Question

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)	$50.00
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

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 negotiated 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 agree to a negotiated rate of $80.00 per hour to be paid to the Tax Division 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	180,000.00		180,000.00
9	Tax hours provided by Tax Division		236,250.00	236,250.00
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

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)	1200000.00		1200000.00
4	Tax fees (45 engagements)		708750.00	708750.00
5	Transfer-pricing fees *		64000.00	64000.00
6	Expenses:			0.00
7	Variable:			0.00
8	Audit hours provided by Audit Division	180000.00		180000.00
9	Tax hours provided by Tax Division		236250.00	236250.00
10	Excess capacity hours paid to salaried staff **		40000.00	40000.00
11	Audit hours provided by Tax Division ***	64000.00		64000.00
12	Fixed expenses	50000.00	65500.00	115500.00
13	Income from operations before service department charges (3+4+5-7-8-9-10)	906000.00	431000.00	1337000.00
14	Service department charges for payroll ****	7150.00	22100.00	29250.00
15	Income from operations	898850.00	408900.00	1307750.00
16	Assets Invested	10000000.00	4000000.00	14000000.00
17	ROA	9%	10%	9%
Transfer pricing fee = 800 hours x $80 = $64,000 *
Excess capacity haours paid to salaried staff = 800 hrs x $50 = $40,000 **
Audit hours privided by tax division = 800 hrs x $80 = $64,000 ***
Payroll charges ****		Audit division	Tax division	Total
	Number paychecks	110	340	450
	Expenses	7150	22100	29250