Mastery Problem: Evaluating Decentralized Operations BOR CPAs, Inc. BOR CPAS, Inc. is a dosely held corporation owned by three stockholders who used the initials of their last names to form the corporation's name: Cyrus Batey, John Ogden, and Samuel Rogers. The firm's Certified Public Accountants (CPA) perform audits of both public companies and privately owned companies. BOR'S CPAs also provide tax services to both individuals and businesses. The corporation is divided into two profit centers the Audit Division and the Tax Division. Each division is composed of two cont centers. The Audit Division is composed of two cost-center departments: Public Company Audits and Private Company Audits. The Tax Division is composed of two cost-center departments to Individual Tax and Business Tax BOR, a decentralized organization, is interested in evaluating the performance of the two divisions. The stockholders are responsible for deciding en investment in the two divisions. Cyrus Balley is in charge of the performance evaluation, and turns to you for assistance. Mr. Baley is only interested in evaluating operations at the praft center (division) level, and not at the cost center (department) level Mr. Bailey is considering temporarily using some of the shot from the Tax Division to assist the Audier Division during the upcoming busy wodt season, and would set to evaluate the effect of this on net income. The Tax Division is estimated to have 800 hours of excess capacity The unit for determining sales revenue in both divisions is the engagement", which means the total agreed-upon work for a given client in either audit or tax for a given year. The company charges on average a fee of $75,000 per audit engagement, and $15,750 per tax engagement The company has its own Payroll office, which provides payroll services to both divisions and will allocate its total expenses to the two awon as suport department allocations The following chart shows some basie data for the company Hourly market rate for staff (the price the company would have to pay from an outside contractor for staff services) Average hourly cost rate for staff (the average price the company pays to its stam Number of paychecks issued by Audit Division Number of paychecks issued by Tax Division $110 560 110 340 $29,250 Tunser Payroll Office Printem Amount of assets invested in Audit Division by BOR CPAS, Inc. Amount of assets invested in Tax Division by BOR CPAS, Inc. $10,000,000 $4,000,000 Payroll Mr. Balley would like you to start by analyzing the Payroll Office expenses, and allocating the total expenses to each division. He has decided to use the number of payroll checks as the activity base for the allocation. Fill in the following blanks, allocating the total expense for the Payroll Office to each of the two divisions. Payroll Charge Rates per payroll check Support Department Allocations Audit Division Division Tax Division 1 Performance Evaluation A profit center manager has the responsibility and authority for making decisions that affect revenues and costs and, thus, profits. The manager of a profit center does not make decisions concerning the fixed assets invested in the center. Responsability accounting for profit centers such as the Audit Division and Tax Division take the form of income statements, which should include only controllable revenues and controllable expenses. Although it is not technically a decentralized unit, BORCPAS, Inc. as a whole may be considered as an investment center. Thus, Mr. Baley is also interested in evaluating the performance of the company as a whole. Two performance measures that are used at the investment center level are return on investment and residual income Mr. Bailey would like to use the DuPont formula, composed of profit margin and investment turnover, to break down the return on investment, in order to evaluate cach division. At the company level, Mr. Bailey would like to use return on investment to evaluate the overall performance of the company and its investment decisions with regard to each division. Answer the following questions (1) and (2) 1. What is the most likely reason Mr. Bailey chose the DuPont formula to evaluate the divisions? Answer the following questions (1) and (2). 1. What is the most likely reason Mr. Bailey chose the DuPont formula to evaluate e divisions? a. Mr. Balley wants to focus on whether the profit centers are spending in accordance with their budgets. b. Mr. Balley believes that the investment turnover will provide a good assessment of each division's profitability c. Mr. Balley would like to analyze differences in the return on investment across divisions 2. What is the most likely reason Mr. Bailey chose return on investment to evaluate the company as a whole? 