Kokopelli ResortIntroductionAbout a month ago, Stuart Tyler, President and Chief Executive Officer (CEO) was sitting with his Chief Financial Officer (CFO), Rachana Patel. Stuart had been CEO of the Kokopelli Resort for the past four years, having replaced the prior CEO who was firedafter EBITDA had fallen nearly 50%. During his tenure, Stuart hasnt seen much growth in revenues, but EBITDA has increased 29%. The Board of Directors, wanting to get back to the record revenues and EBITDA of a decade ago, has been putting pressure onto Stuart. That led to last months meeting between Stuart and Rachana. Sitting in one of the restaurants of the 740-room hotel, Stuart said:We started out as a mid-size hotel in Scottsdale, steadily expanding to where we are today.The problem I have is that our annual income statements are an outgrowth of what we used more than 40 years ago. Back then we were a 180-room hotel. But weve expanded over the years, adding two new buildings for hotel rooms, added an event center 20 years ago and, more recently,added a golf course and spa. Ourincome statement treats the organization as a hotel with multiple departments. But I think of us as a multi-divisional company,and each line of business should be evaluated on its own merits. Can you put together a new income statement that betterreflectsthe performanceofour various divisions?Stuart felt that he needed to better understand how the different managers were performing. Currently, Stuart canbe thought of as an investment center manager. He haseight senior managers reporting to him (see Figure 1 for the organization chart). The managers of the Hotel, Events and Food & Beverage, Golf and Spa divisions were treated as profit center managers, while hisother direct reportsare cost centermanagers. The accounting department has followed the industry practice ofpreparingincome statement in accordance withthe Uniform System of Accounts for the Lodging Industry (USALI). Income statements for the past three years are shownin Table 1.BackgroundThe Kokopelli Resort was developed in the 1970s when Scottsdale, Arizona was a small, upscale suburb of Phoenix. Scottsdale has grown into a large suburban city (population 250,000) with multiple high-end resorts, golf courses, spa centers, a thriving businesscenter and numerous high-end retail centers. Phoenix-Mesa-Scottsdale, with a population of nearly 5 million, is the 11th-largest metropolitan area in the United States. With a large, international airport (13thbusiest with 22 million passengers), Scottsdale area resorts host golf tournaments, business meetings and group events, in addition to normal business travel and tourism.For many years, hotels were simply buildings for accommodating transient guests. The food and beverage (F&B) outlets were there to feed guests. But serving the events market (corporate meetings, sales meetings, weddings, professional conferences, etc), shifted their customer base. Many of the new customers required that the Kokopelli provide better facilities with bundled services (direct billing, bidding on the event and meeting space along with hotel rooms and banquets). Stuart felt that a new incentive compensation plan, along with a new reporting format, might be whats needed to get the performance being sought by the KokopellliBoard of Directors.

2TheComplaintLate last week Rachana distributedherproposed Divisional Income Statement. See Table 2. This statement summarized and reorganized what was on the current statement. She listed five separate areas of responsibility: Hotel, Events, Golf, Spa and Other. The first four were the profit centers, but the last category was a collection of items that Rachana wasnt sure about. She felt that shed need more input from Stuart and the other members of the senior executive team to refine the new income statement.Today, in the monthly executive team meeting, Melanie express some concerns over the new format. She spoke up: Stuart, I think this new approach is a good idea. But I think we need to make some improvements. I dont think this statement accurately reflectsmy contribution to the organization. Last year I booked more than 40 major events, with an average attendance of 300 persons, staying an average of 5 nights. These numbers suggest that my hard work brought in more than 60,000 room-nights. The marketing, sales, negotiations and successful executions have made us a leader in the events business in the Valley of the Sun. Mark gets all of the credit for those room rentals but and I hate to say this he hasnt done anything tocapture that incremental business. Now if you look at Marks business, he rented about 169,000 rooms last year. If he didnt have the customers I brought, his revenues would have dropped more than $13.4 million. But since his marginal costs are low, most of that would have fallen to his bottom line. His gross margin and EBITDA would have dropped about $10 million.Stuart recognized right away that Melanie had a valid point. He needs to recognize and award her for doing a good job for working hard and making the right decisions. It was clear that the proposed income statement, while an improvement, wasnt quite there yet. Stuart had taken a management accounting course and had heard of transfer pricing. While the examples hed seen were all in a manufacturing setting, he didnt see why Mark couldnt sell rooms to Melanie. But was he wrong?Stuart asked Rachana to look into this further and come to the executive committee next month with a revised income statement that will incorporate a transfer price that the two managers (Mark and Melanie) could agree upon.Stuart also had two otherconcerns.Recently, the executive committee had thought about closing the golf course and spa. The land around the hotel is valuable and the Board of Directors asked Stuart to look into selling the land to a local developer who would turn the land into a shopping center. The Executive Committee did a study and found that most golf patrons were attending events. Apparently, the golf course was a major selling point for events and Melanie feared that her event events business would drop 20-40% if the golf course were to go away. For this reason, the Board decided to keep the golf course. But Stuart wondered if Bob Nasr, GM of the golf course should remain as a profitcenter reporting to him. Stuarts second concern was whether the spa should be closed. It has not done well and last year the division lost more than $100,000. Neither Mark or Melanie felt that closing the spa would have an effect on the performance of their profit centers.

