Question

Midwest Entertainment has four operating divisions: Bus Charters, Lodging, Concerts, and Ticket Services. Each division is a separate segment for financial reporting purposes. Revenues and costs related to outside transactions were as follows for the past year (dollars in thousands):

	Bus Charters			Lodging			Concerts			Ticket Services
Revenues	$	11,700		$	5,250		$	4,530		$	1,800
Costs		7,850			3,580			3,300			1,700

Bus Charters Division participates in a frequent guest program with Lodging Division. During the past year, Bus Charters reported that it traded lodging award coupons for travel that had a retail value of $1.3 million, assuming that the travel was redeemed at full fares. Concerts Division offered 20 percent discounts to Midwest’s bus passengers and lodging guests. These discounts to bus passengers were estimated to have a retail value of $360,000. Midwest's lodging guests redeemed $150,000 in concert discount coupons. Midwest’s hotels also provided rooms for Bus Charters’s employees (drivers and guides). The value of the rooms for the year was $650,000.

Ticket Services Division sold chartered tours for Bus Charters valued at $220,000 for the year. This service for intracompany lodging was valued at $100,000. It also sold concert tickets for Concerts; tickets for intracompany concert admission were valued at $54,000.

While preparing all of these data for financial statement presentation, Lodging Division’s controller stated that the value of the bus coupons should be based on their differential and opportunity costs, not on the full fare. This argument was supported because travel coupons are usually allocated to seats that would otherwise be empty or that are restricted similar to those on discount tickets. If the differential and opportunity costs were used for this transfer price, the value would be $250,000 instead of $1.3 million. Bus Charters’s controller made a similar argument concerning the concert discount coupons. If the differential cost basis were used for the concert coupons, the transfer price would be $54,000 instead of the $360,000.

Midwest reports assets in each division as follows (dollars in thousands):

Bus Charters	$	48,250
Lodging		19,350
Concerts		15,700
Ticket Services		3,500

a. Using the retail values for transfer pricing for segment reporting purposes, what are the operating profits for each Midwest division? (Enter your answers in thousands of dollars.)

b. What are the operating profits for each Midwest division using the differential cost basis for pricing transfers? (Enter your answers in thousands of dollars.)

c. Rank each division by ROI using the transfer pricing methods in requirements (a) and (b). (Round your answers to 2 decimal places.)

Answer 1

Amounts are in $ (in thousands)

(a)

Revenue under Retail method

For Bus Charter = 11,700 + 1,300 = 13,000

For Lodging = 5,250 + 650 = 5,900

For Concert = 4,530 + 360 + 150 = 5,040

For Ticket services = 1,800 + 220 + 100 + 54 = 2,174

Cost under retail method

For Bus Charter = 7,850 + 650 + 360 + 220 = 9,080

For Lodging = 3,580 + 1300 + 150 + 100 = 5,130

For Concert = 3,300 + 54 = 3,354

For Ticket Services = 1,700

Operating Profit = Revenue - Cost

For Bus Charter = 13,000 - 9,080 = 3,920

For Lodging = 5,900 - 5,130 = 770

For Concert = 5,040 - 3,354 = 1,686

For Ticket Services = 2,174 - 1,700 = 474

(b)

Under Differential Costing

Operating profits are

For Bus Charter = 3,920 - (1,300-250) + (360-54) = 3,176

For Lodging = 770 + (1,300-250) = 1,820

For Concert = 1,686 - (360-54) = 1,380

For Ticket Services = 474

c)

Ranking based on Return On Investment

Retail method

	ROI	Rank
Bus Charter	8.12%	3
Lodging	3.98%	4
Concert	10.74%	2
Ticket services	13.54%	1

Deferential Cost Method

	ROI	Rank
Bus Charter	6.58%	4
Lodging	9.41%	2
Concert	8.79%	3
Ticket Services	13.54%	1