Fundamentals of Cost Accounting, 6e (Lanen)
Chapter 14 Business Unit Performance Measurement
1) Divisional income statements do not have to follow generally accepted accounting principles
(GAAP) because they are internal reports.
2) One advantage of using after-tax income as a performance measure of divisional results is that
it is a financial accounting measure that is used to compute organizational income.
3) One disadvantage of using after-tax income as a performance measure of divisional results is
that it is an absolute measure which makes it difficult to compare divisions of significantly
different sizes.
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4) The profit margin ratio is computed by dividing after-tax income by sales.
5) In general, it is better to have a higher return on investment (ROI) than a lower one.
6) One problem associated with using accounting measures to evaluate divisional performance is
the measures are based on historical information.
7) A problem with ratio-based measures is that managers can make decisions that improve
divisional income but lower organizational performance.
8) It is not possible for a manager to accept an unacceptable project when his/her performance is
evaluated using ROI.
9) Residual income is the difference between the divisional income and the cost of invested
capital required to operate the division.
10) The use of residual income reduces, but does not eliminate, the suboptimization problem.
11) Managerial myopia is the distortion in incentives that results from using accounting
measures to evaluate performance.
12) Most organizations use residual income instead of return on investment (ROI) as a
performance measure.
13) Economic value added (EVA) adjustments are made to both the after-tax income and the
capital employed.
14) Treating research and development costs as an expense rather than a long-term asset may
reduce a manager’s inclination to participate in research and development activities.
15) One problem with economic value added (EVA) adjustments is determining the appropriate
life for expenditures that benefit multiple periods.
16) Like return on investment (ROI), economic value added (EVA) adjustments fail to
sufficiently address the suboptimization problem.
17) In general, a division’s investment base includes an allocated share of the corporate
headquarters’ assets.
18) Treating research and development costs as an expense rather than a long-term asset may
reduce a manager’s inclination to participate in research and development activities.
19) Current costs should not be used to compute either return on investment (ROI) or residual
income because current costs are not generally accepted accounting principles (GAAP).
20) Treating research and development costs as an expense rather than a long-term asset may
reduce a manager’s inclination to participate in research and development activities.
21) Which of the following is not an advantage of after-tax income as a performance measure?
A) It reflects the results of decisions under the division manager’s control.
B) It summarizes the results of decisions affecting revenues and costs.
C) It makes comparison of divisions easy because they use the same measure, dollars of income.
D) It is financial income computed differently from the income of the firm.
22) Which of the following statements is(are) true?
(A) Divisional income statements do not include allocated common costs.
(B) The gross margin ratio is computed by dividing operating income by sales.
A) Only A is true.
B) Only B is true.
C) Both of these are true.
D) Neither of these is true.
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23) After-tax income divided by sales is called the:
A) gross margin ratio.
B) profit margin ratio.
C) operating margin ratio.
D) contribution margin ratio.
24) The measure (ratio) that reflects the performance of a manager regarding sales and cost of
goods sold, but not other operating costs and income taxes, is called the:
A) gross margin ratio.
B) profit margin ratio.
C) operating margin ratio.
D) contribution margin ratio.
25) If a division is evaluated using return on investment (ROI) without regard to how assets are
financed, the denominator in the ROI calculation will be:
A) current assets.
B) working capital.
C) total assets available.
D) total assets employed.
26) Return on investment (ROI) can be decomposed into the asset turnover and the:
A) gross margin ratio.
B) profit margin ratio.
C) operating margin ratio.
D) contribution margin ratio.
27) The asset turnover is a measure (ratio) of an investment center’s ability to:
A) earn profits.
B) generate sales.
C) control costs.
D) remain solvent.
28) Which of the following statements does not represent a limitation of using return on
investment (ROI) for measuring and evaluating performance?
A) ROI uses accounting income which is based on historical information.
B) ROI cannot be used to compare divisions of different sizes.
C) ROI has the potential to create goal congruence problems.
D) ROI fails to align some costs incurred in one period with the benefits received in another
period.
29) How will increases in the following items affect return on investment (ROI)?
Increase in Expenses Increase in Inventory
A. Decrease ROI Decrease ROI
B. Decrease ROI Increase ROI
C. Increase ROI Decrease ROI
D. Increase ROI Increase ROI
A) Option A
B) Option B
C) Option C
D) Option D
30) A manager can increase his/her return on investment (ROI) by:
A) reducing the asset turnover.
B) decreasing residual income.
C) increasing the operating profit margin.
D) expanding operating assets while holding sales and expenses constant.
31) The Maxim Corporation reported the following operating results for its three divisions:
South, West, and East.
South Division West Division East Division
Sales $ 380,000 $ 1,700,000 $ 2,000,000
After-tax income $ 20,000 $ 50,000 $ 100,000
Divisional assets $ 200,000 $ 625,000 $ 800,000
Which division has the smallest return on investment (ROI)?
A) South.
B) West.
C) East.
D) All three divisions have the same ROI.
32) The Maxim Corporation reported the following operating results for its three divisions:
South, West, and East.
