Chapter 12 – Performance Evaluation and Decentralization
1. The practice of delegating decision-making authority to lower levels of management in a company is called
centralization.
a.
True
b.
False
False
2. In a decentralized company, overall profit margins can mask inefficiencies within the various subdivisions.
a.
True
b.
False
3. Decentralization is usually achieved by creating units called divisions.
a.
True
b.
False
True
4. A production department within the factory, such as assembly, is an example of a profit center.
a.
True
b.
False
5. In a decentralized company, central management is able to focus on strategic planning and decision making.
a.
True
b.
False
True
6. Turnover is the most common measure of performance for an investment center.
a.
True
b.
False
False
Return on investment (ROI) is the most common measure of performance for an investment center.
7. Return on investment (ROI) can be calculated by multiplying margin times turnover.
a.
True
b.
False
True
8. Turnover is the ratio of sales to average operating assets.
a.
True
b.
False
True
9. Decreasing inventories leads to a reduction in return on investment (ROI).
a.
True
Chapter 12 – Performance Evaluation and Decentralization
b.
False
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.
a.
True
b.
False
True
11. Unlike ROI, residual income does not encourage a short-run orientation.
a.
True
b.
False
12. Economic value added (EVA) is similar to ROI in that it links net income to capital employed.
a.
True
b.
False
True
13. A key feature of economic value added (EVA) is that it emphasizes after-tax operating income and the actual cost of
capital.
a.
True
b.
False
True
14. Residual income is the difference between operating income and the product of the hurdle rate and the company’s
average operating assets.
a.
True
b.
False
True
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.
a.
True
b.
False
True
16. The use of residual income encourages managers to accept any project that earns above the minimum rate.
a.
True
b.
False
True
17. The direct comparison of the performance of two different investment centers is difficult using residual income
because residual income is an absolute measure.
Chapter 12 – Performance Evaluation and Decentralization
a.
True
b.
False
True
18. Economic value added is just a specific way of calculating residual income.
a.
True
b.
False
True
A specific way of calculating residual income is economic value added.
19. The net income reduced by the total annual cost of capital is equal to the economic value added.
a.
True
b.
False
True
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).
a.
True
b.
False
True
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.
a.
True
b.
False
True
22. In terms of operating income for the company as a whole, the transfer price set by the buying and selling divisions
nets out.
a.
True
b.
False
True
23. If there is a competitive outside market for the transferred product, then the best transfer price is the cost-based
transfer price.
a.
True
b.
False
False
Chapter 12 – Performance Evaluation and Decentralization
24. In negotiated transfer pricing, the buying division sets the ceiling (maximum possible transfer price) for the bargaining
range.
a.
True
b.
False
True
25. In negotiated transfer pricing, the selling division sets the ceiling (maximum possible transfer price) for the bargaining
range.
a.
True
b.
False
26. The selling division would never agree to a transfer price below its full manufacturing cost.
a.
True
b.
False
27. A transfer price is the price charged for a component by the selling division to the buying division of the same
company.
a.
True
b.
False
True
28. The price charged for the transferred good affects the costs of the buying division and the revenues of the selling
division.
a.
True
b.
False
True
29. Transfer pricing is a complex issue.
a.
True
b.
False
True
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.
a.
True
b.
False
True
31. Several transfer pricing policies are used in practice. These transfer pricing policies include market price, cost-based
transfer prices, and negotiated transfer prices.
a.
True
b.
False
True
Chapter 12 – Performance Evaluation and Decentralization
32. The selling division is forced to transfer a product internally when a cost-based transfer pricing policy is set by top
management.
a.
True
b.
False
False
33. When a product is transferred at market price, the transfer will optimize both divisional and company-wide profits.
a.
True
b.
False
True
34. In _______________ decision making, decisions are made at the very top level, and lower-level managers are charged
with implementing these decisions.
centralized
35. ________________ decision making allows managers at lower levels to make and implement key decisions pertaining
to their areas of responsibility.
