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)	$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

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 panels and selection lists provided.

	Audit Division
	Profit Margin	x	Investment Turnover	=	ROI
No Transfer		x		=
Market Price		x		=
Negotiated Price		x		=
Cost Price		x		=

	Tax Division
	Profit Margin	x	Investment Turnover	=	ROI
No Transfer		x		=
Market Price		x		=
Negotiated Price		x		=
Cost Price		x		=

	BOR CPAs, Inc.
	Profit Margin	x	Investment Turnover	=	ROI
No Transfer		x		=
Market Price		x		=
Negotiated Price		x		=
Cost Price		x		=

Answer 1

			Income statement
				Audit Division	Tax Division	Total Company
	Fees earned:
	Audit fees (16 engagements)			1200000		1200000
	Tax fees (45 engagements)				708750	708750
	Transfer-pricing fees				64000	64000
					(80*800)
	Total Fees earned (A)			1200000	772750	1972750
	Expenses:
	Variable:
	Audit hours provided by Audit Division			180000		180000
	Tax hours provided by Tax Division				236250	236250
	Excess capacity hours paid to salaried staff			64000		64000
				(80*800)
	Audit hours provided by Tax Division				40000	40000
					(50*800)
	Fixed expenses			50000	65500	115500
	Total expenses (B)			294000	341750	635750
	Income from operations before service department charges ©=(A)-(B)			906000	431000	1337000
	Service department charges for payroll			7150	22100	29250
				(29250/450)*110	(29250/450)*340
	Income from operations			898850	408900	1307750
	Computation of ROI for different alternatives:
	Profit margin=Income from operations/Total revenues
	Investment turnover=Total revenues/Amount of assets invested
			Income statement	No Transfer			Market price			Negotiated price			Cost price
				Audit Division	Tax Division	Total Company	Audit Division	Tax Division	Total Company	Audit Division	Tax Division	Total Company	Audit Division	Tax Division	Total Company
	Fees earned:
	Audit fees			900000		900000	1200000		1200000	1200000		1200000	1200000		1200000
				(12*75000)			(16*75000)
	Tax fees (45 engagements)				708750	708750		708750	708750		708750	708750		708750	708750
	Transfer-pricing fees							88000	88000		64000	64000		40000	40000
								(800*110)			(80*800)			(50*800)
	Total Fees earned (A)			900000	708750	1608750	1200000	796750	1996750	1200000	772750	1972750	1200000	748750	1948750
	Expenses:
	Variable:
	Audit hours provided by Audit Division			180000		180000	180000		180000	180000		180000	180000		180000
	Tax hours provided by Tax Division				236250	236250		236250	236250		236250	236250		236250	236250
	Excess capacity hours paid to salaried staff			0		0	88000		88000	64000		64000	40000		40000
							(800*110)			(80*800)			(50*800)
	Audit hours provided by Tax Division					0		40000	40000		40000	40000		40000	40000
								(800*50)			(50*800)			(50*800)
	Fixed expenses			50000	65500	115500	50000	65500	115500	50000	65500	115500	50000	65500	115500
	Total expenses (B)			230000	301750	531750	318000	341750	659750	294000	341750	635750	270000	341750	611750
	Income from operations before service department charges ©=(A)-(B)			670000	407000	1077000	882000	455000	1337000	906000	431000	1337000	930000	407000	1337000
	Service department charges for payroll			7150	22100	29250	7150	22100	29250	7150	22100	29250	7150	22100	29250
				(29250/450)*110	(29250/450)*340		(29250/450)*110	(29250/450)*340		(29250/450)*110	(29250/450)*340		(29250/450)*110	(29250/450)*340
	Income from operations (D)			662850	384900	1047750	874850	432900	1307750	898850	408900	1307750	922850	384900	1307750
	Profit margin (D)/(A)			73.65%	54.31%	65.13%	72.90%	54.33%	65.49%	74.90%	52.91%	66.29%	76.90%	51.41%	67.11%
	Asset invested €			10000000	4000000	14000000	10000000	4000000	14000000	10000000	4000000	14000000	10000000	4000000	14000000
	Investment turnover (A)/€			0.09	0.18	0.11	0.12	0.20	0.14	0.12	0.19	0.14	0.12	0.19	0.14
		Audit division
			Profit margin	*	Investment Turnover	=	ROI
	No transfer		73.65%	*	0.09	=	6.63%
	Market price		72.90%	*	0.12	=	8.75%
	Negotiated price		74.90%	*	0.12	=	8.99%
	Cost price		76.90%	*	0.12	=	9.23%
		Tax division
			Profit margin	*	Investment Turnover	=	ROI
	No transfer		54.31%	*	0.18	=	9.78%
	Market price		54.33%	*	0.2	=	10.87%
	Negotiated price		52.91%	*	0.19	=	10.05%
	Cost price		51.41%	*	0.19	=	9.77%
		BOR CPAs, Inc.
			Profit margin	*	Investment Turnover	=	ROI
	No transfer		65.13%	*	0.11	=	7.16%
	Market price		65.49%	*	0.14	=	9.17%
	Negotiated price		66.29%	*	0.14	=	9.28%
	Cost price		67.11%	*	0.14	=	9.40%