Responsibility Centres

Responsibility centres
A responsibility centre is part of an organisation for whose activities a manager is deemed to be responsible. The type of
responsibility centre depends on the type of activities for which responsibility is carried.
Cost Centre
A cost centre or expense centre can be defined as a responsibility centre where a manager is accountable only for costs
which are under his control. It is a production or service location for which costs can be identified or accumulated prior to
allocation to cost units. A cost centre manager is responsible for the cost of inputs to the organisation. The performance of
the manager of a cost centre can be assessed by comparing actual performance with budgeted targets for price, usage and
efficiency.
Revenue Centre
A revenue centre is a responsibility centre where a manager is accountable solely for the revenue generation that is under
his control. An example would be a sales team with a target geographical area which is under the control of a sales
manager. The manager would have no responsibility for the production cost of the items his team is selling, but has
responsibility for meeting sales targets in terms of sales volume, sales revenue or market share. A revenue centre manager
has responsibility for the revenue generated by outputs from the organisation.
Profit Centre
A profit centre is a combination of a cost centre and a revenue centre where a manager has responsibility for both
production costs and revenue generation. The degree of responsibility carried by a manager can be higher with a profit
centre than with a cost centre or a revenue centre, and the manager may be responsible for purchasing, production
planning, product mix and pricing decisions. The performance of the manager of a profit centre is unlikely to be assessed on
the fine detail of cost and revenue data but by the extent to which agreed targets for overall cost, revenue and profit have
been achieved.
Investment Centre
With an investment centre, the manager of a profit centre is given additional responsibility for investment decisions
regarding working capital and the purchase and replacement of fixed assets. The manager of an investment centre is likely
to be assessed with an aggregate measure that links periodic profit to the assets employed in the period to generate that
profit. An example of such an aggregate measure is return on capital employed.

Advantages of ROI
 Comparison: It can compare performance of different divisions having different amount of capital invested.
 It can be benchmarked against the performance of similar divisions so that company can have idea about return
generated through capital investment
 A convenient method to understand
Disadvantages of ROI
 This may not be suitable method for many division facing different types of risks
 Misleading impression of improved performance as if investments Centre maintains the same annual profit and
keeps same assets, then its ROI will continuously increase due to decrease in net book value of assets.
 Criticism is also on ROI arise from the valuation of assets used in the denominator
 If managers will be judged on the basis of ROI only then it will result in short term focus of managers
Advantages of RI
 It approves only those projects which earn above cost of capital of investment and eliminate any project earning
lower profits
 More flexible as compared with ROI since different cost of capital can be used for investment centres facing
different risks

Disadvantages of RI
 Since its an absolute value, it cannot be used for performance measurement of cost centres having different
amount of investment
 Criticism is also on RI arise from the valuation of assets used in the calculation of imputed interest

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Transfer Pricing
Q1. Division A, which is a part of the ACF Group, manufactures only one type of product, a Bit, which it sells
to external customers and also to division C, another member of the group, ACF Group’s policy is that divisions
have the freedom to set transfer prices and choose their suppliers.
The ACF Group uses residual income (RI) to assess divisional performance and each year it sets each division a
target RI. The group’s cost of capital is 12% a year.
Division A
Budgeted information for the coming year is:
Maximum capacity 150,000 Bits
External sales 110,000 Bits
External selling price $35 per bit
Variable cost $22 per bit
Fixed cost $1,080,000
Capital employed $3,200,000
Targeted residual income $180,000
Division C
Division C has found two other companies willing to supply Bits:
X could supply at $28 per Bit, but only for annual orders in excess of 50000 Bits.
Z could supply at $33 per Bit for any quantity ordered.
Required:-
Division C provisionally request a quotation of 60000 Bits from Division A for the coming year.
(i) Calculate the transfer price per bit that division A should quote in order to meet its residual income target.
(6 marks)
(ii) Calculate the two prices division A would have to quote to division C, If It became group policy to quote
transfer prices based on opportunity costs. (4 marks)

Q3. Manuco ltd has been offered supplies of special ingredient Z by Helpo ltd which is part of the same group
of companies. Helpo ltd is currently selling ingredient Z to external customer at £15 per kg. Helpo ltd bases its
selling price on cost plus 25% profit mark up. Total costs has been estimated as 75%variable and 25% fixed.
Required: -
Discuss the transfer price/prices at which Helpo ltd should offer to transfer special ingredient Z to Manuco ltd in
each of the following situations.
(a) Helpo ltd has an external market for all of its production of special ingredient Z at a selling price of £15 per
kg. Internal transfers to Manuco ltd would enable to save £1.50 per kg of variable packing cost to be
avoided.
(b) Conditions are as per (i) but Helpo ltd has spare capacity for 3000 kg os special ingredient Z for which no
external market is available.
(c) Conditions are as per (ii) but Helpo ltd has an alternative use for some of its spare production capacity. This
alternative use is equivalent to 2,000 kg of apecial ingredient Z and would earn a contribution of £6,000.
(10 marks)