CaseRequirements

1.What is responsibility accounting? How is it related to an organizations structure?

2.What is a financial responsibility center? Distinguish between the four types of financial responsibility centers.

3.What is a transfer price?

4.What are the common methods for setting a transfer price?

5.If Melanies point is valid, perhaps Mark should transfer rooms to her. For the Kokopelli Resort, what would be the transfer price for rooms usingthe different methods described in case requirement4? What is the effect of each transfer price on divisional profits?

6.What is the difference, if any, between cost assignments and transfer prices?

7.If you were Rachana, what transfer price would you recommend to Stuart?What criteria would you use in evaluating the alternative transfer pricing methods?If you dont believe transfer pricing is appropriate in this context, what arguments do you put forward for keeping the financial reporting as it is?

8.Should the golf course remain as a responsibilitycenter reporting to Stuart? If not, what recommendation would you make to Stuart about the golf course?

9.Should the spa be closed? What would you recommend to Stuart regarding the spa? What, if any, suggestions might you make for improving the financial performance of the spa?

Table 1 Income Statements Part 1: Rentals and Revenues Room Nights Available Room Rentals 2019 269,272 169,467 2018 269,068 184,747 2017 221,796 160,741 Transient Revenue Group Revenue Rooms Other Total Rooms $ 14,321,446 21,598,944 1,944,550 $ 37,864,940 $ 12,708,218 22,340,493 1,652,437 $ 36,701,148 $ 10,433,763 19,438,393 2.917,357 $ 32,789,513 Outlets In-room Dining Banquet/Catering Mini Bar and Other Meeting Room Rental $ 10,078,543 790,987 20,686,606 451,317 478.228 $ 9,828,486 885,872 20,088,864 450,419 409.588 $ 9,865,115 957,647 21,702,607 522,204 306.037 Meeting Room Rental Other Audio/Visual Rentals Service Charges Total Food & Beverage 478,228 1,123,051 4,389,131 2,430,491 $ 40,428,354 409,588 1,366,164 4,325,106 2,425,543 $ 39,780,042 306,037 1,404,299 4,074,827 6,338,279 $ 45,171,015 Golf - Retail (Merchandise) Golf - Other Spa - Treatments Spa - Retail Spa - Other Garage/Parking Telecom Laundry Other Total Other Operated Departments Rentals & Other Income Cancellation Penalties $ 1,643,452 178,572 1,539,723 169,678 183,100 647,526 704,558 0 403,033 $ 5,469,642 $ 1,514,476 178,302 1,835,534 192,736 153,572 529,893 677,019 63,485 399,671 $ 5,544,688 $ 1,591,175 186,227 1,955,865 230,233 100,454 667,948 718,223 77,198 2,000,592 $ 7,527,915 1 $1,916,199 0 $1,190,850 397,234 $2,528,751 314.476 TOTAL REVENUES $ 85,679,135 $ 83,613,962 $ 88,331,670 Part 2: Expenses 2018 $ 3,480,816 1,143,510 3,513,834 $ 