CHAPTER 22

RESPONSIBILITY ACCOUNTING AND

TRANSFER PRICING

OVERVIEW OF EXERCISES, PROBLEMS, CASES,

AND INTERNET ASSIGNMENT
Learning
Exercises Topic Objectives Characteristics
22–1 Terminology 1, 4, 6 Conceptual
22–2 Types of responsibility centers 1 Conceptual
22–3 Classifications of costs 4, 5 Conceptual
22–4 Tootsie Roll’s business units 1, 4, 6 Conceptual, analytical, real
22–5 Preparing responsibility statements 1–5 Mechanical
22–6 Evaluating responsibility centers 1, 2 Mechanical, conceptual
22–7 Closing an unprofitable business unit 1–3 Mechanical, conceptual
22–8 CVP analysis 1, 2, 3, 4 Mechanical, analytical
22–9 Transfer pricing decisions 1, 2, 6 Conceptual
*22–10 Full and variable costing comparisons 7, 8 Mechanical, conceptual
*22–11 Full and variable costing comparisons 7, 8 Mechanical, conceptual

Problems
22–1 Identifying responsibility centers 1 Conceptual
22–2 Preparing and using responsibility 3, 4, 5 Mechanical, conceptual
statements
22–3 Preparing and using responsibility 3, 4, 5 Mechanical, conceptual
statements
22–4 Preparing and using responsibility 3, 4, 5 Mechanical, analytical
statements
22–5 Preparing and using responsibility 3, 4, 5 Mechanical, analytical
statements
22–6 Evaluating unprofitable centers 3, 4, 5 Mechanical, conceptual
22–7 Transfer pricing decisions 1, 2, 6 Mechanical, conceptual
*22–8 Variable costing issues 7, 8 Mechanical, conceptual

Cases
22–1 Allocating costs to business centers 1, 2, 4 Conceptual, analytical,
communication
22–2 Nonfinancial issues and ethical 1, 3, 6 Analytical communication,
considerations ethics

Business Week
Assignment
22–3 Business Week assignment: Frequent 1, 2, 5, 6 Conceptual, group, ethics
Flier Miles
____________
*Supplemental Topic A, “Variable Costing.”

194 © The McGraw-Hill Companies, Inc., 2005

 Internet Learning
Assignment Topic Objectives Characteristics
22–1 Identifying responsibility centers 1, 2, 3 Conceptual

DESCRIPTIONS OF PROBLEMS, CASES,

AND INTERNET ASSIGNMENT
Below are brief descriptions of each problem, case, and the Internet assignment. These descriptions are
accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time
estimates assume use of the partially filled-in working papers.

Problems
22–1 Some Familiar Responsibility Centers 15 Easy
Students are to indicate whether certain parts of well-known corporations are
cost centers, profit centers, or investment centers. Also, describe criteria for
evaluating each type of responsibility center.

22–2 Regal Flair Enterprises 30 Medium

Prepare a responsibility income statement and identify the business units that
will provide the most benefit from short-run product promotion and from
long-run expansion. Requires an understanding of the different roles of
contribution margin and responsibility margin in managerial decisions.

22–3 Giant Chef Equipment Company 30 Medium

Prepare a responsibility income statement and use the data to perform cost-
volume-profit analysis.

22–4 Health Tech, Inc. 60 Strong

Prepare income statements at two successive levels of responsibility. Also,
compute the return on assets for two investment centers and use data in
several managerial decisions.

22–5 Butterfield, Inc. 45 Strong

Given income statements at two levels of responsibility, students are asked to
make several decisions based upon the data and to explain the
“disappearance” of the common costs as the responsibility centers are
redefined. Also calls for a revised version of one responsibility statement
reflecting different sales levels.

22–6 Flywiz, Inc. 15 Easy

Students are asked to evaluate a decision to close a seemingly unprofitable
unit of a business. However, upon closer examination, they may discover that
seasonality is distorting the data and that products of the unprofitable unit
support sales in the more profitable unit.

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 22–7 Westfall Corporation 15 Easy
Students are asked to evaluate a transfer price used by two responsibility
centers of a business. The manager of one center wants the transfer price
reduced. Students are to recognize that, regardless of the transfer price used,
the profit of the entire company remains the same. Students must also con-
sider opportunity costs and the way in which center managers are evaluated.

*22–8 Lathrop Corporation 40 Strong

Prepare partial income statements using full costing and variable costing.
Also, explain the differences between reported amounts. Identify which
amounts are reported in financial statements and perform basic cost-volume-
profit analysis.

Cases
22–1 Land’s End Hotel 35 Medium
A conceptual (nonnumerical) case focusing upon the problems that often
arise from efforts to allocate common fixed costs among profit centers. A
practical problem, in that many businesses make such allocations—perhaps
without recognizing the pitfalls.

22–2 Osborn Diversified Products, Inc. 40 Medium

A computer error results in the overstatement of a division manager’s bonus.
He needs the money because he has large medical bills and a daughter in
college. The only other person who may be aware of the problem is another
division manager who is angry with the company. This is a good problem to
assign to small groups or teams of students.

Business Week Assignment

22–3 Business Week Assignment: Frequent Flier Miles 30 Medium
Students identify costs and revenues associated with changes in frequent flier
program rules. Ethical issues are identified for both the airline and the airline
customer.

Internet Assignment
22–1 General Mills and the Kirby Company 30 Medium
Students are asked to visit the web pages of two companies and decide how
responsibility centers could be assigned within each. They are also asked to
think of examples of investment centers, profit centers, and cost centers
within each firm. Finally, they are asked what characteristics lead to the
differences in the responsibility center systems.

