Question

Calculator

Mastery Problem: Evaluating Decentralized Operations

BOR CPAs, Inc.

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 support department allocations.

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
Average hourly cost rate for staff (the average price the company pays to its staff)	$50
Number of paychecks issued by Audit Division	110
Number of paychecks issued by Tax Division	340
Total expense for Payroll Office	$29,250
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

Payroll

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	Support Department Allocations
Audit Division	$
Tax Division	$

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. Responsibility 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, BOR CPAs, Inc. as a whole may be considered as an investment center. Thus, Mr. Bailey 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 each 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?

a. Mr. Bailey wants to focus on whether the profit centers are spending in accordance with their budgets.

b. Mr. Bailey believes that the investment turnover will provide a good assessment of each division’s profitability.

c. Mr. Bailey 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?

a. Mr. Bailey would like to determine which division has the highest net income.

b. Return on investment will allow Mr. Bailey to measure the income (return) on each dollar invested in the divisions, and decide where to invest additional assets or expand operations.

Answer 1

Division	Support Department Allocations
Audit Division	$                              7,150
Tax Division	$                            22,100

Working:

Total number of payroll checks = 110 + 340 = 450

Payroll charge rate = $29250/450 = $65 per payroll check

Audit Division: 110 x $65 = $7150

Tax Division: 340 x $65 = $22100

1. Answer: Option a. Mr. Bailey wants to focus on whether the profit centers are spending in accordance with their budgets.

2. Answer: Option b. Return on investment will allow Mr. Bailey to measure the income (return) on each dollar invested in the divisions, and decide where to invest additional assets or expand operations.