Chapter 12—Performance Evaluation and Decentralization
TRUE/FALSE
1. The practice of delegating decision-making authority to lower levels of management in a company is
called centralization.
2. In a decentralized company, overall profit margins can mask inefficiencies within the various
subdivisions.
3. Decentralization is usually achieved by creating units called divisions.
4. A production department within the factory, such as assembly, is an example of a profit center.
5. In a decentralized company, central management is able to focus on strategic planning and decision
making.
6. Turnover is the most common measure of performance for an investment center.
7. Return on investment (ROI) can be calculated by multiplying margin times turnover.
8. Turnover is the ratio of sales to average operating assets.
9. Decreasing inventories leads to a reduction in return on investment (ROI).
10. Residual income is sometimes used to overcome the tendency of ROI to discourage investments that
are profitable for the company, but that lower the division’s ROI.
11. Unlike ROI, residual income does not encourage a short-run orientation.
12. Economic value added (EVA) is similar to ROI in that it links net income to capital employed.
13. A key feature of economic value added (EVA) is that it emphasizes after-tax operating income and the
actual cost of capital.
14. Residual income is the difference between operating income and the product of the hurdle rate and the
company’s average operating assets.
15. In calculating residual income, the minimum rate of return is set by top management and is the same as
the hurdle rate used for return on investment.
16. The use of residual income encourages managers to accept any project that earns above the minimum
rate.
17. The direct comparison of the performance of two different investment centers is difficult using
residual income because residual income is an absolute measure.
18. Economic value added is just a specific way of calculating residual income.
19. The net income reduced by the total annual cost of capital is equal to the economic value added.
20. Basically, EVA is residual income with the cost of capital equal to the actual cost of capital for the
firm (as opposed to some minimum rate of return desired by the company for other reasons).
21. Using EVA to calculate residual income, the dollar cost of capital employed is the actual percentage
cost of capital multiplied by the total capital employed.
22. In terms of operating income for the company as a whole, the transfer price set by the buying and
selling divisions nets out.
23. If there is a competitive outside market for the transferred product, then the best transfer price is the
cost-based transfer price.
24. In negotiated transfer pricing, the buying division sets the ceiling (maximum possible transfer price)
for the bargaining range.
25. In negotiated transfer pricing, the selling division sets the ceiling (maximum possible transfer price)
for the bargaining range.
26. The selling division would never agree to a transfer price below its full manufacturing cost.
27. A transfer price is the price charged for a component by the selling division to the buying division of
the same company.
28. The price charged for the transferred good affects the costs of the buying division and the revenues of
the selling division.
29. Transfer pricing is a complex issue.
30. When the selling division can sell and the buying division can buy externally at the market price, the
company as a whole will be in the same position whether or not a market price transfer takes place
internally.
31. Several transfer pricing policies are used in practice. These transfer pricing policies include market
price, cost-based transfer prices, and negotiated transfer prices.
32. The selling division is forced to transfer a product internally when a cost-based transfer pricing policy
is set by top management.
33. When a product is transferred at market price, the transfer will optimize both divisional and
company-wide profits.
MATCHING
Select the term from below to match with the correct statement.
a.
centralization
b.
revenue center
c.
profit center
d.
cost center
e.
investment center
f.
decentralization
1. A(n) ___________ is a responsibility center in which a manager is responsible only for costs.
2. A(n) ___________ is a responsibility center in which a manager is responsible only for sales, or
revenues.
3. A(n) ___________ is a responsibility center in which a manager is responsible for revenues, costs, and
investments.
4. The manager of a(n) ___________ is evaluated on the basis of income.
5. The practice of delegating decision-making authority to lower levels is __________.
Select the appropriate definition for each of the items listed below.
a.
Turnover
b.
Margin
c.
ROI
d.
Residual income
6. The most common measure of performance for an investment center.
7. The ratio of operating income to sales.
8. The ratio of sales to average operating assets.
9. The dollar difference between operating income and minimum required return on a company’s
operating assets.
COMPLETION
1. In _______________ decision making, decisions are made at the very top level, and lower-level
managers are charged with implementing these decisions.
2. ________________ decision making allows managers at lower levels to make and implement key
decisions pertaining to their areas of responsibility.
3. Decentralization usually is achieved by creating units called ___________.
4. A ____________________ is a segment of the business whose manager is accountable for specific
sets of activities.
5. When a manager is responsible for only costs it is known as a(n) _______________.
6. A(n) ________________ is when a manager is responsible only for sales.
7. An ______________________ is when a manager is responsible for revenues, costs and investments.
8. Typically, investment centers are evaluated on the basis of __________________.
9. _____________________ refers to earnings before interest and taxes.