____________
*Supplemental Topic A, “Variable Costing.”

196 © The McGraw-Hill Companies, Inc., 2005

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1. Management makes use of accounting information about individual responsibility centers of the
business in many ways, including (1) planning and allocating resources, (2) evaluating the
performance of responsibility centers, (3) controlling costs, and (4) evaluating the performance of
center managers.
2. A responsibility accounting system accumulates information separately for each area of management
responsibility. A budget is prepared for each responsibility center’s performance, the actual perfor-
mance is recorded, and performance reports are prepared comparing the performance of each respon-
sibility center to the budgeted amounts. This process helps managers to control costs in two major
ways. First, management’s attention is quickly focused upon those parts of the business in which costs
have become excessive. Second, individual managers become more conscious of keeping costs in line
with budgeted amounts, as they know that they will be held accountable for excessive deviations.
3. A cost center is a part of the business that incurs cost but that does not directly generate revenue.
Examples include service departments, such as the accounting department, that render services to
other parts of the business.
A profit center generates revenue as well as incurring costs. Examples include a sales department
within a store, the store itself, and a sales territory.
An investment center is a profit center for which management can readily identify the assets invested
(without resorting to arbitrary allocations). This characteristic allows the use of “return on
investment” techniques in evaluating performance. Examples of investment centers include stores,
branch offices, and hotels.
4. The bakery is basically a cost center. It is not intended to earn a profit but rather to render service
(attracting customers) to the store. In evaluating the bakery as a cost center, the question becomes, “Is
the cost (the negative responsibility margin of the bakery) justified by the services rendered to the
other parts of the store?”
5. Setting transfer prices for goods and services transferred between profit centers is controversial
because the transfer price allocates profits between the two profit centers. Since the profit center
managers are evaluated on profits each manager wants more profits allocated to their profit center.
6. A responsibility accounting system is designed to separately measure the performance of each unit of
the business that is under the control of a particular manager. The idea is to shape reporting to follow
the organizational structure or managerial responsibility. Thus, individual managers are held account-
able for the performance of the business units under their direct control.
7. The three basic steps in the operation of a responsibility accounting system are:
(1) Preparing budgets for each responsibility center.
(2) Measuring the performance of each responsibility center.
(3) Comparing actual performance with the budget, and determining the reasons for significant
variations.
8. In a responsibility accounting system, the recording of revenue and costs should begin with the
smallest areas of responsibility. This enables the preparation of income statements for even the
smallest profit centers. The income statements for larger responsibility centers are then prepared
largely by combining the income statements of the center’s subunits.
9. The concepts used in classifying costs in responsibility income statements are (1) whether the costs
are variable or fixed and (2) whether the costs are directly traceable to specific responsibility centers.

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 10. Traceable fixed costs are fixed costs that arise because of the existence of a particular business unit
and that would be eliminated if that unit were closed. Common fixed costs are fixed costs that jointly
benefit two or more business units. Often, the level of these common costs would not change even if
one of the units were discontinued.
In an automobile dealership divided into a sales department and a service department, the salary of
the service manager and depreciation on garage equipment are examples of fixed costs traceable to
the service department. The property taxes on the dealership’s location is an example of a common
fixed cost.
11. Unless the costs of operating the service center can be traced directly to one or more of the responsi-
bility centers appearing in the responsibility income statement, these costs are shown as common
fixed costs.
12. No. Although the salary of the sales territory manager is a common fixed cost when the sales territory
is divided by the product line, this cost is directly traceable to the activities of the territory. Thus, if an
income statement were divided by sales territory, the territory manager’s salary would be classified as
a traceable fixed cost.
13. Department A. Short-run product promotion affects revenue and variable costs but generally does
not affect fixed costs. Thus, the $10,000 advertising cost should be compared to the additional
contribution margin expected to result from a $50,000 increase in departmental sales. The department
with the highest contribution margin ratio will generate the highest dollar amount of contribution
margin from a sales increase of a given size.
14. This statement is not a logical criterion for closing departments. First, a business unit that has any
responsibility margin is contributing to the common fixed costs and profitability of the business.
Unless the resources relating to the unit can be put to better use, there generally is no reason to close
any unit with a positive responsibility margin.
Second, the responsibility margin ratio (15%) states responsibility margin as a percentage of sales,
not a percentage of assets employed by the unit. A unit with high inventory turnover, such as a
supermarket, may show a very low responsibility margin ratio, yet provide a very high return on the
assets utilized in the unit’s operations.
Finally, the statement ignores the possibility that the existence of one business unit may contribute
substantially to sales of other units. In summary, the decision of whether or not to close a department
involves far more analysis than using a “cutoff” responsibility margin ratio.
15. Contribution margin is a measurement of performance that takes into consideration only revenue and
variable costs. Therefore, this measurement is useful in evaluating the probable outcomes of deci-
sions that affect primarily revenue and variable costs. These would include pricing decisions and
other marketing strategies.
Responsibility margin is a measure of performance that takes into consideration not only revenue and
variable costs but also fixed costs traceable to the responsibility center. Therefore, responsibility
margin is useful in evaluating decisions that involve significant changes in traceable fixed costs, such
as expanding or contracting plant capacity.
16. All the elements of responsibility margin—revenue, variable costs, and traceable fixed costs—will
be eliminated if a center is closed. Without considering other issues, this information implies that
closing the department will eliminate the negative responsibility margin, thus increasing the operating
income of the business by this amount.

198 © The McGraw-Hill Companies, Inc., 2005

 In addition to the negative responsibility margin, several questions to be considered in the decision of
whether or not to close a center are:
(1) To what extent might closing the center affect the sales of other centers?
(2) What are the alternative uses of the facilities now used by the center?
(3) What is the likelihood that center performance can be improved?
17. Controllable fixed costs and committed fixed costs are subclassifications of fixed costs traceable to a
responsibility center. The controllable fixed costs are those that are readily controllable by the center
manager. Committed fixed costs, on the other hand, are those that the center manager cannot readily
change.
Performance margin is revenue, less variable costs, and less controllable fixed costs. This subtotal
often is used to evaluate the performance of center managers, because it represents the subtotal of
those revenue and cost flows under the manager’s direct control. Thus, this subtotal does not penalize
the manager with committed costs, which he or she is unable to change in the short run.
18. No. The costs relating to operations of the corporate headquarters cannot be traced to the revenue of
specific restaurants on a basis of cause and effect. With respect to the individual restaurants, the costs
of operating the corporate headquarters should be viewed as common fixed costs. Reasons for not
allocating these costs include:
(1) Any allocation would be arbitrary, not necessarily corresponding to benefit derived or factors
causing the cost to be incurred.
(2) As these costs would not be eliminated even if a specific restaurant were closed, including these
costs in the restaurants’ income statements obscures the contribution that each restaurant makes
toward the profitability of the business.
(3) These costs are not controllable by the individual restaurant managers. This decreases the
usefulness of the departmental income statements for evaluating managerial performance and also
causes managers to lose confidence in the significance and fairness of the performance evaluation
system.
19. A profit center is evaluated based upon its ability to generate profits. If cost is used as a transfer price,
the center has no opportunity to earn a profit on the products that it produces and transfers to other
parts of the business. In essence, profit ultimately reported on these products is transferred from the
profit center that produced them to the profit center that sells them to an outside customer.
*20. Under full costing, all manufacturing costs—whether fixed or variable—are viewed as product costs.
Product costs become “attached” to the units manufactured and follow those units through the
financial statements. Thus, product costs are deducted from revenue (as part of the costs of goods
sold) in the period in which the related units are sold.
Under variable costing, only variable manufacturing costs are viewed as product costs. Fixed
manufacturing costs are considered period costs. Thus, fixed manufacturing costs are deducted from
revenue in the period in which the costs are incurred, without regard to whether the related units of
product have been sold or remain in inventory.
Full costing is required in both financial statements and in income tax returns. Variable costing is a
tool used only in “internal” financial statements, prepared exclusively for use by management.

