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DE LA SALLE UNIVERSITY – DASMARIÑAS College of Business istration and ancy ancy Department Management ing Part II Classroom Exercises Functional-Based Responsibility ing Benefits of Decentralization 1. 2. 3. 4. 5.

Top management freed to concentrate on strategy Lower-level managers gain experience in decision-making Decision-making authority leads to job satisfaction Lower-level decisions often based on better information Lower level managers can respond quickly to customers

Disadvantages of Decentralization 1. 2. 3. 4.

May be a lack of coordination among autonomous manager Lower-level managers may make decisions without seeing the “big picture” Lower-level manager’s objectives may not be those of the organization May be difficult to spread innovative ideas in the organization

Responsibility Reporting System Exercise 1. Marcum Company’s organization chart includes the president; the vice president of production; three assembly plants – Manila, Cavite, and Laguna; and two departments within each plant – Machining and Finishing. Budget and actual manufacturing cost data for May 2013 are as follows: Finishing Department-Manila: Direct Materials P41,000 actual, P45,000 budget; direct labor P83,000 actual, P82,000 budget; manufacturing overhead P51,000 actual, P49,200 budget. Machining Department-Manila: Total manufacturing costs P220,000 actual, P214,000 budget. Cavite Plant: Total manufacturing costs P424,000 actual, P421,000 budget. Laguna Plant: Total manufacturing costs P494,000 actual, P499,000 budget. The Manila plant manager’s office costs were P95,000 actual and P92,000 budget. The vice president of production’s office costs were P132,000 actual and P130,000 budget. Office costs are not allocated to departments and plants. Required: Prepare the reports in a responsibility system for: (a) The Finishing Department – Manila (b) The plant manager – Manila (c) The vice president of production Exercise 2. Kojak Company uses a responsibility reporting system. It has divisions in Sta. Rosa, Calamba, and San Pablo. Each division has three production departments: Cutting, Shaping, and Finishing. The responsibility for each department rests with a manager who reports to the division production manager. Each division manager reports to the vice president of production. There are also vice presidents for marketing and finance. All vice presidents report to the president. In January 2013, incomplete manufacturing overhead cost data and variance analysis for the departments and divisions were as shown below. Individual Costs – Calamba Cutting Dept. Variable Costs Gas and Oil Indirect Labor Utilities Maintenance Fixed Costs Rent Supervision

Master Budget

Actual P

37,500 ? ? 5,200 ? 8,800

P

? 50,000 ? ? 8,000 ?

Flexible Budget P

Spending Variance

38,500 55,000 8,250 ? ? ?

P

Activity Variance

? 2,000 F 1,150 F 300 F

P 3,500 U ? 750 U 500 U

200 U 200 F

? ?

Actual Total costs Shaping Department - Calamba Finishing Department - Calamba Sta. Rosa Division San Pablo Division

P

158,000 210,000 676,000 722,000

Comparison with Master Budget P

10,000 2,000 3,000 7,000

favorable favorable unfavorable favorable

Additional overhead costs were incurred as follows: Calamba division production manager— actual costs P52,500, budget P51,000; vice president of production—actual costs P65,000, budget P64,000; president—actual costs P76,400, budget P74,200. These expenses are not allocated. The vice presidents who report to the president, other than the vice president of production, had the following expenses. Vice president Marketing Finance

P

Actual 133,600 108,000

P

Budget 130,000 105,000

Required: Prepare the following reports (using master budget) in a responsibility reporting system: (a) Manufacturing overhead – Cutting Department manager (b) Manufacturing overhead – Calamba division manager (c) Manufacturing overhead – Vice president of production (d) Manufacturing overhead and expenses – President

Segment Reporting & Analysis

Economic Value Added

The following data pertain to Dana Industries: Interest rate on debt capital: 9% Cost of equity capital: 12% Before-tax operating income: $35 million Market value of debt capital: $60 million Market value of equity capital: $120 million Total assets: $150 million Income tax rate: 30% Total current liabilities: $15 million

Required: 1. Compute Dana’s weighted-average cost of capital. 2. Compute Dana’s economic value added.

Transfer Pricing in Multinational Corporations (MNC) 1.

Inter-Land, Inc., transfers a product between its U.S. Division and its Danish division. The product sells for $45 in the United States. The cost of shipping to Denmark is $3.20, and Danish duty is $9. The U.S. division pays approximately $4.50 per unit for advertising and related selling expenses. Using the comparable uncontrolled price method, calculate the transfer price.

2.

The U.S. division of Inter-Land, Inc., purchases a product from the Danish division, which sells for $80 per unit in the United States. The U.S. division typically has a 25 percent markup on goods. Calculate the transfer price under the resale price method.

3.

