CMA® > CMA® Part 1 > C.2. Responsibility Centers and Transfer Pricing > Flashcards

C.2. Responsibility Centers and Transfer Pricing Flashcards

Evaluate business performance through responsibility accounting, contribution margin reporting, and transfer pricing methods. (37 cards)

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1
Q

What is a responsibility center?

A

Any part, segment, or subunit of an organization, such as a division, product line, or department.

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2
Q

What is responsibility accounting?

A

The process of breaking down revenues and expenses according to responsibility centers; and within each responsibility center, breaking them down according to those that can be controlled by the manager and those that cannot be controlled by the manager.

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3
Q

What is the purpose of a responsibility accounting system?

A

To measure accounting results of each responsibility center separately and combine them to measure the results for the whole company.

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4
Q

How are a responsibility center’s plans expressed?

A

In its budget; and the actual results for that responsibility center are then compared against its budget to determine how well it is achieving its plans.

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5
Q

What are the main classifications of responsibility centers?

A
  • Cost center
  • Revenue center
  • Profit center
  • Investment center
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6
Q

What is a cost center responsible for?

A

For the incurrence of costs only, not for generating revenue or profit.

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7
Q

How is a revenue center evaluated?

A

By the level of revenue it generates, focusing on effectiveness.

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8
Q

What distinguishes a profit center from other responsibility centers?

A

It is responsible for both revenues and expenses, and the manager of a profit center can be evaluated based on both.

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9
Q

What is the key evaluation criterion for an investment center?

A

Return on investment.

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10
Q

What is the main link between planning and control in a responsibility accounting system?

A

Feedback from reporting actual results as compared against budgeted amounts.

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11
Q

Why should managers be evaluated only on controllable factors?

A

To ensure they are not blamed or credited for factors outside their control.

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12
Q

What are common costs?

A

Costs that cannot be allocated to specific users on any cause-and-effect basis.

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13
Q

What is the stand-alone cost allocation method?

A

Each responsibility center bears a proportionate share of total costs. Common costs are allocated based on each unit’s proportion of the entire organization’s usage, using an appropriate allocation base.

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14
Q

What is the incremental cost allocation method?

A

Units are ranked according to size or some similar basis. The largest, the primary party, is charged for costs up to what its cost would be if it were the only unit. The remaining cost is allocated to the other unit or units, called incremental parties.

The largest unit bears all the fixed common costs plus an allocation of the variable common costs, while the incremental parties bear only an allocation of the remaining variable common costs.

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15
Q

What is an alternative to cost allocation?

A

Assigning a percentage of each department’s contribution to cover common costs.

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16
Q

How does a contribution income statement differ from a traditional income statement?

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A
  • In a contribution income statement, only variable costs of production are allocated to the units sold. Variable costs deducted from revenue to calculate the contribution margin include not only variable production costs but also variable selling, general, and administrative costs. Fixed costs of production are segregated from variable costs and are presented as expenses below the contribution margin line.
  • A traditional income statement uses absorption costing, including both fixed and variable costs of manufacturing in the cost of goods sold. Fixed and variable SG&A costs are reported as expenses below cost of goods sold.
17
Q

What does the contribution margin represent in a contribution income statement?

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A

It is the difference between sales revenues and all variable costs, including both production and non-production variable costs.

18
Q

What are traceable fixed costs?

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A

Fixed costs that can be assigned to a particular segment on a cause-and-effect basis and would be eliminated if the segment were sold or closed.

19
Q

What are untraceable common costs?

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A

Costs that cannot be assigned to any specific segment on a cause-and-effect basis and would continue even if a segment were discontinued.

20
Q

What is the purpose of a contribution income statement in performance evaluation?

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A

It is used to evaluate managers of profit and investment centers by isolating controllable costs from non-controllable costs.

21
Q

What is the profit margin ratio?

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A

A measure of the amount of sales revenues that become profits, calculated as net income divided by sales revenue.

22
Q

What is transfer pricing?

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A

The process of setting prices for sales between sub-units of an organization for products or services supplied internally.

23
Q

What is an intermediate product in the context of transfer pricing?

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A

A product or service sold and purchased internally within an organization, often used as a component of a final product.

24
Q

Why is transfer pricing important for multinational companies?

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A

It affects tax consequences and compliance with regulations, as transfer prices must be set as arm’s-length transactions to avoid shifting income between countries to reduce tax payments.

25
What is the impact of **transfer pricing** on consolidated financial statements?
No impact. The internal transaction is **eliminated** in consolidated financial statements, and the net income includes only the revenue from the sale to the final customer and the cost to manufacture the item.
26
What is the goal of setting a proper transfer price?
To motivate division managers to make decisions that provide the greatest benefit to the company while fairly rewarding the managers, achieving **goal congruence**.
27
What are the **objectives** of a transfer pricing system?
* Promote goal congruence and sustained management effort * Help the company achieve its goals and fit its organizational structure * Motivate profit center managers to pursue profit goals * Help senior managers evaluate performance * Preserve autonomy in decision making * Permit each unit to earn a fair profit * Meet legal and external reporting requirements * Be easy to apply
28
What is the market price method in transfer pricing?
A transfer price equal to the **current or market price** of the selling division’s product in an arm’s-length transaction.
29
What is a **disadvantage** of using market price for transfer pricing?
The management of the buying division is not motivated to purchase internally, as they can get the **same price externally**.
30
What does the cost of production plus opportunity cost method include?
The **cost of production** (outlay cost) and the **profit margin** the selling division gives up by selling internally.
31
What does the full cost method include in transfer pricing?
All **materials**, **labor**, and a full allocation of **overhead**, calculated using absorption costing.
32
What is the cost-plus method in transfer pricing?
The selling division adds a **fixed monetary amount** or a **percentage of costs** to the cost of production to approximate a normal profit markup.
33
What is a **negotiated price** in transfer pricing?
An acceptable **transfer price** determined through **negotiation** between affected division managers and senior management.
34
What is **arbitrary transfer pricing** and what is its disadvantage?
A transfer price **set by senior management** to achieve some overall objective. Its disadvantage is that it defeats the goal of making divisional managers **profit-conscious** and hampers their **autonomy** and **profit incentive**.
35
What is **dual-rate transfer pricing**?
A method where the selling and purchasing divisions record the transaction at **different prices**.
36
What **factors** should management consider when deciding on a transfer pricing method?
* Goals of the company (goal congruence) * Capacity of the producing division * Ability to sell or buy on the open market * Legal and regulatory requirements
37
What is the **optimal transfer price** when the selling division has excess capacity?
Over and above the variable cost of the item, the **benefit to the consolidated company** from producing and transferring internally (and not paying a profit to an outside company) should be divided between the selling division and the purchasing division by means of the transfer price used, so that both divisions benefit.
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