____________
*Supplemental Topic A, “Variable Costing.”

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*21. In a variable costing income statement, costs are divided into the classification of variable costs and
fixed costs. This classification permits arranging the income statement in a manner showing subtotals
for contribution margin and total fixed costs—two key figures in cost-volume-profit analysis. These
subtotals cannot readily be determined from a conventional (full costing) income statement, because
both fixed and variable costs are combined into classifications such as “cost of goods sold” and
“general and administrative expenses.”
*22. Under full costing, temporarily increasing production to a level exceeding unit sales causes a portion
of the fixed manufacturing costs for the period to be “deferred” into inventory. As the deferred fixed
costs are not offset against revenue in the current period, the responsibility margin in the current
period will increase. The larger the excess of current production over sales, the more fixed costs that
will be deferred. Thus, responsibility margin may be affected by the number of units produced.
Under variable costing, responsibility margin will not be affected by the number of units produced,
because no fixed manufacturing costs are deferred into inventory. The cost of goods sold is based
only upon variable production cost per unit, which remains constant despite fluctuations in the level
of production. All fixed manufacturing costs are deducted from revenue in the period incurred,
regardless of the level of production.

____________
*Supplemental Topic A, “Variable Costing.”

200 © The McGraw-Hill Companies, Inc., 2005

 SOLUTIONS TO EXERCISES

Ex. 22–1 a. Traceable fixed costs

b. Cost-plus transfer price.
c. None (The statement describes controllable fixed costs.)
d. Performance margin
e. Contribution margin
f. Responsibility margin
g. Transfer price

Ex. 22–2 a. An individual video arcade within a chain of video arcades will be evaluated as an
investment center because each arcade will generate a profit and will have an identi-
fiable asset base.
b. A snack bar within one of the company’s arcades will most likely be evaluated as a
profit center. It is unlikely that a snack bar will be evaluated as an investment center
because it will share common assets with other profit centers in each arcade.
c. A particular game within one of the company’s arcades will most likely be evaluated as
a profit center. However, if the company’s investment in each game is viewed as its
asset base (and the common assets it shares with other games within the arcade are
ignored), the company could consider each game an investment center.
d. The security for each arcade will most likely be evaluated as a cost center because
security officers contribute no profit to the company.

Ex. 22–3 a. Common fixed costs

b. Traceable fixed costs—controllable
c. None (Sales taxes are a liability, not an expense.)
d. Traceable fixed costs—committed
e. Traceable fixed costs—controllable
f. Common fixed costs
g. Variable costs

Ex. 22–4 a. The Tootsie Roll business segments are classified by geography: the United States
segment and the Mexico and Canada segment. These segments are likely to be
investment centers because the total assets and net assets are identified separately in
note 13.
b. Sales from the United States segment to the Mexico and Canada segment are
$4,978,000. Sales from the Mexico and Canada segment to the United States segment
are $2,892,000. Sales from Mexico and Canada to United States increased from 2001 to
2002. Sales from United States to Mexico and Canada increased from 2001 to 2002.
These changes might be related to changes in demand for the products. In addition,
changes in the exchange rates between the countries might be driving the increases in
sales between geographic regions.

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Ex. 22–5 Gemini’s responsibility income statement is shown below:
GEMINI TECHNOLOGIES
Responsibility Income Statement
For the Current Month
Integrated
Entire Company Laser Line Circuits Line
Dollars Percent Dollars Percent Dollars Percent
Sales ............................... $ 1,300,000 100.0 $500,000 100.0 $800,000 100.0
Variable costs ................ 680,000 52.3 200,000 40.0 480,000 60.0
Contribution margin .... $ 620,000 47.7 $300,000 60.0 $320,000 40.0
Fixed costs traceable
to product lines............. $ 450,000 34.6 200,000 40.0 $250,000 31.3
Product responsibility
margin........................... $ 170,000 13.1 $100,000 20.0 $ 70,000 8.7
Common fixed costs...... 80,000 6.2
Income from
operations ..................... $ 90,000 6.9

Ex. 22–6 a. Store 3. The effect of an advertising campaign upon operating income is determined by
comparing the cost of the advertising ($15,000 per month) with the additional contri-
bution margin that will be generated by the increase in sales. Given that the increase in
monthly sales is expected to be $60,000 per month regardless of which store is advertised
($600,000 × 10%), the company will derive the most benefit by increasing the sales of the
store with the highest contribution margin ratio (45% for Store 3).
A $60,000 increase in sales will produce $27,000 in contribution margin at Store 3
($60,000 × 45%); $22,800 at Store 1 ($60,000 × 38%); and $22,200 at Store 2 ($60,000
× 37%).

b. Store 1. The contribution that each store makes toward common costs and toward the
profitability of Drexel-Hall is measured by responsibility margin—that is, revenue less
all costs directly traceable to the store. Store 1 has the highest responsibility margin—
surpassing Store 2 by $6,000 per month, and Store 3 by $66,000 per month.
Store 1 surpasses Store 3 in profitability, despite Store 3’s higher contribution margin,
because of Store 3’s excessive level of controllable fixed costs. Store 1’s small
advantage over Store 2 is in the area of committed fixed costs, which probably stems
from the lower depreciation charges on Store 1’s building.

c. Store 2. The effectiveness of the store manager’s strategies are best evaluated by
looking at the relationship of revenue to expenses under the manager’s direct control.
This relationship is measured by the subtotal performance margin ratio. Store 2 has
the highest performance margin and performance margin ratio. The only reason that
Store 2 is not more profitable than Store 1 is that Store 2 is saddled with higher
depreciation charges due to higher costs at the time the store was built. These
depreciation charges, however, are not controllable by the store manager and should
not enter into an evaluation of his or her effectiveness. The managers of Stores 1 and 3
should both consider the marketing strategies in use at Store 2.