Solution
a) Helpo limited has unlimited external market for it special ingredient Z, therefore it should base its transfer
price on variable cost plus opportunity cost.
Internal transfer is expected to result in savings of $1.5 per unit therefore it variable cost for internal
transfer is $7.5 (9-1.5). Contribution per unit from sale of component Z to external customer is $6 (15-9).
Therefore the division should charge $13.5 for internal transfer
 
b) Now the division has spare capacity of 3,000 units which it cannot sell to external customers therefore for
the first 3,000 units, transfer price should be only internal variable cost which is $7.5 as there is no
opportunity cost for compoenent Z.
For any output from 3,001 and above, it should charge VC plus opportunity cost from Munaco division as
discussed in part (1) above
 

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a. Helpo Division still has spare capacity of 1,000 units which it cannot sell to external customers therefore for
the first 1,000 units, transfer price should be only internal variable cost which is $7.5 as discussed in part
(2) above. However, Helpo division can use 2000 units of component Z out of 3000 to somewhere else
which will result in unit contribution of $3. Therefore, it should charge $10.5 (7.5+3) for selling next 2,000
units.
For any output from 3,001 and above, it should charge VC plus opportunity cost from Munaco division as
discussed in part (1) above

Q2. Bath Co is a company specialising in the manufacture and sale of baths. Each bath consists of a main unit
plus a set of bath fittings. The company is split into two divisions, A and B. Division A manufactures the bath
and Division B manufactures sets of bath fittings. Currently, all of Division A’s sales are made externally.
Division B, however, sells to Division A as well as to external customers. Both of the divisions are profit
centres.
The following data is available for both divisions:
Division A
Current selling price for each bath $450
Costs per bath:
Fittings from Division B $75
Other materials from external suppliers $200
Labour costs $45
Annual fixed overheads $7,440,000
Annual production and sales of baths (units) 80,000
Maximum annual market demand for baths (units) 80,000
Division B
Current external selling price per set of fittings $80
Current price for sales to Division A $75
Costs per set of fittings:
Materials $5
Labour costs $15
Annual fixed overheads $4,400,000
Maximum annual production and sales of sets of fittings (units) 200,000
(including internal and external sales)
Maximum annual external demand for sets of fittings (units) 180,000
Maximum annual internal demand for sets of fittings (units) 80,000
The transfer price charged by Division B to Division A was negotiated some years ago between the previous
divisional managers, who have now both been replaced by new managers. Head Office only allows Division A
to purchase its fittings from Division B, although the new manager of Division A believes that he could obtain
fittings of the same quality and appearance for $65 per set, if he was given the autonomy to purchase from
outside the company. Division B makes no cost savings from supplying internally to Division A rather than
selling externally.
Required:
(a) Under the current transfer pricing system, prepare a profit statement showing the profit for each of
the divisions and for Bath Co as a whole. Your sales and costs figures should be split into external sales
and inter-divisional transfers, where appropriate. (6 marks)
(b) Head Office is considering changing the transfer pricing policy to ensure maximisation of company profits
without demotivating either of the divisional managers. Division A will be given autonomy to buy from external
suppliers and Division B to supply external customers in priority to supplying to Division A.
Calculate the maximum profit that could be earned by Bath Co if transfer pricing is optimised.
(c) Discuss the issues of encouraging divisional managers to take decisions in the interests of the company
as a whole, where transfer pricing is used. Provide a reasoned recommendation of a policy Bath Co
should adopt. (6 marks)

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4
Q3. The Rotech group comprises two companies, W Co and C Co.
W Co is a trading company with two divisions: The Design division, which designs wind turbines and supplies
the designs to customers under licences and the Gearbox division, which manufactures gearboxes for the car
industry.
C Co manufactures components for gearboxes. It sells the components globally and also supplies W Co with
components for its Gearbox manufacturing division.
The financial results for the two companies for the year ended 31 May 2014 are as follows:

* Includes cost of components purchased from C Co.