8,138,160 Salaries & Wages Payroll Taxes & Benefits All Other Room Expense Total Rooms Cost of Food Sales Cost of Beverage Sales Salaries & Wages Payroll Taxes & Benefits All Other F & B Expenses Total Food & Beverage Total Golf Expenses Spa - Salaries & Wages Spa - Payroll Taxes & Benefits Spa - Cost of Sales (Merchandise) Spa - Other Expenses Parking Expenses Telecom Expenses Other - Salaries & Wages Other - Payroll Tax & Benefits 2019 $ 3,541,610 1,259,271 3,668,882 $ 8,469,763 $ 4,540,544 1,347,852 6,937,536 3,328,114 4,632,571 $ 20,786,617 $ 4,580,571 1,325,367 7,036,709 3,110,256 4,565,746 $ 20,618,649 2017 $ 3,660,587 1,195,865 3,877,131 $ 8,733,583 $ 4,863,727 1,455,987 10,792,574 3,145,694 4,413,615 $ 24,671,597 0 786,091 260,238 94,829 204,844 146,208 561,434 708,389 229,514 0 880,689 283,128 105,133 247,468 135,641 534,173 705,587 211,696 0 948,878 293,925 143,394 207,174 128,252 508,505 862,984 249,951 Uus TUTT 701UZ 20 Water & Sewer Total Utility Expense 950,407 3,305,392 985,344 3,407,163 990,814 3,317,737 $ 2,196,120 2,619,250 $ 4,815,370 $ 2,045,615 2,547,973 $ 4,593,588 $ 1,958,639 2,467,765 $ 4,426,404 Payroll & Related Expense Maintenance Other Expenses Total Maintenance Expense Management Fees Land/Building Property Tax Expenses Insurance Expense Other Fixed Charges Total Fixed Cost Expenses TOTAL EXPENSES EBITDA (NET OP. INCOME) $ 2,570,374 15,552 2,666,332 965,347 2,426,274 $ 8,643,879 $ 63,459,012 $ 22,220,123 $ 2,508,419 10,260 2,970,839 1,303,397 5,968,575 $ 12,761,490 $ 66,795,686 $ 16,818,276 $ 2,649,950 0 2,949,938 1,198,350 3,684,189 $ 10,482,427 $ 71,434,839 $ 16,896,831 5 Figure 1 Organization Chart Carrie Weld Executive Assistant Stuart Tyler President & CEO Greg Jones Vice President, Information Systems Steve Hood Vice President & General Counsel Rachana Patel Vice President & Chief Financial Officer Mark Kern Vice President, HR Mark Thompson VP, Hotel Melanie Stump VP, Events and F&B Bob Nasr General Manager, Golf Victoria Gazzo General Manager, Spa Table 2 Proposed Divisional Income Statement (in millions of $) Revenue Expense Gross Margin Hotel $ 37.865 8.470 $ 29.395 Events/F&B $ 40.428 20.787 $ 19.642 Golf $ 1.822 0 $ 1.822 Spa $ 1.893 1.346 $ 0.546 Other $ 3.671 2.514 $ 1.157 Total $ 85.679 33.116 $ 52.563 Allocated Costs Administration Marketing Utilities Maintenance Management Fee Other Fixed Costs Total Allocation $ 2.910 3.090 1.461 2.128 1.136 2.684 $ 13.410 $ 3.107 3.299 1.560 2.272 1.213 2.866 $ 14.317 $ 0.140 0.149 0.070 0.102 0.055 0.129 $ 0.645 $ 0.145 0.154 0.073 0.106 0.057 0.134 $ 0.670 $ 0.282 0.300 0.142 0.206 0.110 0.260 $ 1.300 $ 6.586 6.992 3.305 4.815 2.570 6.074 $ 30.343 EBITDA $ 15.986 $ 5.325 $ 1.177 $ (0.124) $ (0.143) $ 22.220