202 © The McGraw-Hill Companies, Inc., 2005

Ex. 22–7 a. Decrease in monthly sales from closing Store 3................................................. $600,000
Less: Increases in sales expected at Stores 1 and 2 ($60,000 + $120,000) ....... 180,000
Net decrease expected in total monthly sales ..................................................... $420,000

Store 1 Store 2
b. Expected increase in monthly contribution margins:
Store 1: ($60,000 additional sales × 38%) .................................. $22,800
Store 2: ($120,000 additional sales × 37%) ................................ $44,400
Less: Additional traceable fixed costs ............................................ –0– –0–
Expected increases in monthly responsibility margins ................. $22,800 $44,400

c. Increase in income from operations from elimination of the negative

responsibility margin of Store 3.......................................................................... $ 6,000
Expected increase in income from operations resulting from
increase in responsibility margins of Stores 1 and 2
($22,800 + $44,400, per part b) ......................................................................... 67,200
Expected increase in monthly operating income from closure
of Store 3 ............................................................................................................. $73,200

Ex. 22–8 Strategy 1: Advertise the name Drexel-Hall:

Expected increase (decrease) in monthly contribution margins:
Store 1: ($228,000 × 5% increase) ................................................................ $11,400
Store 2: ($222,000 × 5% increase) ................................................................ 11,100
Store 3: ($270,000 × 5% increase) ................................................................ 13,500
Total expected increase in monthly contribution margins* ........................... $36,000
Monthly cost of advertising campaign ............................................................. 15,000
Expected increase in monthly income from operations.................................. $21,000
*As the contribution margin of all stores is expected to increase at the same 5% rate,
we could shorten our computation by applying the 5% increase to the companywide
contribution margin of $720,000.

Strategy 2: Advertise low prices at Store 2:

Expected increase (decrease) in contribution margins:
Store 1: ($30,000 decrease in sales × 38% contribution margin ratio) ..... $ (11,400)
Store 2: ($150,000 increase in sales × 37% contribution margin ratio) .... 55,500
Store 3: ($30,000 decrease in sales × 45% contribution margin ratio) ..... (13,500)
Total expected increase in monthly contribution margins............................. $ 30,600
Monthly cost of advertising campaign ............................................................. 15,000
Expected increase in monthly income from operations.................................. $ 15,600

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 Ex. 22–9 The higher each division’s responsibility margin, the higher each division’s
profitability will be. Thus, since the managers are paid a bonus based on the
profitability of their respective divisions, each will favor a transfer price that
maximizes his division’s responsibility margin. For the Processed Meat Division, a
market value approach would most likely result in the highest responsibility margin.
For the Frozen Pizza Division (the buying division), a cost approach or a negotiated
approach would probably be most beneficial.

* Ex. 22–10 a. (1) Cost of goods sold: full costing, 200,000 units manufactured and sold:
Per-unit manufacturing costs:
Direct materials used............................................................................... $15
Direct labor .............................................................................................. 12
Variable manufacturing overhead......................................................... 3
Total variable manufacturing costs per unit............................................. $30
Fixed manufacturing costs per unit ($3,400,000 ÷ 200,000 units
manufactured) ....................................................................................... 17
Total (full) manufacturing cost per unit.................................................... $47

Cost of goods sold: full costing (200,000 units sold @

$47 per unit).......................................................................................... $9,400,000

(2) Cost of goods sold: full costing, 340,000 units manufactured, 200,000 units sold:
Per-unit manufacturing costs:
Variable manufacturing costs from a (1) .............................................. $30
Fixed manufacturing costs per unit ($3,400,000 ÷ 340,000 units
manufactured) ....................................................................................... 10
Total (full) manufacturing cost per unit.................................................... $40

Cost of goods sold: full costing (200,000 units sold @

$40 per unit).......................................................................................... $8,000,000

b. (1) Variable cost of goods sold [variable cost per unit, $30, as
computed in part a (1), × 200,000 units sold]..................................... $6,000,000
(2) $6,000,000; same computation as in part b (1).

c. Under full costing, when more units are manufactured than are sold, the fixed manu-
facturing costs attached to the unsold units are deferred into inventory. These costs
amounted to $1,400,000 (140,000 unsold units × $10 per unit). This explains the dif-
ference between the cost of goods sold figure under the two assumptions in part a
($9,400,000 − $8,000,000 = $1,400,000).

____________
*Supplemental Topic A, “Variable Costing.”

204 © The McGraw-Hill Companies, Inc., 2005

*Ex. 22–11 a. (1) Per-unit manufacturing cost (full costing):
Variable costs ($1,750,000 ÷ 125,000 units)............................................... $14
Fixed costs ($2,125,000 ÷ 125,000 units) .................................................... 17
Total per unit manufacturing cost ......................................................... $31
(2) Per-unit manufacturing cost (variable costing):
Variable costs ($1,750,000 ÷ 125,000 units)............................................... $14

b. (1) Income from operations (full costing):

Sales (100,000 units @ $50) ................................................................... $5,000,000
Cost of goods sold [100,000 units at $31, per part a (1)] ..................... 3,100,000
Gross profit on sales ............................................................................... $1,900,000
Selling and administrative expenses ..................................................... 750,000
Income from operations (full costing)................................................... $1,150,000
(2) Income from operations (variable costing):
Sales (100,000 units @ $50) ................................................................... $5,000,000
Variable cost of goods sold [100,000 units at $14, per part a (2)] ...... 1,400,000
Contribution margin .............................................................................. $3,600,000
Fixed costs:
Manufacturing ............................................................ $2,125,000
Selling and administrative ......................................... 750,000 2,875,000
Income from operations (variable costing) .................. $ 725,000

c. Under full costing, $425,000 in fixed manufacturing costs were deferred into inven-
tory (25,000 units × $17 per unit), whereas under variable costing, all fixed manufac-
turing costs were deducted from revenue in the current period.

____________
*Supplemental Topic A, “Variable Costing.”

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 SOLUTIONS TO PROBLEMS
15 Minutes, Easy PROBLEM 22–1
SOME FAMILIAR SEGMENTS

a. (1) Profit center

(2) Investment center
(3) Cost center
(4) Cost center
(5) Profit center
(6) Investment center

b. (1) Evaluating investment centers:

Because the cost of the assets representing an investment center may be determined, it may be
evaluated by the return provided on the amount invested. Return on assets for an investment
center normally is computed by expressing responsibility margin as a percentage of average
assets invested.

(2) Evaluating profit centers (other than investment centers):

Profit centers are evaluated primarily upon their profitability. As this profitability cannot be
expressed as a “rate of return,” it is instead compared with such standards as budgeted
amounts, past performance, and the profitability of other profit centers.