3. Mr. Balley would like to determine which division has the highest net income b. Return on Investment wit aliow Me, Bailey to measure the income (return) on each dollar invested in the divisions, and decide where to invest additional sets or and operations 1 No Transfer Mr. Bailey has prepared the following divisional income statement for you to review, assuming no transfer of excess capacity hours occurs. He has also included the total amounts for BOR CPAS, Inc. in the rightmost column Complete the following Divisional Income Statements with your data from the Payroll. BOR CPAs, Inc. Divisional Income Statements For the Year Ended December 31, 2018 Audit Division Tax Division Total Company Fees earned: Audit fees (12 engagements) $900,000 $900,000 Tante 2702 Check My Work BOR CH Divisional Income Statements For the Year Ended December 31, 2018 Audit Division Tax Division Total Company $900,000 $900,000 $709,750 708,750 0 (216,000) Fees earned: Audit fees (12 engagements) Tax fees (45 engagements) Transfer pricing fees Expenses: Variable: Audit hours provided by Audit Division Tax hours provided by Tax Division I Excess capacity hours paid to salaried staff Audit hours provided by Tax Division Fixed expenses Operating income before support department allocations Support department allocations for payroll Operating income (283,500) (216,000) (283,500) (48,000) (48,000) 0 0 (65,500) (50,000) $634,000 (115,500) 5945,750 $311,750 Market Transfer Price Mr. Bailey asks that you prepare Divisional Income Statements showing what 2018 results would have been had the Audit Division purchased all the excess capacity of the Tax Division, using a market transfer price. The divisional managers tell you that, with the excess capacity of the Tax Division of 800 hours, the Audit Division can perform 4 more audits during the year, and the Tax Division would charge the Audit Division the market rate of $110 per hour for the additional hours required, selling all its excess capacity to the Audit Division. The Tax Division would still be responsible for paying the salaries of their employees Tax Division Total Company $1,200,000 $708,750 708,750 BOR CPAs, Inc. Divisional Income Statements For the Year Ended December 31, 2048 Audit Division Fees earned: Audit fees (16 engagements) $1,200,000 Tax fees (45 engagements) Transfer pricing fees Expenses: Variable: Audit hours provided by Audit Division (216,000) Tax hours provided by Tax Division I Excess capacity hours paid to salaried staff Audit hours provided by Tax Division Fixed expenses (50,000) Operating income before support department allocations Support department allocations for payroll Operating income (216,000) (283,500) (283,500) (65,500) (115,500) Negotiated Transfer Price Mr. Bailey asks that you prepare Divisional Income Statements showing what 20 results would have been had the Audit Division purchased all the excess capacity of the Tax Division, using a negotiated transfer price. The divisional managers tell you that, with the excess capacity of the Tax Division of 800 hours, the Audit Division perform 4 more audits during the year, and the Audit Division would agree to a negotiated rate of $90 per hour to be paid to the Tax Division for the additional hours required, with the Tax Division selling all is excess capacity to the Audit Division. The Tax Division would still be responsible for paying the salaries of their employees Check My Work BOR CPAs, Inc. Divisional Income Statements For the Year Ended December 31, 2018 Audit Division Tax Division Total Company $1,200,000 $1,200,000 709,750 $708,750 (216,000) Fees earned: Audit fees (16 engagements) Tax fees (45 engagements) Transfer pricing fees Expenses: Variable: Audit hours provided by Audit Division Tax hours provided by Tax Division I Excess capacity hours paid to salaried staff Audit hours provided by Tax Division Fixed expenses Operating income before support department allocations Support department allocations for payroll Operating income (216,000) (283,500) (283,500) (50,000) (65,500) (115,500) Cost Transfer Price Mr. Bailey asks that you prepare Divisional Income Statements showing what 2018 results would have been had the Audit Division purchased at the excess capacity of the Tax Division, using a cost transfer price. The divisional managers tell you that, with the excess capacity of the Tax Division of 800 hours, the Audit Division can perform 4 more audits during the year, and the Audit Division would pay the Tax Division's internal hourly rate of $60 per hour for the additional hours required, with the Tax Division selling all its excess capacity to the Audit Division. The Tax Division would still be responsible for paying the salaries of their employees Tax Division Total Company $1,200,000 708,750 $708,750 BOR CPAs, Inc. Divisional Income Statements For the Year Ended December 31, 20Y8 Audit Division Fees earned: Audit fees (16 engagements) $1,200,000 Tax fees (45 engagements) Transfer pricing fees Expenses: Variable: Audit hours provided by Audit Division (216,000) Tax hours provided by Tax Division 1 Excess capacity hours paid to started staff Audit hours provided by Tax Division Fixed expenses (50,000) Operating income before support department allocations Support department allocations for payroll Operating income (216,000) (283,500) (283,500) (65,500) (115.500) Analysis You are now able to put together all the information you've collected and analyze the data. In the following table, "ROI stands for "Return on Investment." Complete the following tables using the information from the other requirements and selection tists provided. Audit Division Check My Work