Decentralized
36. Decentralization usually is achieved by creating units called ___________.
divisions
37. A ____________________ is a segment of the business whose manager is accountable for specific sets of activities.
38. When a manager is responsible for only costs it is known as a(n) _______________.
39. A(n) ________________ is when a manager is responsible only for sales.
40. An ______________________ is when a manager is responsible for revenues, costs and investments.
41. Typically, investment centers are evaluated on the basis of __________________.
42. _____________________ refers to earnings before non-operating revenue, expenses, interest and taxes.
43. _____________ is the ratio of operating income to sales.
Margin
Chapter 12 – Performance Evaluation and Decentralization
44. _________________ is found by dividing sales by average operating assets.
Turnover
45. _______________ indicate the minimum ROI necessary to accept an investment.
Hurdle rate
46. The difference between operating income and the minimum dollar return required on a company’s operating assets is
the _______________.
residual income
47. ___________________ is after-tax operating income minus the dollar cost of capital employed.
Economic value added
48. A _________________ is the price charged for a component by the selling division to the buying division of the same
company.
transfer price
49. If there is a competitive outside market for the transferred product, then the best transfer price is the _____________.
market price
50. The ________________ is a strategic management system that defines a strategic-based responsibility accounting
system.
Balanced Scorecard
51. ______________________ occurs whenever managers receive information about the effectiveness of strategy
implementation as well as the validity of the assumptions underlying the strategy.
Double-loop feedback
52. _________________ emphasizes only effectiveness of implementation.
Single-loop feedback
53. ________________ is the difference between realization and sacrifice, where realization is what the customer receives
and sacrifice is what is given up in return.
Customer value
54. 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.
55. 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.
Chapter 12 – Performance Evaluation and Decentralization
e.
All of these.
e
56. 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.
All of these answers are correct.
e.
None of these answers are correct.
57. 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.
58. 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.
59. 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.
c
60. 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.
61. The decision-making approach that allows managers at lower levels to make and implement key decisions pertaining
to their areas of responsibility is
Chapter 12 – Performance Evaluation and Decentralization
a.
responsibility accounting.
b.
controllable accounting.
c.
decentralization.
d.
optimal strategic accounting.
e.
None of these.
c
62. 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.
63. 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.
c
64. 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.
65. 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.
66. Margin is calculated as
a.
operating income / sales.
Chapter 12 – Performance Evaluation and Decentralization
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.
67. 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.
68. 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.
69. 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%.
70. 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.
71. 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.
Chapter 12 – Performance Evaluation and Decentralization
e.
It can accomplish all of these disadvantages.
72. 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%
73. 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.
74. 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%.
75. If the National Division of American Products Company had a turnover ratio of 4.2 and a margin of 0.10, the return on
investment would be
a.
23.8%.
b.
420.0%.
c.
42.0%.
d.
238.0%.
4.2 × 0.10 = .42 or 42%
Chapter 12 – Performance Evaluation and Decentralization
76. If the margin of 0.30 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.
**0.30 × 5.00
77. 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.
1.30 × 1.20 = 1.56 or a 56% increase
78. 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%.
SUPPORTING CALCULATIONS: 1.50 × 1.50 = 2.25 or 125% increase
79. 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.
a
80. 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:
Chapter 12 – Performance Evaluation and Decentralization
Operating income
$86,000
Sales
$225,000
Beginning operating assets
$390,000
Ending operating assets
$420,000
81. 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
Margin = $86,000 / $225,000 = 0.38
82. 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.
Turnover = $225,000 / [($420,000 + $390,000) / 2] = 0.56
83. 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
$18,000
$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%
84. Refer to Figure 12–5. What are the average operating assets for Division C?
a.
$95,000
b.
$410,000
Chapter 12 – Performance Evaluation and Decentralization
c.
$82,000
d.
$420,000
$82,000 / 0.20 = $410,000
85. Refer to Figure 12–5. What is the turnover for Division C?
a.
3.28
b.
0.20
c.
6.670
d.
1.500
Average operating assets
$82,000 / 0.20 = $410,000
Turnover
$1,345,000 / $410,000 = 3.28 times
86. 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
$18,000 / 0.015 = $1,200,000
87. 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
$18,000 / 0.15 = $120,000
Figure 12–2.
The manager of Stock Division projects the following for next year:
Sales
$185,000
Operating income
$60,000
Operating assets
$375,000
The manager can invest in an additional project that would require $40,000 investment in additional assets and would
generate $6,000 of additional income. The company’s minimum rate of return is 14%.
88. Refer to Figure 12–2. What is the residual income for Stock Division without the additional investment?
a.
$40,000
b.
$6,000
c.
$6,600
d.
$6,200
e.
$7,500
Residual income = $60,000 – (0.14 × $375,000) = $7,500
Chapter 12 – Performance Evaluation and Decentralization
89. Refer to Figure 12–2. What is the residual income for Stock Division with the additional project?
a.
$40,000
b.
$6,000
c.
$7,900
d.
$4,200
e.
$25,600
Residual income = ($60,000 + $6,000) – [0.14 × ($375,000 + $40,000)] = $7,900
90. Refer to Figure 12–2. Which of the following statements is true?
a.
If the manager invests in the additional project, ROI of the division will decrease.
b.
The residual income of the project is less than the residual income of the division without the project; therefore
the project will be rejected.
c.
Average investment for Stock Division will decrease if the project is accepted for investment.
d.
If the manager invests in the additional project, residual income of the division will increase.
e.
None of these.
91. Residual income is calculated as
a.
operating income − (ROI × average operating assets).
b.
operating income / (ROI × average operating assets).
c.
operating income / (minimum rate of return × average operating assets).
d.
operating income − (minimum rate of return × average operating assets).
e.
(minimum rate of return × average operating assets) / operating income.
92. The performance measure that uses after-tax operating income and the actual cost of capital employed is
a.
return on investment (ROI).
b.
residual income.
c.
economic value added (EVA).
d.
margin.
e.
turnover.
c
93. Which of the following is an absolute dollar measure rather than a percentage?
a.
average operating assets.
b.
operating income.
c.
residual income.
d.
economic value added (EVA).
e.
All of these.
e
94. Economic Value Added is residual income with the cost of capital equal to the firm’s
a.
budgeted cost of capital.
Chapter 12 – Performance Evaluation and Decentralization
b.
average cost of capital.
c.
standard cost of capital.
d.
actual cost of capital.
95. In calculating residual income, the variable set by top management is called the
a.
average operating assets.
b.
operating income.
c.
hurdle rate.
d.
actual operating assets.
96. The calculation of Economic Value Added is
a.
margin minus total annual cost of capital.
b.
operating income minus average cost of capital.
c.
operating income minus total annual cost of capital.
d.
operating income minus taxes and the total annual cost of capital.
Economic value added (EVA) is after-tax operating income minus the total annual cost of capital.
97. Using Economic Value Added (EVA) to calculate residual income, the cost of capital employed is
a.
the standard percentage cost of capital multiplied by the average capital employed.
b.
the actual percentage cost of capital multiplied by the average capital employed.
c.
the standard percentage cost of capital multiplied by the total capital employed.
d.
the actual percentage cost of capital multiplied by the total capital employed.
98. The following information pertains to the three divisions of Marlow Company:
Division X
Division Y
Division Z
Sales
?
?
$1,250,000
Net operating income
$36,000
$25,000
$75,000
Average operating assets
$300,000
?
?
Return on investment
?
20%
15%
Margin
0.10
0.05
?
Turnover
1.2
?
?
Target ROI
15%
12%
10%
What is the residual income for Division X?
a.
$36,000
b.
$45,000
c.
$(9,000)
Chapter 12 – Performance Evaluation and Decentralization
d.
$(36,000)
99. The Auto Division of Big Department Store had a net operating income of $560,000, a net asset base of $4,000,000,
and a required rate of return of 12%. Sales for the period totaled $3,000,000. The residual income for the period is
a.
$480,000.
b.
$360,000.
c.
$120,000.
d.
$80,000.
100. A price charged for a component by the selling division to the buying division of the same company is called a(n)
a.
transfer price.
b.
economic value added.
c.
market price.
d.
cost-based price.
e.
None of these.
a
101. The level of the transfer price can affect the overall company because
a.
the higher the transfer price, the higher the operating income.
b.
it may impact on the taxes paid by the multinational company.
c.
the lower the transfer price, the lower the total costs.
d.
internal transfers are always costly to the firm.
e.
the transfer price may be higher than the cost-based price.
102. If there is a competitive outside market for the transferred product, then the best transfer price is the
a.
cost-based price.
b.
negotiated price.
c.
market price.
d.
price set by central management.
e.
None of these.
c
103. If the selling division is operating at less than full capacity, the floor of the bargaining range would most probably be
set at
a.
market price.
b.
full manufacturing cost.
c.
average price of all products sold by the selling division.
d.
manufacturing cost plus some percentage for profit.
Chapter 12 – Performance Evaluation and Decentralization
e.
variable cost of manufacturing.
e
104. The Engine Division provides engines for the Tractor Division of a company. The standard unit costs for Engine
Division are:
Direct materials
$ 600
Direct labor
1,200
Variable overhead
300
Fixed overhead
150
Market price per unit
2,730
What is the transfer price based on full cost plus a markup of 30%?
a.
$2,925
b.
$585
c.
$2,760
d.
$2,730
($600 + $1,200 + $300 + $150) × 1.30 = $2,925
105. Several transfer pricing policies are used in practice. These transfer pricing policies include
a.
transfer at market price.
b.
transfer at negotiated price.
c.
transfer at cost.
d.
All of these.
106. Division A produces a component and wants to sell it to Division B. The transfer price is
a.
revenue to Division ‘A’ and a cost to Division B.
b.
revenue to Division ‘B’ and a cost to Division A.
c.
revenue to Division ‘A’ and no effect on Division B.
d.
a cost to Division ‘B’ and no effect on Division A.
a
107. The Engine Division provides engines for the Tractor Division of a company. The standard unit costs for Engine
Division are:
Direct materials
$ 600
Direct labor
1,200
Variable overhead
300
Fixed overhead
150
Market price per unit
2,730
The engine department has excess capacity. What is the best transfer price to avoid transfer price problems?
a.
$1,350
b.
$300
c.
$900
Chapter 12 – Performance Evaluation and Decentralization
d.
$2,100
SUPPORTING CALCULATIONS:
108. Pautner Company had the following historical accounting data per unit:
Direct materials
$60
Direct labor
30
Variable overhead
15
Fixed overhead
24
Variable selling expenses
45
Fixed selling expenses
9
The units are normally transferred internally from Division A to Division B. The units also may be sold externally for
$210 per unit. The minimum profit level accepted by the company is a markup of 30%. There were no beginning or
ending inventories.
What would be the transfer price if Division X uses full cost plus markup?
a.
$167.70
b.
$198.90
c.
$136.50
d.
$129.00
($60 + $30 + $15 + $24) × 1.30 = $167.70
Figure 12–3.
Grey Inc. has many divisions that are evaluated on the basis of ROI. One division, Centra, makes boxes. A second
division, Mantra, makes chocolates and needs 80,000 boxes per year. Centra incurs the following costs for one box:
Direct materials
$0.35
Direct labor
$0.60
Variable overhead
$0.40
Fixed overhead
$0.13
Total
$1.48
Centra has capacity to make 700,000 boxes per year. Mantra currently buys its boxes from an outside supplier for $1.80
each (the same price that Centra receives).
109. Refer to Figure 12–3. Assume that Grey Inc. mandates that any transfers take place at full manufacturing cost. What
would be the transfer price if Centra transferred boxes to Mantra?
a.
$1.35
b.
$1.48
c.
$1.00
d.
Cannot be determined from the information given.
e.
$0.90
The cost-based transfer price is $1.48.
110. Refer to Figure 12–3. Assume that Grey Inc. allows division managers to negotiate transfer price. Centra is producing