(3) Evaluating cost centers:

From a financial point of view, cost centers are evaluated only upon their ability to control the
costs applicable to their operations.
In a few cases, costs provide a reasonably objective measurement of performance. For exam-
ple, unit costs are quite useful in evaluating the performance of a production department
organized as a cost center. Many cost centers, however, provide only services to other parts of
the organization.
Evaluating the “value” of the services rendered by a cost center such as the accounting depart-
ment involves much subjective judgment. In the absence of revenue as a measure of “value
produced,” the evaluation of cost centers often relies heavily upon qualitative considerations.

206 © The McGraw-Hill Companies, Inc., 2005

30 Minutes, Medium PROBLEM 22–2
REGAL FLAIR ENTERPRISES
a. Responsibility income statement: REGAL FLAIR ENTERPRISES
Responsibility Income Statement
For the Current Month
Entire Company Jewelry Line Apparel Line
Dollars Percent Dollars Percent Dollars Percent
Sales $1 2 5 0 0 0 0 1 0 0 .0 $8 0 0 0 0 0 1 0 0 .0 $4 5 0 0 0 0 1 0 0 .0
Variable costs 5 6 6 0 0 0 4 5 .3 4 4 0 0 0 0 5 5 .0 1 2 6 0 0 0 2 8 .0
Contribution margin $ 6 8 4 0 0 0 5 4 .7 $3 6 0 0 0 0 4 5 .0 $3 2 4 0 0 0 7 2 .0
Fixed costs traceable to product lines 4 5 0 0 0 0 3 6 .0 2 0 0 0 0 0 2 5 .0 2 5 0 0 0 0 5 5 .6
Product responsibility margin $ 2 3 4 0 0 0 1 8 .7 $1 6 0 0 0 0 2 0 .0 % $ 7 4 0 0 0 1 6 .4 %
Common fixed costs 1 0 0 0 0 0 8 .0
Income from operations $ 1 3 4 0 0 0 1 0 .7 %

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 PROBLEM 22–2
REGAL FLAIR ENTERPRISES (concluded)

b. Recommendations on increased advertising:.

It appears that increasing advertising expenditures on apparel will increase the profitability of the
business, but spending the proposed amount to advertise jewelry would reduce profitability.
Short-run decisions that are not likely to affect fixed costs may be evaluated based upon the
expected change in contribution margin. Thus, the expected effect of the proposed advertising
campaign upon income from operations may be summarized as follows:

Jewelry Apparel
Expected increase in contribution margin:
Jewelry ($150,000 × 45%) $ 6 7 5 00
Apparel ($150,000 × 72%) $1 0 8 0 0 0
Less: Increase in advertising expenditures 7 5 0 0 0 7 5 0 0 0
Expected increase (decrease) in operating income $ (7 5 0 0 ) $ 3 3 0 0 0

Because of the relatively high contribution margin in the apparel segment, spending $75,000 per
month to achieve a monthly sales increase of $150,000 will increase overall profitability. Jewelry,
however, provides a lower contribution margin. After variable costs, a $150,000 increase in
jewelry sales leaves only $67,500 in contribution margin, which does not cover the cost of the
proposed advertising campaign.

c. Results of investment in each product line:

Jewelry Apparel
Expected increase in contribution margin:
Jewelry ($300,000 × 45%) $1 3 5 0 00
Apparel ($300,000 × 72%) $2 1 6 0 0 0
Less: Increase in traceable fixed costs (75%) 1 5 0 0 0 0 1 8 7 5 0 0
Expected increase (decrease) in operating income $ ( 15 0 0 0 ) $ 2 8 5 0 0

Thus, it would appear that an investment in the Apparel line would produce the most profitable
results. The contribution margin ratio of the Jewelry line is considerably less than that of the
Apparel line (45% compared to 72%). Thus, an expected increase of $300,000 in sales will only
contribute $135,000 toward covering the expected increase in the line’s traceable fixed costs of
$150,000 ($200,000 × 75%). On sales of $300,000, the relatively high contribution margin of the
Apparel line will enable it to contribute $216,000 to cover its $187,500 increase in fixed costs
($250,000 × 75%).

208 © The McGraw-Hill Companies, Inc., 2005

30 Minutes, Medium PROBLEM 22–3
GIANT CHEF EQUIPMENT COMPANY
a. Responsibility income statement for June: GIANT CHEF EQUIPMENT COMPANY
Responsibility Income Statement
For June
Entire Company Commercial Sales Division Home Products Division
Dollars Percent Dollars Percent Dollars Percent
Sales $2 4 0 0 0 0 0 1 0 0 .0 $15 0 0 0 0 0 1 0 0 .0 $9 0 0 0 0 0 1 0 0 .0
Variable costs 14 4 0 0 0 0 6 0 .0 9 9 0 0 0 0 6 6 .0 4 5 0 0 0 0 5 0 .0
Contribution margin $ 9 6 0 0 0 0 4 0 .0 $ 5 1 0 0 0 0 3 4 .0 $4 5 0 0 0 0 5 0 .0
Fixed costs traceable to divisions 3 6 0 0 0 0 1 5 .0 1 8 0 0 0 0 1 2 .0 1 8 0 0 0 0 2 0 .0
Division responsibility margin $ 6 0 0 0 0 0 2 5 .0 $ 3 3 0 0 0 0 2 2 .0 % $2 7 0 0 0 0 3 0 .0 %
Common fixed costs 1 2 0 0 0 0 5 .0
Operating income $ 4 8 0 0 0 0 2 0 .0 %

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 209
 PROBLEM 22–3
GIANT CHEF EQUIPMENT COMPANY (concluded)

b. Sales volume required for a $500,000 monthly responsibility margin in the Home Products Divi-
sion may be computed as follows:
Division Sales = [Division Fixed Costs + Responsibility Margin] ÷ Contribution Margin Ratio
= [$180,000 + $500,000] ÷ 50% = $1,360,000

c. The decision to increase monthly advertising expenditures is supported by the following

calculations:

Incremental revenue ($900,000 × 5%) $ 4 5 0 0 0

Less: Incremental variable costs ($45,000 × 50%) 2 2 5 0 0
Increase in contribution margin $ 2 2 5 0 0
Less: Incremental increase in fixed costs 1 5 0 0 0
Incremental increase in responsibility margin $ 7 5 0 0