Howell Company has a division in the United States that produces computerized thermostats for heating units. These thermostats are transferred to a division in Luxembourg. The thermostats can be (and are) sold externally in the United States for $30 each. It costs $2.35 per thermostat for shipping and $2.70 per thermostat for import duties. When the thermostats are sold externally, Howell spends $3 per thermostat for commissions and an average of $1 per thermostat for advertising. a. Which Section 482 method should be used to calculate the allowable transfer price? b. Using the appropriate Section 482 method, calculate the transfer price.

4.

Assume that Valley Electronics transfers a component from a U.S. division to a German division for $11.70. The landing costs are $2.50 per unit, and the avoidable commissions and advertising total $0.50 per unit. The component has a market price within the United States of $10. Is the company complying with the comparable uncontrolled price method? Would the IRS be concerned if the transfer price is greater than the market price after adjustments? Why or why not?

5.

Assume that a manufacturing division in the United States transfers a component to a marketing division for resale. The resale price is $8, the gross profit percentage (gross profit divided by sales) is 25 percent, the landing costs total $1.20 per unit. Suppose that the actual transfer price (excluding landing costs) is $4.50. Should the company continue transferring at $4.50?

6.

Suppose that a U.S. division has excess capacity. A European division has offered to buy a component that would increase the U.S. division’s utilization of its capacity. The component has an outside market in the United States with a unit selling price of $12. The variable costs of production for the component are $6. Landing costs total $2 per unit, and an internal transfer avoids $1.25 per unit of marketing costs. The European division can purchase the component locally for $12. a. Ignoring income taxes, what is the minimum price that the European division should pay for the component (including landing costs)? The maximum price? b. Assuming that the t benefit is split equally, what is the transfer price?

7.

Sprint, Inc., has a Pennsylvania-based division that produces electronic components, with a very strong domestic market for circuit no. 222. The variable production cost is $140, and the division can sell its entire output for $190. Sprint is subject to a 30% income tax rate. Alternatively, the Pennsylvania division can ship the circuit to a division that is located in Mississippi, to be used in the manufacture of a global positioning system (GPS). Information about the global positioning system and Mississippi's costs follow. Selling price: $380 Circuit shipping and handling fees to Mississippi: $10 Labor, overhead, and additional material costs of GPS: $120 A. Assume that the transfer price for the circuit was $160. How would Pennsylvania's divisional manager likely react to a corporate decision to transfer the circuits to Mississippi? Why? B. Calculate Pennsylvania income, Mississippi income, and income for the company as a whole if the transfer took place at $160 per circuit. C. Assuming that transfers took place at a price higher than $160, would the revised price increase, decrease, or have no effect on Sprint's income? Briefly explain. D. Assume that Sprint moved its GPS production facility to a division located in , which is subject to a 45% tax rate. The transfer took place at $180. Shipping fees (absorbed by the overseas division) doubled to $20; the German division paid an import duty equal to 10% of the transfer price; and labor, overhead, and additional material costs were $150 per GPS. If the German selling price of the GPS amounted to $450, calculate Pennsylvania income, German income, and income for Sprint as a whole. E. Suppose that U.S. and German tax authorities allowed some discretion in how transfer prices were set. Given the difference in tax rates, should Sprint attempt to generate the majority of its income in Pennsylvania or ? Why?

Solution Key Answer: A. The manager would be unhappy, as the division is being forced to take a "hit" of $30 per circuit ($190 vs. $160). B.

Pennsylvania: $160 - $140 = $20; $20 - ($20 x 30%) = $14 Mississippi: $380 - $10 - $120 - $160 = $90; $90 - ($90 x 30%) = $63 Sprint, Inc.: $14 + $63 = $77

A. Sprint's income is unaffected, as the transfer price is a wash between the divisions. In other words, Pennsylvania's revenue is offset by Mississippi's cost. B. Pennsylvania: $180 - $140 = $40; $40 - ($40 x 30%) = $28 : $450 - $20 - $150 - $180 - ($180 x 10%) = $82; $82 - ($82 x 45%) = $45.10 Sprint, Inc.: $28.00 + $45.10 = $73.10 E.

Tax rates are lower in the U.S. than in (30% vs. 45%). Thus, Sprint would benefit if it generated the majority of its income in Pennsylvania.

Economic Value Added, Weighted-Average Cost of Capital 1. WACC = [(9% x 70%) x $60,000,000) + (12% x $120,000,000)] ÷ ($60,000,000 + $120,000,000) WACC = ($3,780,000 + $14,400,000) ÷ $180,000,000 WACC = 10.1% 2.

EVA = ($35,000,000 x 70%) - [($150,000,000 - $15,000,000) x 10.1%] EVA = $24,500,000 - $13,635,000 EVA = $10,865,000

3.

Economic value added (EVA) measures the amount of shareholder wealth being created from a company’s activities and operations. To expand, debt and equity capital are used to fund activities—activities that are hopefully conducted in a profitable manner. Profits cover the cost of the related capital, with shareholders benefiting from the residual (i.e., EVA).