Required:
(a) Discuss the performance of C Co and each division of W Co, calculating and using the following three
performance measures:
(i) Return on capital employed (ROCE)
(ii) Asset turnover
(iii) Operating profit margin
Note: There are 4·5 marks available for calculations and 5·5 marks available for discussion. (10 marks)
(b) C Co is currently working to full capacity. The Rotech group’s policy is that group companies and divisions
must always make internal sales first before selling outside the group. Similarly, purchases must be made from

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within the group wherever possible. However, the group divisions and companies are allowed to negotiate their
own transfer prices without interference from Head Office.
C Co has always charged the same price to the Gearbox division as it does to its external customers. However,
after being offered a 5% lower price for similar components from an external supplier, the manager of the
Gearbox division feels strongly that the transfer price is too high and should be reduced. C Co currently satisfies
60% of the external demand for its components. Its variable costs represent 40% of revenue.
Required:
Advise, using suitable calculations, the total transfer price or prices at which the components should be
supplied to the Gearbox division from C Co. (10 marks)
[Link]
e=s7Avze

Q4. Mobe Co manufactures electronic mobility scooters. The company is split into two divisions: the scooter
division (Division S) and the motor division (Division M). Division M supplies electronic motors to both
Division S and to external customers. The two divisions run as autonomously as possible, subject to the group’s
current policy that Division M must make internal sales first before selling outside the group; and that Division
S must always buy its motors from Division M. However, this company policy, together with the transfer price
which Division M charges Division S, is currently under review. Details of the two divisions are given below.
Division S
Division S’s budget for the coming year shows that 35,000 electronic motors will be needed. An external
supplier could supply these to Division S for $800 each.
Division M
Division M has the capacity to produce a total of 60,000 electronic motors per year. Details of Division M’s
budget, which has just been prepared for the forthcoming year, are as follows:
Budgeted sales volume (units) 60,000
Selling price per unit for external sales of motors $850
Variable costs per unit for external sales of motors $770
The variable cost per unit for motors sold to Division S is $30 per unit lower due to cost savings on distribution
and packaging.
Maximum external demand for the motors is 30,000 units per year.
Required:
Assuming that the group’s current policy could be changed, advise, using suitable calculations, the
number of motors which Division M should supply to Division S in order to maximise group profits.
Recommend the transfer price or prices at which these internal sales should take place. (10 marks)
Mobe Co
From the group’s perspective

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For every motor sold externally, Division M generates a profit of $80 ($850 – $770) for the group as a whole.
For every motor which Division S has to buy from outside of the group, there is an incremental cost of $60 per
unit ($800 – [$770 – $30]).
Therefore, from a group perspective, as many external sales should be made as possible before any internal sales
are made. Consequently, the group’s current policy will need to be changed. This does, however, assume that
the quality of the motors bought from outside the group is the same as the quality of the motors made by
Division M.
Division M’s total capacity is 60,000 units. Given that it can make external sales of 30,000 units, it can only
supply 30,000 of Division S’s demand for 35,000 motors. These 30,000 units should be bought from Division M
since, from a group perspective,
the cost of supplying these internally is $60 per unit cheaper than buying externally. The remaining 5,000
motors required by Division S should then be bought in from the external supplier at $800 per unit.
In order to work out the transfer price which should be set for the internal sales of 30,000 motors, the
perspective of both divisions must be considered.

From Division M’s perspective

Division M’s only buyer for these 30,000 motors is Division S, so the lowest price it would be prepared to
charge is the marginal cost of making these units, which is $740 per unit. However, it would ideally want to
make some profit on these motors too and would consequently expect a significantly higher price than this.

From Division S’s perspective

Division S knows that it can buy as many external motors as it needs from outside the group at a price of $800
per unit. Therefore, this will be the maximum price which it is prepared to pay.

Overall
Therefore, the transfer price should be set somewhere between $740 and $800. From the perspective of the
group, the total group profit will be the same irrespective of where in this range the transfer price is set.
However, it is important that divisional managers and staff remain motivated. Given the external sales price
which Division M can achieve and the fact that Division S would have to pay $800 for each motor bought from
outside the group, the transfer price should probably be at the higher end of the range.