210 © The McGraw-Hill Companies, Inc., 2005

60 Minutes, Strong PROBLEM 22–4
HEALTH TECH, INC.
a. Responsibility income statement of HEALTH TECH, INC.
the Eastern Territory: Responsibility Income Statement
Eastern Territory
For January
Eastern Territory FasTrak RowMaster
Dollars Percent Dollars Percent Dollars Percent
Sales $1 1 5 0 0 0 0 1 0 0 .0 $4 0 0 0 0 0 1 0 0 .0 $7 5 0 0 0 0 1 0 0 .0
Variable costs 6 1 0 0 0 0 5 3 .0 1 6 0 0 0 0 4 0 .0 4 5 0 0 0 0 6 0 .0
Contribution margin $ 5 4 0 0 0 0 4 7 .0 $2 4 0 0 0 0 6 0 .0 $3 0 0 0 0 0 4 0 .0
Fixed costs traceable to product lines 2 3 0 0 0 0 2 0 .0 8 0 0 0 0 2 0 .0 1 5 0 0 0 0 2 0 .0
Division responsibility margin $ 3 1 0 0 0 0 2 7 .0 $1 6 0 0 0 0 4 0 .0 % $1 5 0 0 0 0 2 0 .0 %
Common fixed costs 1 2 0 0 0 0 1 0 .5 *
Operating income $ 1 9 0 0 0 0 1 6 .5 %

b. Responsibility income statement of HEALTH TECH, INC.

the entire company: Responsibility Income Statement
For January
Entire Company Eastern Territory Western Territory
Dollars Percent Dollars Percent Dollars Percent
Sales $1 7 5 0 0 0 0 1 0 0 .0 $11 5 0 0 0 0 1 0 0 .0 $6 0 0 0 0 0 1 0 0 .0
Variable costs 8 8 0 0 0 0 5 0 .3 6 1 0 0 0 0 5 3 .0 2 7 0 0 0 0 4 5 .0
Contribution margin $ 8 7 0 0 0 0 4 9 .7 $ 5 4 0 0 0 0 4 7 .0 $3 3 0 0 0 0 5 5 .0
Fixed costs traceable to territories 4 8 0 0 0 0 2 7 .4 3 5 0 0 0 0 3 0 .5 1 3 0 0 0 0 2 1 .7
Division responsibility margin $ 3 9 0 0 0 0 2 2 .3 $ 1 9 0 0 0 0 1 6 .5 % $2 0 0 0 0 0 3 3 .3 %
Common fixed costs 1 8 0 0 0 0 1 0 .3
Operating income $ 2 1 0 0 0 0 1 2 .0 %

*Minor rounding difference

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 211
 PROBLEM 22–4
HEALTH TECH, INC. (concluded)
c. Each territory’s return on assets:
Eastern Western
Territory Territory
Responsibility margin $ 1 9 0 0 0 0 $ 2 0 0 0 0 0
÷ Average assets 15 0 0 0 0 0 0 10 0 0 0 0 0 0
Return on assets 1 .3 % 2 .0 %

d. All costs are traceable at some level of the organization. While the $120,000 in “common” fixed
costs was not traceable to product lines within the Eastern Territory, these costs are traceable to
the territory itself. Therefore, in the income statement divided by territories, this $120,000 is com-
bined with the other fixed costs of the Eastern Territory and is shown as “Fixed costs traceable to
territories.”

e. The manager should focus the campaign on the product line that will generate the greatest con-
tribution margin in relation to the additional fixed advertising cost. Thus, the manager should
support advertising of FasTrak, as shown below:

FasTrak RowMaster
Incremental revenue $1 2 0 0 0 0 $1 2 0 0 0 0
Less: Incremental variable costs 4 8 0 0 0 7 2 0 0 0
Incremental increase in contribution margin $ 7 2 0 0 0 $ 4 8 0 0 0
Less: Incremental fixed costs 5 0 0 0 0 5 0 0 0 0
Increase (decrease) in responsibility margin $ 2 2 0 0 0 $ ( 2 0 0 0 )

f. In the type of long-run investment described, top management must be aware of the ability of the
investment to cover fixed costs as well as variable costs. Thus, management should look to such
measures as responsibility margin and return on assets. As management knows the cost of assets
currently invested in each sales territory, return on investment techniques may be used to evaluate
the relative profitability of each territory. In part c, we determined that the return on assets of the
Eastern Territory was approximately 1.3% per month, or 15.6% per year. The Western Territory
offers an even higher return of 2% per month, or 24% per year. Thus, the Western Territory
appears to offer the higher potential return on investment.

212 © The McG

45 Minutes, Strong PROBLEM 22–5
BUTTERFIELD, INC.
a. Computation of expected change in responsibility margin:

(1) Product A (2) Product B

Expected increase in sales $ 3 0 0 0 0 $ 3 0 0 0 0
Product contribution margin ratio ×4 8 % ×3 6 %
Expected increase in contribution margin $ 1 4 4 0 0 $ 1 0 8 0 0
Expected change in fixed costs (advertising) 1 0 0 0 0 1 0 0 0 0
Expected change in responsibility margin $ 4 4 0 0 $ 8 0 0

b. When an increase in revenue requires new manufacturing facilities, the revenue must be sufficient
to cover the increase in fixed costs as well as the variable costs of production. The ability to cover
fixed costs is indicated by the responsibility margin ratio. Product B has the higher responsibility
margin ratio, with 28% of total revenue currently adding directly to the operating income of the
business. Therefore, Product B appears to be the logical choice for expansion.

c. In the Division 1 responsibility income statement, this $21,000 in costs was classified as “common”
because the costs could not be traced to the subunits within the division. However, the costs are
traceable to the division itself. Therefore, when the segments are defined as entire divisions, these
costs are combined with the other fixed costs relating to Division 1 and are identified as
“traceable” to the division. Notice that the fixed costs traceable to Division 1 total $63,000; this
represents the $42,000 traceable to the subunits within the division, and this $21,000.

d. An increase in the monthly sales of Division 2 to $200,000 represents a $50,000 increase over the
current level of sales. As Division 2 has a contribution margin ratio of 70%, a $50,000 increase in
sales should add $35,000 in contribution margin to the division. As there should be no change in
fixed costs, this entire $35,000 should also increase the operating income of the company.

