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Responsibility Accounting and Transfer Pricing - Math Problem Example

Extract of sample Responsibility Accounting and Transfer Pricing

Required: a. Calculate depreciation expense and book value of the metal press under both historical cost and price-level-adjusted historical cost. For the historical cost, the metal fabrication press would depreciate \$43,500 per year (\$522,000/12). In terms of the book value of the metal fabrication press under historical cost, the net book value would be \$217,500 (\$522,000-(\$43,500*7)). In comparison, the price-level-adjusted historical cost would give a new cost of \$621,180 (Increase of 19% on the original cost. If this is so, the new book value would amount to \$316,680 (\$621,180-\$304,500). Because this value would depreciate over the remaining five years of its life, the depreciation expense would be\$63,336 (\$316,680/5). b. In general, what is the effect on ROA of changing valuation bases from historical cost to current values? Because assets are generally higher, the return on assets would be lower because a fraction always becomes less when the denominator is increased. This would result in the managers having more motivation to change the equipment because the return on the equipment would not be as great. c. The manager of the investment center with the metal press is considering replacing it because it is becoming obsolete. Will the manager's incentives to replace the metal press change if the firm shifts from historical cost valuation to the proposed price-level-adjusted historical cost valuation? It would not be advisable to do this because the company would need to alter the value of its asset each year. This change would result in giving the actual return at that point of time. However, it would mean that an extra cost would be incurred to fulfil with the accounting standards of the government. This would be too complicated to carry out so it is best to not replace the metal press. Problem 5-15 "U.S Pump Systems" US Pumps is a multidivisional firm that manufactures and installs chemical piping and pump systems. Its valve division makes a single standardized valve. The valve division and installation division currently are involved in a transfer-pricing dispute. Last year, half of the valve division's output was sold to the installation division for \$40 and the remaining half was sold to outsiders for \$60. The existing transfer price of \$40 per pump has been set through a negotiation process between the two divisions and with the involvement of senior management. The installation division has received a bid from an outside value manufacturer to supply it with an equivalent valve for \$35 each. The manager of the valve division manager has argued that if it is forced to meet the external price of \$35 it will lose money on internal sales. The operating data for the last year for the valve division follow: Valve Division Operating Statement-Last year To Installation Division To Outside Sales 20,000 @ \$40 \$800,000 20,000 @ \$60 \$1,200,000 Variable cost 20,000 @ \$30 (600,000) (600,000) Allocated fixed cost (135,000) (135,000) Gross margin \$ 65,000 \$465,000 Analyze the situation and recommend a course of action. What should the installation division managers do? What should the valve division managers do? What should the US Pumps senior manager do? From this situation, we can see that the installation division managers are able to achieve the necessary valve division output at a lower price. Also, the valve divisio ...Show more

Summary

P5-6 "Metal Press" Your firm uses return on assets (ROA) to evaluate investment centers and is considering changing the valuation basis of assets from historical cost to current value. When the historical cost of the asset is updated, a price index is used to approximate replacement value…
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