10. _____________ is the ratio of operating income to sales.
11. _________________ is found by dividing sales by average operating assets.
12. _______________ indicate the minimum ROI necessary to accept an investment.
13. The difference between operating income and the minimum dollar return required on a company’s
operating assets is the _______________.
14. ___________________ is after tax operating income minus the dollar cost of capital employed.
15. A _________________ is the price charged for a component by the selling division to the buying
division of the same company.
16. If there is a competitive outside market for the transferred product, then the best transfer price is the
_____________.
17. The ________________ is a strategic management system that defines a strategic-based responsibility
accounting system.
18. ______________________ occurs whenever managers receive information about the effectiveness of
strategy implementation as well as the validity of the assumptions underlying the strategy.
19. _________________ emphasizes only effectiveness of implementation.
20. ________________ is the difference between realization and sacrifice, where realization is what the
customer receives and sacrifices is what is given up in return.
MULTIPLE CHOICE
1. The practice of delegating decision-making authority to the lower levels of management in a company
is
a.
centralization.
b.
decentralization.
c.
performance evaluation.
d.
authorization.
e.
hierarchy flattening.
2. Which of the following is a reason for decentralization?
a.
Ease of gathering and using local information.
b.
Focusing of central management.
c.
Training and motivating segment managers.
d.
Exposing segments to market forces.
e.
All of these.
3. Divisions in a decentralized company can be created along which of the following lines?
a.
geographical
b.
types of goods or services produced
c.
type of responsibility given to divisional manager
d.
two or more of the other answers are correct
e.
None of these.
4. A responsibility center in which a manager is responsible only for costs is a(n)
a.
investment center.
b.
revenue center.
c.
profit center.
d.
cost center.
e.
center not presented here.
5. A responsibility center in which a manager is responsible only for sales is a(n)
a.
cost center.
b.
revenue center.
c.
profit center.
d.
investment center.
e.
None of these.
6. A responsibility center in which a manager is responsible for both revenues and costs is a(n)
a.
cost center.
b.
revenue center.
c.
profit center.
d.
investment center
e.
None of these.
7. A responsibility center in which a manager is responsible for revenues, cost, and investment is a(n)
a.
cost center.
b.
revenue center.
c.
profit center.
d.
investment center.
e.
None of these.
8. The decision-making approach that allows managers at lower levels to make and implement key
decisions pertaining to their areas of responsibility is
a.
responsibility accounting.
b.
controllable accounting.
c.
decentralization.
d.
optimal strategic accounting.
e.
None of these.
9. Decentralization is frequently chosen by companies because it
a.
allows higher management to make all decisions.
b.
allows higher management to gather local information to make better decisions.
c.
protects segments of the company from competitive pressures.
d.
allows for training and motivation of local managers.
e.
allows the CEO to make all important decisions.
10. A segment of Mega Inc., manufactures and sells blankets. The various models of blankets are
produced in a single factory using stable technology. They are sold by the sales department, also
located in the factory. The segment is most probably accounted for as a(n)
a.
cost center.
b.
revenue center.
c.
profit center.
d.
investment center.
e.
None of these.
11. JetSky Airways has three divisions, the Western Division, the Eastern Division, and the Northern
Division. The manager of the Western Division had wanted to purchase replacement airplanes for the
division. However, he decided against it because, although revenues would increase and the new
planes would be less expensive to operate, the initial cost of the planes was quite large. The Western
Division is most probably accounted for as a(n)
a.
cost center.
b.
investment center.
c.
profit center.
d.
revenue center.
e.
None of these.
12. Return on investment (ROI) is calculated as
a.
operating income/average operating assets.
b.
average operating assets/operating income.
c.
(beginning operating assets + ending operating assets)/2.
d.
sales/average operating assets.
e.
operating income/sales.
13. Margin is calculated as
a.
operating income/sales.
b.
average operating assets/operating income.
c.
(beginning operating assets + ending operating assets)/2.
d.
sales/average operating assets.
e.
operating income/average operating assets operating income/sales.
14. Turnover is calculated as
a.
operating income/average operating assets.
b.
average operating assets/operating income.
c.
(beginning operating assets + ending operating assets)/2.
d.
sales/average operating assets.
e.
operating income/sales.
15. A positive result that stems from the use of return on investment (ROI) is that it encourages managers
to focus on
a.
the relationship among sales, expenses, and investment.
b.
cost efficiency.
c.
operating asset efficiency.
d.
the efficient use of resources in generating income.
e.
All of these.
16. Division A had ROI of 15% last year. The manager of Division A is considering an additional
investment for the coming year. What step will the manager likely choose to take?
a.
Accept the investment as long as it provides positive operating income.
b.