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 213
 PROBLEM 22–5
BUTTERFIELD, INC. (concluded)
e. BUTTERFIELD, INC.
Income Statement by Divisions
For the Month Ended March 31
Divisions
Butterfield, Inc. Division 1 Division 2
Dollars Percent Dollars Percent Dollars Percent
Sales $5 0 0 0 0 0 1 0 0 $3 0 0 0 0 0 1 0 0 $2 0 0 0 0 0 1 0 0
Variable costs 2 4 0 0 0 0 4 8 1 8 0 0 0 0 6 0 6 0 0 0 0 3 0
Contribution margin $2 6 0 0 0 0 5 2 $1 2 0 0 0 0 4 0 $1 4 0 0 0 0 7 0
Fixed costs traceable to divisions 1 3 5 0 0 0 2 7 6 3 0 0 0 2 1 7 2 0 0 0 3 6
Division responsibility margins $1 2 5 0 0 0 2 5 $ 5 7 0 0 0 1 9 $ 6 8 0 0 0 3 4
Common costs 4 5 0 0 0 9
Income from operations $ 8 0 0 0 0 1 6

214 © The McGraw-Hill Companies, Inc., 2005

15 Minutes, Easy PROBLEM 22–6
FLYWIZ, INC.

a. Based solely on the financial data given, closure of the Rod Division would have increased the
company’s operating income to $9,000 (a $4,000 increase resulting from the elimination of the
negative responsibility margin generated by that division).

b. It is very possible that the Rod Division contributes to the sales volume of the Reel Division.
Indeed, these products seem extremely complementary in nature (i.e., if you buy a fishing rod,
you’ll need a fishing reel, and if you buy a fishing reel, you’ll need a fishing rod). The other issue
to consider is the seasonality of the fishing equipment industry. January is typically a very slow
month for sales of fishing equipment. Thus, to close the Rod Division based on a single month of
activity in the slow season may be premature.

c. The Rod Division has a contribution margin ratio of 50% ($13,000 ÷ $26,000). Thus, for each
dollar of sales, the division’s responsibility margin is increased by $0.50. In order for the Rod
Division to generate a positive responsibility margin of $4,000, it would have to increase its
current responsibility margin (a $4,000 loss) by $8,000. Thus, it would have to increase monthly
sales by $16,000, calculated as follows:
Sales Increase Required × 50% Contribution Margin Ratio = $8,000
Sales Increase Required = $8,000 ÷ 50% = $16,000

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 215
15 Minutes, Easy PROBLEM 22–7
WESTFALL CORPORATION

a. Using the market price, the contribution margins for each division and for the company as a whole:

Entire Motor Pump

Company Division Division
Sales (1) $12 0 0 0 0 0 0 $70 0 0 0 0 0 $50 0 0 0 0 0
Variable Costs (2) 79 5 0 0 0 0 37 0 0 0 0 0 42 5 0 0 0 0
Contribution Margin $ 40 5 0 0 0 0 $33 0 0 0 0 0 $ 7 5 0 0 0 0

(1) Motor Division Sales = 20,000 units × $350 = $7,000,000

Pump Division Sales = 10,000 units × $500 = $5,000,000
(2) Motor Division Variable Costs = 20,000 units × $185 = $3,700,000
Pump Division Variable Costs = 10,000 units × ($75 + $350) = $4,250,000

b. Using the discount price, the contribution margins for each division and for the company as a
whole:

Entire Motor Pump

Company Division Division
Sales (1) $11 7 0 0 0 0 0 $67 0 0 0 0 0 $50 0 0 0 0 0
Variable Costs (2) 76 5 0 0 0 0 37 0 0 0 0 0 39 5 0 0 0 0
Contribution Margin $ 40 5 0 0 0 0 $30 0 0 0 0 0 $10 5 0 0 0 0

(1) Motor Division Sales = (10,000 units × $350) + (10,000 units × $320) = $6,700,000
Pump Division Sales = 10,000 units × $500 = $5,000,000
(2) Motor Division Variable Costs = 20,000 units × $185 = $3,700,000
Pump Division Variable Costs = 10,000 units × ($75 + $320) = $3,950,000

c. If division managers are evaluated and rewarded based on their division’s contribution margin,
the transfer price becomes an important issue of concern. However, it is important to note that
regardless of the transfer price used, the contribution margin for the company as a whole remains
the same ($4,050,000). Only if the pump division could buy less expensive motors of equal quality
from an outside vendor would the contribution margin of the company as a whole increase. Of
course, the cost savings to the Pump Division would also have to offset the increase in advertising
costs that would be experienced by the Motor Division.

216 © The McGraw-Hill Companies, Inc., 2005

40 Minutes, Strong PROBLEM 22–8
LATHROP CORPORATION

Unit Costs
a. (1) Computation of unit cost (full costing):
Direct materials used $ 18
Direct labor 9
Variable manufacturing overhead 3
Fixed manufacturing overhead ($900,000 ÷ 90,000 units) 1 0
Total per-unit manufacturing cost $ 4 0

(2) LATHROP CORPORATION

Partial Income Statement (Full Costing)
For the Year Ended December 31, 2005
Sales (75,000 units @ $60) $45 0 0 0 0 0
Cost of goods sold (75,000 units @ $40, per part a (1) ) 30 0 0 0 0 0
Gross profit on sales $15 0 0 0 0 0
Selling and administrative expenses:
Variable (75,000 units sold × $7 per unit) $525000
Fixed 250000 775000
Income from operations $ 725000

Unit Costs
b. (1) Computation of unit cost (variable costing):
Direct materials used $ 18
Direct labor 9
Variable manufacturing overhead 3
Total variable manufacturing cost per unit $ 3 0

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 217
 PROBLEM 22–8
LATHROP CORPORATION (concluded)
(2) LATHROP CORPORATION
Partial Income Statement (Variable Costing)
For the Year Ended December 31, 2005
Sales $45 0 0 0 0 0
Variable costs:
Variable cost of goods sold (75,000 units @ $30) $22 5 0 0 0 0
Selling and administrative expenses (75,000 × $7) 525000 27 7 5 0 0 0
Contribution margin $17 2 5 0 0 0
Fixed costs:
Manufacturing $ 900000
Selling and administrative 250000 11 5 0 0 0 0
Income from operations $ 575000

c. The $150,000 difference in income from operations results from the different treatments accorded
to fixed manufacturing overhead. Under variable costing, all fixed overhead costs were deducted
from revenue in the current period. Under full costing, however, $150,000 in fixed overhead was
deferred into inventory ($10 per unit × 15,000 units) rather than being deducted from revenue.
Costs assigned to inventory will be offset against revenue in the period in which the goods are sold.
The full costing approach is required in financial statements prepared in conformity with
generally accepted accounting principles. Variable costing, however, is quite useful to managers
for two reasons. First, when variable costing is used, the income statement shows separately the
variable costs, contribution margin, and fixed costs, which is useful for cost-volume-profit
analysis. Second, variable costing avoids the distortions in unit cost that may result under full
costing from short-run fluctuations in the level of production. By avoiding these distortions, var-
iable costing helps managers to identify significant variations in unit cost.