Q5. The Better Agriculture Group (BAG), which has a divisional structure, produces a range of products for the
farming industry. Divisions B and C are two of its divisions. Division B sells a fertiliser product (BF) to
customers external to BAG. Division C produces a chemical (CC) which it could transfer to Division B for use
in the manufacture of its product BF. However, Division C could also sell some of its output of chemical CC to
external customers of BAG.
An independent external supplier to The Better Agriculture Group has offered to supply Division B with a
chemical which is equivalent to component CC. The independent supplier has a maximum spare capacity of
60,000 kilograms of the chemical which it is willing to make available (in total or in part) to Division B at a
special price of $55 per kilogram.
Forecast information for the forthcoming period is as follows:
Division B:
Production and sales of 360,000 litres of BF at a selling price of $120 per litre.
Variable conversion costs of BF will amount to $15 per litre.
Fixed costs are estimated at $18,000,000.
Chemical (CC) is used at the rate of 1 kilogram of CC per 4 litres of product BF.
Division C:
Total production capacity of 100,000 kilograms of chemical CC.
Variable costs will be $50 per kilogram of CC.
Fixed costs are estimated at $2,000,000.
Market research suggests that external customers of BAG are willing to take up sales of 40,000 kilograms of CC
at a price of $105 per kilogram. The remaining 60,000 kilograms of CC could be transferred to Division B for
use in product BF. Currently no other market external to BAG is available for the 60,000 kilograms of CC.
Required:
(a) (i) State the price/prices per kilogram at which Division C should offer to transfer chemical CC to
Division B in order that the maximisation of BAG profit would occur if Division B management
implement rational sourcing decisions based on purely financial grounds.
Note: you should explain the basis on which Division B would make its decision using the information
available, incorporating details of all relevant calculations. (6 marks)

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(ii) Division C is considering a decision to lower its selling price to customers external to the group to $95 per
kilogram. If implemented, this decision is expected to increase sales to external customers to 70,000 kilograms.
Required:
For BOTH the current selling price of CC of $105 per kilogram and the proposed selling price of $95 per
kilogram, prepare a detailed analysis of revenue, costs and net profits of BAG. (6 marks)

b) The new manager at BAG does not wants divisions to buy/sell from external
supplier/customer. He wants to have a calculation regarding the impact on profits if both
divisions to transfer chemical CC INTERNALLY at transfer price of $75 per unit.

[Link]
JcheABgrlM8ixfGL5xcG2iBf2QvQ?e=5Ysd5O

(link of excel sheet including BAG and Envico limited question)

Q8. FP sells and repairs photocopiers. The company has operated for many years with two departments, the
Sales
Department and the Service Department, but the departments had no autonomy. The company is now thinking
of restructuring so that the two departments will become profit centres.

The Sales Department

This department sells new photocopiers. The department sells 2,000 copiers per year. Included in the selling
price is £60 for a one year guarantee. All customers pay this fee. This means that during the first year of
ownership if the photocopier needs to be repaired then the repair costs are not charged to the customer. On
average 500 photocopiers per year need to be repaired under the guarantee. The repair work is carried out by the

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Service Department who, under the proposed changes, would charge the Sales Department for doing the repairs.
It is estimated that on average the repairs will take 3 hours each and that the charge by the Service Department
will be £136,500 for the 500 repairs.

The Service Department

This department has two sources of work: the work needed to satisfy the guarantees for the Sales Department
and repair work for external customers. Customers are charged at full cost plus 40%. The details of the budget
for the next year for the Service Department revealed standard costs of:
Parts at cost
Labour £15 per hour
Variable overheads £10 per labour hour
Fixed overheads £22 per labour hour
The calculation of these standards is based on the estimated maximum market demand and includes the
expected 500 repairs for the Sales Department. The average cost of the parts needed for a repair is £54. This
means that the charge to the Sales Department for the repair work, including the 40% mark-up, will be
£136,500.

Proposed Change
It has now been suggested that FP should be structured so that the two departments become profit centres and
that the managers of the Departments are given autonomy. The individual salaries of the managers would be
linked to the profits of their respective departments.
Budgets have been produced for each department on the assumption that the Service
Department will repair 500 photocopiers for the Sales Department and that the transfer price for this work will
be calculated in the same way as the price charged to external customers.
However the manager of the Sales Department has now stated that he intends to have the repairs done by
another company, RS, because they have offered to carry out the work for a fixed fee of £180 per repair and this
is less than the price that the Sales Department would charge.

Required:
(a) Calculate the individual profits of the Sales Department and the Service Department, and of FP as a whole
from the guarantee scheme if:
(i) The repairs are carried out by the Service Department and are charged at full cost plus 40%;
(ii) The repairs are carried out by the Service department and are charged at marginal cost;
(iii) The repairs are carried out by RS. (8 marks)
(b)
(i) Explain, with reasons, why a ‘full cost plus’ transfer pricing model may not be appropriate for FP. (3
marks)
(ii) Comment on other issues that the managers of FP should consider if they decide to allow RS to carry out the
repairs.

[Link]
JcheABgrlM8ixfGL5xcG2iBf2QvQ?e=w8vsTn