South Division West Division East Division
Sales $ 380,000 $ 1,700,000 $ 2,000,000
After-tax income $ 20,000 $ 50,000 $ 100,000
Divisional assets $ 200,000 $ 625,000 $ 800,000
Which division has the largest asset turnover?
A) South.
B) West.
C) East.
D) All three divisions have the same asset turnover.
33) The Maxim Corporation reported the following operating results for its three divisions:
South, West, and East.
South Division West Division East Division
Sales $ 380,000 $ 1,700,000 $ 2,000,000
After-tax income $ 20,000 $ 50,000 $ 100,000
Divisional assets $ 200,000 $ 625,000 $ 800,000
Which division has the highest profit margin?
A) South.
B) West.
C) East.
D) All three divisions have the same profit margin.
34) The following information was presented by User-Friendly Industries Company for an asset
purchased at the beginning of the previous year.
Original cost of the asset $ 20,000
Useful life of the asset 10 years
Annual operating profit, including depreciation $ 4,000
Salvage value $ -0-
What is the return on investment (ROI) assuming User-Friendly uses (a) the straight-line method
for depreciation and (b) beginning-of-year net book values to compute ROI?
A) 11.1%.
B) 20.0%.
C) 22.2%.
D) 25.0%.
35) The following information was presented by Outdoors Manufacturing Company for an asset
purchased at the beginning of the previous year.
Original cost of the asset $ 20,000
Useful life of the asset 10 years
Cash flow annual operating profit $ 4,000
Salvage value $ -0-
What is the return on investment (ROI) assuming Outdoors uses (a) the straight-line method for
depreciation and (b) beginning-of-year net book values to compute ROI?
A) 11.1%.
B) 20.0%.
C) 10.0%.
D) 22.2%.
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36) The following information was presented by Shower Wonder Enterprises for an asset
purchased at the beginning of the previous year.
Original cost of the asset $ 20,000
Useful life of the asset 10 years
Cash flow annual operating profit $ 4,000
Salvage value $ -0-
What is the return on investment (ROI) assuming Shower Wonder uses (a) the straight-line
method for depreciation and (b) average net book values to compute ROI?
A) 21.1%.
B) 20.0%.
C) 22.2%.
D) 11.76%.
37) Garage Corporation’s return on investment (ROI) on some new equipment was 20% using
beginning-of-year net book value. The gross book value of the equipment is $250,000.
Accumulated depreciation at the beginning of the year was $10,000. This represents one-half
year’s straight-line depreciation. What is the annual before-tax cash flow from the new
equipment?
A) $68,000.
B) $60,000.
C) $48,000.
D) $20,000.
38) Madrigal Corporation purchased a new machine for $120,000. The machine has an estimated
useful life of 10-years with no salvage value and a return on investment (ROI) of 15%. ROI is
computed using annual cash flows and straight-line depreciation. What is the annual cash flow
using the gross book value method?
A) $12,200.
B) $18,000.
C) $28,200.
D) $30,000.
39) The Nacho Division of the Tex-Mex Company has a return on investment (ROI) of 12%,
sales of $200,000, and an asset turnover of 2.0. What was Nacho’s operating income?
A) $6,000.
B) $12,000.
C) $24,000.
D) $48,000.
40) The following information is available for Sweet Dreams Company:
Sales $ 100,000
Operating expenses $ 94,000
Operating assets $ 40,000
Stockholder’s equity $ 25,000
Cost of capital 10 %
What is Sweet Dreams Company’s return on investment (ROI)?
A) 6.0%.
B) 10.0%.
C) 15.0%.
D) 24.0%.
41) The Gallop Company has an asset turnover of 3.0 times, using assets of $45,000. The
company also has a return on investment (ROI) of 20%. What was Gallop’s operating profit
margin?
A) 5.0%.
B) 6.0%.
C) 6.7%.
D) 8.3%.
42) How will decreases in the following items affect return on investment (ROI)?
Decrease in Sales Decrease in Equipment
A. Decrease ROI Decrease ROI
B. Decrease ROI Increase ROI
C. Increase ROI Decrease ROI
D. Increase ROI Increase ROI
A) Option A
B) Option B
C) Option C
D) Option D
43) A firm earning a profit can increase its return on investment by: (CMA adapted)
A) increasing sales revenue and operating expenses by the same dollar amount.
B) decreasing sales revenues and operating expenses by the same percentage.
C) increasing investment and operating expenses by the same dollar amount.
D) increasing sales revenues and operating expenses by the same percentage.
44) Return on investment (ROI) is a very popular measure employed to evaluate the performance
of corporate segments because it incorporates all of the major ingredients of profitability
(revenue, cost, investment) into a single measure. Under which one of the following
combinations of actions regarding a segment’s revenues, costs, and investment would a segment’s
ROI always increase? (CIA adapted)
Sales Equipment Investment
A. Increase Decrease Increase
B. Decrease Decrease Decrease
C. Increase Increase Increase
D. Increase Decrease Decrease
A) Option A
B) Option B
C) Option C
D) Option D