Total Contribution Margin

d. (1) Contribution Margin per Unit Sold =
Number of Units Sold

$1,725,000 [per part b (2)]

=
75,000 units

= $23 per unit

Fixed Costs and Expenses

(2) Unit Sales Volume to Break Even =
Unit Contribution Margin

$900,000 + $250,000
=
$23

$1,150,000
= = 50,000 units
$23

218 © The McGraw-Hill Companies, Inc., 2005

 SOLUTIONS TO CASES
35 Minutes, Medium CASE 22–1
LAND’S END HOTEL

a. Evaluation of Chamberlain’s comments:

A basic purpose of a responsibility accounting system is to measure the performance of specific
responsibility centers. This means that the revenue and costs upon which a center is evaluated
should be traceable directly to that center and, ideally, be under the center manager’s control.
Chamberlain is correct that allocating all fixed costs of the hotel (many of which are common
costs) on the basis of gross revenue penalizes a successful profit center. Not only is the profit
center charged with more costs as its revenue rises, it can be charged with more costs merely
because the revenue in other profit centers declines. Thus, center performance may be obscured;
the performance of strong profit centers may be understated, and the performance of weaker
centers may be overstated since these centers are charged with less costs.
In summary, Chamberlain’s criticisms of the existing approach to assigning costs to profit centers
are valid. His suggestion that fixed costs should instead be allocated in proportion to square feet of
space is discussed below.

Evaluation of Mettenburg’s comments:

Mettenburg is also correct in her criticism of Chamberlain’s suggestion that fixed costs should be
allocated on a basis of square feet of occupied space. Many fixed costs, such as salaries, may bear
little or no relationship to square feet of space. Further, space occupied by a department may be a
matter of circumstances not under the center’s manager’s direct control. Mettenburg, for
example, does not have the option of “shrinking” the Sunset Lounge.
The criticisms of the two managers point out that any allocation of common costs is necessarily
arbitrary, rewarding some profit centers, but penalizing others.

b. Note to instructor: In part b, students are asked to develop their “own approach” to allocating
fixed costs to departments. Thus, our answer is intended only to represent one point of view.
We recommend that the revenue of a center should be offset only by the related variable costs and
by those fixed costs that are directly traceable to the center. Common fixed costs—those that
jointly benefit several profit centers—should not be allocated among the centers deriving benefit.
Thus, the responsibility income statement includes only those costs directly traceable to the
center’s activities.
Furthermore, traceable fixed costs may be divided into the subcategories of controllable fixed
costs and committed fixed costs. This enables the responsibility income statement to show as a
subtotal (performance margin) those aspects of the center’s operations that are readily
controllable by the center manager.

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 219
40 Minutes, Medium CASE 22–2
OSBORN DIVERSIFIED PRODUCTS, INC.

a. Financially, the $40,000 error is not apt to significantly damage Osborn. However, this does not
mean that Jim should keep the money and let the error go unreported. Jim has an ethical respon-
sibility to make the company aware of its mistake. To do otherwise is the same as stealing.

b. There is no easy answer to this question. One option for Sara is to inform Jim that she knows
about the error in his bonus payment. She should also let him know that he has an ethical and
legal obligation to return the money to the company. If he says that he will return it, she may
choose to trust him. If he says that he will not return it, one may argue that she has an obligation
to “blow the whistle” on Jim.

c. It is not ethical for Jim’s attorney to suggest that he keep the money. The attorney’s professional
code of ethics certainly does not condone stealing. Thus, the attorney should strongly suggest that
Jim return the money. However, if Jim refuses to do so, the attorney may not “blow the whistle”
on him because of the legal profession’s legal and ethical responsibility to maintain client
confidentiality.

d. Once again, there is no correct answer to this question. However, if Jim’s daughter decides to stay
in Boston, she must live with the fact that her college education was subsidized with stolen money.
It would certainly be advantageous for her to graduate with a degree from the prestigious
university. Therefore, she should make every possible effort to obtain financial aid (work-study,
student loans, grants, etc.). If her efforts fail, and Jim returns the money, she may have to finish
her education in Ohio.

220 © The McGraw-Hill Companies, Inc., 2005

30 Minutes, Medium CASE 22–3
BUSINESS WEEK ASSIGNMENT:
FREQUENT FLIER MILES

a. From the perspective of the airline customer, cost to the customer will increase because it will cost
more miles to fly and it will be more difficult to use the miles for airline seats.

From the perspective of the airline company, revenues should increase because more seats per
flight will have paying customers. Alternatively, customer dissatisfaction may cause customers to
go to other airlines.

b. The ethical issues exist for both the airline customer and the airline company. The value of the
points fluctuates with prices for airline tickets. In a competitive time period when ticket prices are
low, the value of the points may be relatively low because it takes the same amount of points to
obtain a ticket as when the prices are high. So the value of the frequent flier points fluctuates for
the customer over time. Thus, it is difficult to accept the customer-oriented argument that points
earned under previous rules should not be subject to the new rules. However, the airlines would
seem to have some obligation to reserve a certain percent of seats for these programs since the
program’s specific goals were to allow frequently flying customers to have the advantage of a free
ticket.

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 221
 SOLUTION TO INTERNET ASSIGNMENT
30 Minutes, Medium INTERNET 22–1
GENERAL MILLS AND THE KIRBY COMPANY

a. Given the diverse nature of the products supplied by General Mills, there are many ways in which
to organize responsibility centers. One way would be to define responsibility centers based on
major product groups such as cereals, baked goods, restaurant services, etc. An example of an
investment center might be one of General Mills’ restaurant lines, such as Red Lobster. Examples
of profit centers may be individual restaurants. Cost centers would likely include manufacturing
plants.

b. The Kirby company produces one product line that is marketed through independent sales
managers. One way of assigning responsibility centers is by geographical region, since sales
managers are likely assigned specific territories. Investment and/or profit centers may include
such geographical regions. Cost centers are likely to include the plants that manufacture Kirby
products.

c. Two fundamental differences between General Mills and Kirby that drive the differences in re-
sponsibility center systems are the scope of product lines and the sales methods.

222 © The McGraw-Hill Companies, Inc., 2005