.00 65,500.00 115,500.00 13 Income from operations before service department charges 14 Less service department charges for payroll 15 Income from operations Mr. Bailey asks that you prepare Divisional Income Statements showing what 20Y1 results would have been had the Audit Division purchased all the excess capacity of the Tax Division, using a negotiated transfer price. The divisional managers tell you that, with the excess capacity of the Tax Division of 800 hours, the Audit Division can perform 4 more audits during the year, and the Audit Division would agree to a negotiated rate of $90.00 per hour to be paid to the Tax Division for the additional hours required, with the Tax Division selling all its excess capacity to the Audit Division. The Tax Division would still be responsible for paying the salaries of their employees. Complete the following Income Statements. Enter all amounts as positive numbers. If there is no amount or an amount is zero, enter 0. BOR CPAs, Inc. Income Statements For the Year Ended December 31, 20Y1 1 Audit Division Tax Division Total Company 2 Fees earned: 3 Audit fees (16 engagements) $1,200,000.00 $1,200,000.00 4 Tax fees (45 engagements) $708,750.00 708,750.00 5 Transfer-pricing fees 6 Expenses: 7 Variable: 8 Audit hours provided by Audit Division 180,000.00 180,000.00 9 Tax hours provided by Tax Division 236,250.00 236,250.00 10 Excess capacity hours paid to salaried staff 11 Audit hours provided by Tax Division 12 Fixed 50,000.00 65,500.00 115,500.00 13 Income from operations before service department charges 14 Less service department charges for payroll 15 Income from operations Mr. Bailey asks that you prepare Divisional Income Statements showing what 20Y1 results would have been had the Audit Division purchased all the excess capacity of the Tax Division, using a cost transfer price. The divisional managers tell you that, with the excess capacity of the Tax Division of 800 hours, the Audit Division can perform 4 more audits during the year, and the Audit Division would pay the Tax Division's internal hourly rate of $50.00 per hour for the additional hours required, with the Tax Division selling all its excess capacity to the Audit Division. The Tax Division would still be responsible for paying the salaries of their employees. Complete the following Income Statements. Enter all amounts as positive numbers. If there is no amount or an amount is zero, enter 0. BOR CPAs, Inc. Income Statements For the Year Ended December 31, 20Y1 1 Audit Division Tax Division Total Company 2 Fees earned: 3 Audit fees (16 engagements) $1,200,000.00 $1,200,000.00 4 Tax fees (45 engagements) $708,750.00 708,750.00 5 Transfer-pricing fees 6 Expenses: 7 Variable: 8 Audit hours provided by Audit Division 180,000.00 180,000.00 9 Tax hours provided by Tax Division 236,250.00 236,250.00 10 Excess capacity hours paid to salaried staff 11 Audit hours provided by Tax Division 12 Fixed 50,000.00 65,500.00 115,500.00 13 Income from operations before service department charges 14 Less service department charges for payroll 15 Income from operations You are now able to put together all the information youve collected and analyze the data. In the following table, ROI stands for Return on Investment. Complete the following tables using the information from the other panels and selection lists provided. Audit Division Profit Margin x Investment Turnover = ROI No Transfer x = Market Price x = Negotiated Price x = Cost Price x = Tax Division Profit Margin x Investment Turnover = ROI No Transfer x = Market Price x = Negotiated Price x = Cost Price x = BOR CPAs, Inc. Profit Margin x Investment Turnover = ROI No Transfer x = Market Price x = Negotiated Price x = Cost Price x = After analyzing the data, you are able to answer Mr. Baileys questions (1) - (4) that follow. 1. Given that Mr. Bailey is evaluating BOR CPAs, Inc., which is an investment center, what transfer pricing option(s) would he most prefer that the divisions use? Check all that apply. No transfer between divisions. Variable standard cost transfer price of $50.00 per hour. Market transfer price of $100.00 per hour. Negotiated transfer price of $90.00 per hour. 2. Which transfer pricing option(s) would the manager of the Audit Division prefer? Check all that apply. No transfer between divisions. Negotiated transfer price of $90.00 per hour. Market transfer price of $100.00 per hour. Variable standard cost transfer price of $50.00 per hour. 3. Which transfer pricing option(s) would the manager of the Tax Division prefer? Check all that apply. Negotiated transfer price of $90.00 per hour. Variable standard cost transfer price of $50.00 per hour. Market transfer price of $100.00 per hour. No transfer between divisions. 4. Given the preferences of the managers of the Audit and Tax Divisions, and also considering the preferences of BOR CPAs, Inc., what might be the decision that provides the best outcome for all levels and entities within the company? The company should use the variable standard cost transfer price, because it would be unfair for the Tax Division to make a profit in dealing with the Audit Division, since theyre in the same company. If the divisional managers cannot come to an agreement, its best to forgo any transfers between divisions in order to reduce conflict within the company. The company should use the market transfer price, since its important for the divisions to operate under real market conditions. Use the negotiated transfer price, so that each entity is better off than it would be without any transfers between divisions.