Question

BOR CPAs, Inc. is a closely held corporation owned by three stockholders who used the initials of their last names to form the corporation’s name: Cyrus Bailey, John Ogden, and Samuel Rogers. The firm’s Certified Public Accountants (CPAs) 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 cost 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 also: 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 on investment in the two divisions. Cyrus Bailey is in charge of the performance evaluation, and turns to you for assistance. Mr. Bailey is only interested in evaluating operations at the profit center (division) level, and not at the cost center (department) level.

Mr. Bailey is considering temporarily using some of the staff from the Tax Division to assist the Audit Division during the upcoming busy audit season, and would like 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 divisions as service department charges.

The following chart shows some basic data for the company:

Hourly market rate for staff (the price the company would have to pay from an outside contractor for staff services)	$110.00
Average hourly cost rate for staff (the average price the company pays to its staff)	$60.00
Number of paychecks issued by Audit Division	110
Number of paychecks issued by Tax Division	340
Total expense for Payroll Office	$31,500
Amount of assets invested in Audit Division by BOR CPAs, Inc.	$10,000,000
Amount of assets invested in Tax Division by BOR CPAs, Inc.	$4,000,000

Mr. Bailey 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 Rate

per payroll check

Division	Allocated Service Department Charges
Audit Division
Tax Division

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 Income Statements with your data from the Payroll panel. Enter all amounts as positive numbers.

BOR CPAs, Inc.

Income Statements

For the Year Ended December 31, 20Y1

1		Audit Division	Tax Division	Total Company
2	Fees earned:
3	Audit fees (12 engagements)	$900,000.00		$900,000.00
4	Tax fees (45 engagements)		$708,750.00	708,750.00
5	Transfer-pricing fees			0.00
6	Expenses:
7	Variable:
8	Audit hours provided by Audit Division	216,000.00		216,000.00
9	Tax hours provided by Tax Division		283,500.00	283,500.00
10	Excess capacity hours paid to salaried staff		48,000.00	48,000.00
11	Audit hours provided by Tax Division		0.00	0.00
12	Fixed expenses	50,000.00	65,500.00	115,500.00
13	Income from operations before service department charges	$634,000.00	$311,750.00	$945,750.00
14	Service department charges for payroll
15	Income from operations

Mr. Bailey asks that you prepare Divisional Income Statements showing what 20Y1 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 $110.00 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.

Complete the following Income Statements. Enter all amounts as positive numbers. If there is no amount or an amount is zero, enter “0”.

BOR CPAs, Inc.

Income Statements

For the Year Ended December 31, 20Y1

1		Audit Division	Tax Division	Total Company
2	Fees earned:
3	Audit fees (16 engagements)	$1,200,000.00		$1,200,000.00
4	Tax fees (45 engagements)		$708,750.00	708,750.00
5	Transfer-pricing fees
6	Expenses:
7	Variable:
8	Audit hours provided by Audit Division	216,000.00		216,000.00
9	Tax hours provided by Tax Division		283,500.00	283,500.00
10	Excess capacity hours paid to salaried staff
11	Audit hours provided by Tax Division
12	Fixed expenses	50,000.00	65,500.00	115,500.00
13	Income from operations before service department charges
14	Service department charges for payroll
15	Income from operations

Mr. Bailey asks that you prepare Divisional Income Statements showing what 20Y1 results would have been had the Audit Division purchased all 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 $60.00 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.

Complete the following Income Statements. Enter all amounts as positive numbers. If there is no amount or an amount is zero, enter “0”.

BOR CPAs, Inc.

Income Statements

For the Year Ended December 31, 20Y1

1		Audit Division	Tax Division	Total Company
2	Fees earned:
3	Audit fees (16 engagements)	$1,200,000.00		$1,200,000.00
4	Tax fees (45 engagements)		$708,750.00	708,750.00
5	Transfer-pricing fees
6	Expenses:
7	Variable:
8	Audit hours provided by Audit Division	216,000.00		216,000.00
9	Tax hours provided by Tax Division		283,500.00	283,500.00
10	Excess capacity hours paid to salaried staff
11	Audit hours provided by Tax Division
12	Fixed expenses	50,000.00	65,500.00	115,500.00
13	Income from operations before service department charges
14	Service department charges for payroll
15	Income from operations

Answer 1

Part 1)

Payroll

The completed table is given as below:

$70 [31,500/(110 + 340)]	per payroll check
Division	Allocated Service Department Charges
Audit Division	$7,700 (110*70)
Tax Division	$23,800 (340*70)

Part-2

No Transfer

The completed table is provided as follows:

BOR CPAs, Inc.
Income Statements
For the Year Ended December 31, 20Y1
1		Audit Division	Tax Division	Total Company
2	Fees earned:
3	Audit fees (12 engagements)	900,000.00		900,000.00
4	Tax fees (45 engagements)		708,750.00	708,750.00
5	Transfer-pricing fees			0.00
6	Expenses:
7	Variable:
8	Audit hours provided by Audit Division	216,000.00		216,000.00
9	Tax hours provided by Tax Division		283,500.00	283,500.00
10	Excess capacity hours paid to salaried staff		48,000.00	48,000.00
11	Audit hours provided by Tax Division		0.00	0.00
12	Fixed expenses	50,000.00	65,500.00	115,500.00
13	Income from operations before service department charges	634,000.00	311,750.00	945,750.00
14	Service department charges for payroll	7,700.00	23,800.00	31,500.00
15	Income from operations	$626,300.00	$287950.00	$914,250.00

Part 3)

Market Transfer Price

The completed table is given below:

BOR CPAs, Inc.
Income Statements
For the Year Ended December 31, 20Y1
1		Audit Division	Tax Division	Total Company
2	Fees earned:
3	Audit fees (16 engagements)	1,200,000.00		1,200,000.00
4	Tax fees (45 engagements)		708,750.00	708,750.00
5	Transfer-pricing fees		88,000.00 (800*110)	88,000.00
6	Expenses:
7	Variable:
8	Audit hours provided by Audit Division	216,000.00		216,000.00
9	Tax hours provided by Tax Division		283,500.00	283,500.00
10	Excess capacity hours paid to salaried staff		0.00	0.00
11	Audit hours provided by Tax Division	88,000	48,000	136,000
12	Fixed expenses	50,000.00	65,500.00	115,500.00
13	Income from operations before service department charges	846,000.00	399,750.00	1,245,750
14	Service department charges for payroll	7,700	23,800	31,500
15	Income from operations	$838,300.00	$375,950.00	$1,214250.00

Part 4)

Negotiated Transfer Price

The completed table is prepared as follows:

BOR CPAs, Inc.
Income Statements
For the Year Ended December 31, 20Y1
1		Audit Division	Tax Division	Total Company
2	Fees earned:
3	Audit fees (16 engagements)	1,200,000.00		1,200,000.00
4	Tax fees (45 engagements)		708,750.00	708,750.00
5	Transfer-pricing fees		48,000.00 (800*60)	48,000.00
6	Expenses:
7	Variable:
8	Audit hours provided by Audit Division	216,000.00		216,000.00
9	Tax hours provided by Tax Division		283,500.00	283,500.00
10	Excess capacity hours paid to salaried staff		0.00	0.00
11	Audit hours provided by Tax Division	48,000	48,000	96,000
12	Fixed expenses	50,000.00	65,500.00	115,500.00
13	Income from operations before service department charges	886000.00	359,750.00	1,245,750
14	Service department charges for payroll	7,700	23,800	31,500
15	Income from operations	$878,300.00	$335,950.00	$1,214,250.00