Accept the investment as long as its ROI is positive.
c.
Reject the investment if it returns more than 15% ROI.
d.
Reject the investment if it returns less than 15% ROI.
e.
Reject the investment if it returns an ROI equal to 15%.
17. The manager of a division is displeased with the ROI of the division. One step that would increase
ROI (holding everything else constant) is
a.
increasing investment.
b.
increasing sales.
c.
increasing costs.
d.
decreasing operating income.
e.
None of these.
18. Which of the following is a disadvantage of a focus on return on investment?
a.
It can encourage managers to focus on cost cutting efforts.
b.
It can produce a narrow focus on divisional profitability at the expense of profitability for
the overall firm.
c.
It can encourage managers to cut inventories and reduce overall investment.
d.
It can encourage managers to focus on the long run at the expense of the short run.
e.
It can accomplish all of these disadvantages.
19. Castor Company had income of $10,000, average assets of $100,000 and sales of $40,000. What is
Castor’s ROI?
a.
10%
b.
20%
c.
25%
d.
0.4%
e.
40%
20. Shandling Company had operating income of $70,000, sales of $218,750, and turnover of 0.5. What is
Shandling’s ROI?
a.
32%
b.
50%
c.
16%
d.
64%
e.
Cannot be determined from this information.
21. Beta Division had the following information:
Asset base in Beta Division
$400,000
Operating income in Beta Division
$ 50,000
Cost of capital
12%
Target ROI
15%
Margin for Beta Division
20%
If the asset base is decreased by $100,000, with no other changes, the return on investment of Beta
Division will be
a.
100.0%.
b.
16.7%.
c.
600.0%.
d.
62.5%.
0.10, the return on investment would be
a.
23.8%.
b.
420.0%.
c.
42.0%.
d.
238.0%.
23. If the margin of 0.3 stayed the same and the turnover ratio of 5.0 increased by 10%, the ROI would
a.
increase by 10%.
b.
decrease by 10%.
c.
increase by 15%.
d.
remain the same.
24. If the operating asset turnover ratio increased by 30% and the margin increased by 20%, the divisional
ROI
a.
would increase by 56%.
b.
would decrease by 60%.
c.
would increase by 20%.
d.
cannot be determined.
25. If the operating asset turnover increased by 50% and the margin increased by 50%, the ROI would
increase by
a.
50%.
b.
25%.
c.
100%.
d.
125%.
26. Which of the following is not an advantage of ROI?
a.
It encourages managers of departments with high ROIs to invest in average ROI projects.
b.
It encourages managers to pay careful attention to the relationships among sales, expenses,
and investment.
c.
It encourages cost efficiency.
d.
It discourages excessive investment in operating assets.
27. Which of the following is not a disadvantage of the ROI performance measure?
a.
It encourages managers to focus on the long run rather than the short run.
b.
It discourages managers from investing in projects that would decrease divisional ROI but
increase the profitability of the company as a whole.
c.
It encourages myopic behavior.
d.
All of these are disadvantages of the ROI measure.
Figure 12-1.
Dempsey Company provided the following information for last year:
Operating income
Sales
Beginning operating assets
Ending operating assets
28. Refer to Figure 12-1. Calculate Dempsey’s margin for last year, rounding to two decimal places.
a.
2.0
b.
0.26
c.
0.38
d.
0.50
e.
0.35
29. Refer to Figure 12-1. Dempsey’s turnover ratio for last year was
a.
2.0.
b.
0.46.
c.
0.56.
d.
0.32.
e.
0.10.
30. Refer to Figure 12-1. Dempsey’s return on investment for last year was
a.
2.0.
b.
0.21.
c.
0.32.
d.
0.50.
e.
0.15.
Figure 12-5.
The following information pertains to the three divisions of Yang Company:
Division A
Division B
Division C
Sales
?
?
$1,345,000
Net operating income
$48,000
418,000
$82,000
Average operating assets
$420,000
?
?
Return on investment
?
15%
20%
Margin
0.2
0.015
?
Turnover
2.1
?
?
Target ROI
17%
14%
8%
31. Refer to Figure 12-5. What are the average operating assets for Division C?
a.
$95,000
b.
$410,000
c.
$82,000
d.
$420,000
32. Refer to Figure 12-5. What is the turnover for Division C?
a.
3.28
b.
0.20
c.
6.670
d.
1.500
33. Refer to Figure 12-5. What are the sales for Division B?
a.
$18,000
b.
$1,250,000
c.
$1,200,000
d.
$208,333
34. Refer to Figure 12-5. What are the average operating assets for Division B?
a.
$125,000
b.
$120,000
c.
$18,000
d.
$420,000
Figure 12-2.
The manager of Stock Division projects the following for next year: