Accounting Chapter 14 Homework Per dollar of invested assets, the Lunch Division is the most profitable of the three divisions. Assuming that the returns on investment do not change in the future

462

P14–3

1.

HORIZON FOODS INC.

Divisional Income Statements

For the Year Ended June 30, 20Y7

Breakfast Lunch Dinner

Division Division Division

Sales ……………………………………………. $19,800,000 $ 9,250,000 $12,000,000

2. Return on Investment = Profit Margin × Investment Turnover

Return on Investment = Operating Income

Sales × AssetsInvested

Sales

Lunch Division: ROI =

$647,500

$9,250,000 × $9,250,000

$4,625,000

= 7% × 2.0

= 14.0%

3. Per dollar of invested assets, the Lunch Division is the most profitable of the

three divisions. Assuming that the returns on investment do not change in the

future, an expansion of the Lunch Division will return 14.0 cents (14.0%) on

463

P14–4

1. Return on Investment = Profit Margin × Investment Turnover

Return on Investment = Operating Income

Sales × AssetsInvested

Sales

2.

RIDE OF YOUR LIFE INC.— MOTORBOAT DIVISION

Estimated Income Statements

For the Year Ended December 31, 20Y2

Proposal 1 Proposal 2 Proposal 3

Sales ……………………………………………… $ 6,000,000 $ 6,000,000 $ 4,860,000

Cost of goods sold …………………………. (3,732,000) (3,360,000) (2,900,000)

464

P14–4, Concluded

3. Return on Investment = Profit Margin × Investment Turnover

Proposal 2: ROI =

$1,080,000

$6,000,000 × $6,000,000

$8,000,000

= 18.0% × 0.75

= 13.5%

4. Proposal 2 would yield a return on investment of 13.5%.

5. Return on Investment = Profit Margin × Required Investment Turnover

12% = 14% × Required Investment Turnover

465

P14–5

1.

MOAB BIKE COMPANY

Divisional Income Statements

For the Year Ended October 31, 20Y9

Touring Bike Trail Bike

Division Division

Sales ………………………………………………………….. $1,500,000 $5,400,000

Cost of goods sold ……………………………………… (900,000) (4,000,000)

2. Return on Investment = Profit Margin × Investment Turnover

Trail Bike Division: ROI =

$432,000

$5,400,000 × $5,400,000

$3,600,000

= 8.0% × 1.50

= 12.0%

3. Touring Bike Division: $30,000 [$105,000 – ($750,000 × 10%)]

466

P14–5, Concluded

4. On the basis of operating income, the Trail Bike Division generated $327,000

($432,000 – $105,000) more operating income than did the Touring Bike Divi-

sion. However, operating income does not consider the amount of invested

assets in each division. On the basis of the return on investment, the Touring

Bike Division earned 14.0 cents (14.0%) on each dollar of invested assets,

while the Trail Bike Division earned only 12.0 cents (12.0%) on each dollar of

467

P14–6

1. No. When unused capacity exists in the supplying division (the Commercial

Division), the use of the market price approach may not lead to the maximiza-

tion of total company income.

2. The Commercial Division’s operating income would increase by $800,000:

Increase in Residential

Division’s Operating Income = Market

Price – Transfer

Price × Units

Transferred

$1,200,000 = ($70 – $58) × 100,000 units

By purchasing from the Commercial Division, the Residential Division saves

$12 per unit on its purchases.

468

P14–6, Continued

3.

TAKE A LOAD OFF INC.

Divisional Income Statements

For the Year Ended October 31, 20Y5

Commercial Residential

Division Division Total

Sales:

500,000 units × $72 per unit ……… $ 36,000,000 $ 36,000,000

$ 41,800,000 $ 13,200,000 $ 55,000,000

Expenses:

Variable:

600,000 units × $50 per unit ….. $(30,000,000) $(30,000,000)

100,000 units × $58* per unit … $ (5,800,000) (5,800,000)

100,000 units × $40** per unit .. (4,000,000) (4,000,000)

469

P14–6, Concluded

4. The Commercial Division’s operating income would increase by $1,400,000:

Increase in Commercial

Division’s Operating Income = Transfer

Price –

V

ariable

Cost per Unit × Units

Transferred

$1,400,000 = ($64 – $50) × 100,000 units

By selling to the Residential Division, the Commercial Division earns $14 per

unit on these sales.

By purchasing from the Commercial Division, the Residential Division saves

$6 per unit on its purchases.

Take a Load Off Inc.’s total operating income would increase by the same

amount as in part (2), $2,000,000:

V

5. a. Any transfer price greater than the Commercial Division’s variable ex-

penses per unit of $50 but less than the market price of $70 would be ac-

470

METRIC-BASED ANALYSIS

MBA 14–1

Although there is some judgment in classifying each of these measures, the fol-

lowing represents our assessment with explanations:

Average cardmember spending Customer—demonstrates the usefulness

of the card to the customer.

Cards in force Customer—if customers did not value the

card, they would not have one.

Earnings growth Financial

Number of merchant signings Customer—the larger the number of

merchants that honor the card, the more

valuable it is to cardholders.

Number of card choices Customer—more choices are more valua-

ble to customers.

471

MBA 14–2

a. UPS wanted a performance measurement system that would focus more on

the underlying drivers, or levers, of financial success. It believed that focusing

on the financial numbers by themselves would not reveal how financial objec-

tives were to be achieved, especially with new demands coming from cus-

b. The employee sentiment number is common in service businesses. The em-

ployees are the face of the company to the customer. If employees feel poorly

about the organization, or if they feel that they don’t make a difference, then

472

MBA 14–3

1. Customer

2. Internal process

7. Learning and innovation

8. Learning and innovation

9. Learning and innovation

10. Financial

11. Customer

Note to Instructor: There is judgment in classifying the metrics and initiatives.

The preceding classifications are our best assessment.

473

MBA 14–4

1. Financial

2. Internal process

7. Learning and innovation

8. Customer

9. Financial

10. Learning and innovation

11. Learning and innovation

Note to Instructor: There is judgment in classifying the metrics and initiatives.

The preceding classifications are our best assessment.

474

MBA 14–5

This activity is designed to introduce students to two very popular divisional per-

formance measurement approaches, the balanced scorecard and economic value

added (EVA). Both methods are getting very strong support in corporate America.

The two consulting firms’ home pages provided in this activity have links to brief

strongly oriented to maximizing wealth to the shareholder. Hopefully, the stu-

dents will recognize EVA as a specific application of the residual income concept.

EVA’s strength is in its simplicity and its apparent association with wealth maxi-

mization (share values). It is interesting to note that the two methods flow from

two different philosophies. The balanced scorecard takes a multiple stakeholder

475

CASES

Case 14–1

This scenario is a negotiation between two divisions. Newt is not behaving unethically

by attempting to get a good price from the Optic Lens Division. Also, he is not behav-

ing unethically because he refuses market price. This may not seem “fair,” but price

negotiation is a typical business activity and is part of Newt’s job. It would be unethi-

cal only if the Camera Division refused to deal with the Optic Lens Division to pur-

posefully hurt the Optic Lens Division’s performance, so Camera could look good in

The Camera Division has overall profit responsibility and authority. This means the

Camera Division has the choice of purchasing from the inside or the outside. The

Camera Division should have incentives to purchase from the inside to maximize

overall corporate income. This means the transfer price should be set below market

Case 14–2

The department head is responsible for the quantity of service but not the source of

the service (i.e., not the price). Most accountants would hold the department head re-

sponsible for the cost by transferring the cost of the brochures to the Customer Ser-

vice Department even though the price is 15% higher than could be obtained from the

outside. This may not seem fair, but it does control the use of internal services to

some degree. If there were no internal transfer price, departments would view the Pub-

476

Case 14–3

1. The return on invested assets is computed as follows:

Cereal Produce Snacks

Operating income …………… $432,000 $960,000 $1,080,000

2. Not all projects that have greater than a 10% return would be accepted. This

is because any project accepted between the 10% minimum and their existing

ROI would cause their ROI to drop. This is true because of averaging. There

would be little incentive to accept such projects if the divisions know they are

and 21.6%, respectively.

3. Return on Investment = Operating Income

Invested Assets

= 000,000,5$ + 000,000,8$ + 000,500,4$

000,080,1$ + 000,960$ + 000,432$

= 000,500,17$

000,472,2$ = 14.1%

4. There are two approaches to improving Dixie Foods’ overall return on invest-

ment of 14.1%: (1) improving the profit margin or (2) improving the investment

turnover. The profit margin for all three divisions is as follows:

Case 14–4

1.

20Y6 20Y7 20Y8

Profit margin …………………………………….. 30% 35% 40%

Computations:

2.

20Y6 20Y7 20Y8

Investment turnover ………………………….. 1.5 1.0 0.7

Computations:

3.

20Y6 20Y7 20Y8

Return on investment ……………………….. 45% 35% 28%

Computations:

20Y6: $900,000 ÷ $2,000,000 = 45%

4. Hal is concerned about the Laser Division because the return on investment ap-

pears to be deteriorating over the 20Y6–20Y8 operating period. This is happening

even though the profit margin is increasing over this time period. For this to occur,

the investment turnover must be dropping, which is shown in part (2).

478

Case 14–5

1. Return on Investment = Operating Income

Invested Assets

2. $100,000 (10 × $10,000 = $100,000, where 10 = 24% – 14%)

3. Return on Investment = Operating Income

Invested Assets

= $4,500,000

$810,000

= 18%

or

4. Return on Investment = Operating Income

Invested Assets

479

Case 14–5, Concluded

5. Even though the addition of the new product line would increase the overall

return on investment, its addition would decrease the Patio Division’s return

6. Use of residual income as a performance measure and as the basis for grant-

ing bonuses would motivate division managers to accept investment oppor-

tunities that exceed a minimum rate of return. If the minimum rate of return

was set at 14%, the overall company average rate of return, any investment

opportunity whose rate exceeded 14% would be viewed as acceptable. If this

performance measure had been used, the Patio Division manager would have

increased the division’s residual income by $180,000 through the addition of

the new product line, as shown next.

Operating income ……………………………………………………………… $3,600,000

Minimum desired income (14% × $15,000,000) ……………………. (2,100,000)

Residual income ……………………………………………………………….. $1,500,000

× Bonus percentage ………………………………………………………….. × 6.7%