cost accounting chapter 23

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Cost Accounting, 14e (Horngren/Datar/Rajan)

Chapter 23 Performance Measurement, Compensation, and Multinational Considerations

Objective 23.1

1) A report that measures financial and nonfinancial performance measures for various organization units in a single report is called a(n): A) balanced scorecard

B) financial report scorecard C) imbalanced scorecard D) unbalanced scorecard Answer: A Diff: 1

Terms: Balanced Scorecard Objective: 1

AACSB: Reflective thinking

2) Customer-satisfaction measures are an example of the: A) goal-congruence approach B) balanced scorecard approach

C) financial report scorecard approach D) investment success approach Answer: B Diff: 1

Terms: Balanced Scorecard Objective: 1

AACSB: Reflective thinking

3) An example of a performance measure with a long-run time horizon is: A) direct materials efficiency variances B) overhead spending variances C) number of new patents developed D) All of these answers are correct. Answer: C Diff: 2

Terms: Balanced Scorecard Objective: 1

AACSB: Reflective thinking

4) Does operating income best measure a subunit's financial performance? This question is considered part of which step in designing an accounting-based performance measure?

A) Choose performance measures that align with top management's financial goals. B) Choose the time horizon of each performance measure. C) Choose a definition for each performance measure.

D) Choose a measurement alternative for each performance measure. Answer: A Diff: 2

Terms: Balanced Scorecard Objective: 1

AACSB: Reflective thinking

5) Should assets be defined as total assets or net assets? This question is considered part of which step in designing an accounting-based performance measure?

A) Choose performance measures that align with top management's financial goals. B) Choose the time horizon of each performance measure. C) Choose a definition for each performance measure.

D) Choose a measurement alternative for each performance measure. Answer: C Diff: 2

Terms: return on investment (ROI) Objective: 1

AACSB: Reflective thinking

6) Should assets be measured at historical cost or current cost? This question is considered part of which step in designing an accounting-based performance measure?

A) Choose performance measures that align with top management's financial goals. B) Choose the time horizon of each performance measure. C) Choose a definition for each performance measure.

D) Choose a measurement alternative for each performance measure. Answer: D Diff: 2

Terms: current cost, return on investment (ROI) Objective: 1

AACSB: Reflective thinking

7) Which of the following statements about designing an accounting-based performance measure is FALSE?

A) The steps may be followed in a random order.

B) The issues considered in each step are independent. C) Management's beliefs are present during the analyses.

D) Behavioral criteria are important when evaluating the steps. Answer: B Diff: 2

Terms: Balanced Scorecard Objective: 1

AACSB: Reflective thinking

8) Many common performance measures, such as customer satisfaction, rely on internal financial accounting information. Answer: FALSE

Explanation: Customer satisfaction would be obtained by surveys that are not in the financial accounting records. Diff: 1

Terms: Balanced Scorecard Objective: 1

AACSB: Analytical skills

9) Some companies present financial and nonfinancial performance measures for various organization units in a single report called the \"balanced scorecard.\" Answer: TRUE Diff: 1

Terms: Balanced Scorecard Objective: 1

AACSB: Analytical skills

10) The \"balanced scorecard\" in most organizations is broken down into the following categories: financial perspective, customer perspective, internal business-process perspective, and productivity perspective.

Answer: FALSE

Explanation: The \"balanced scorecard\" in most organizations is broken down into the following categories: financial perspective, customer perspective, internal business-process perspective, and learning-and-growth perspective. Diff: 1

Terms: Balanced Scorecard Objective: 1

AACSB: Reflective thinking

11) The first step in designing accounting based performance measures is to choose a target level of performance and feedback mechanism. Answer: FALSE

Explanation: The first step in designing accounting based performance measures is to choose performance measures that align with top management's financial goals. Diff: 1

Terms: performance measure Objective: 1

AACSB: Reflective thinking

12) Assume you are evaluating a manufacturing company. Match the various organizational activities and concepts with the performance measures listed. Some items may have more than one match.

Activities:

1. Change in revenues 2. Cycle time

3. Economic order quantity 4. Manufacturing defects 5. Market share 6. New products 7. On-time delivery 8. Operating income 9. Product reliability 10. Time-to-market

Performance measure:

__________ a. Profitability

__________ b. Customer satisfaction

__________ c. Innovation

__________ d. Efficiency, quality, and time Answer: 1, 8 a. Profitability

5, 7, 9 b. Customer satisfaction

6, 10 c. Innovation

2, 3, 4, 7, 9, 10 d. Efficiency, quality, and time Diff: 2

Terms: Balanced Scorecard Objective: 1

AACSB: Analytical skills

13) Designing an accounting based performance measure requires six steps. List each step. For three of the steps, describe a question that must be resolved as part of the implementation process. Answer:

1. Choose performance measures that align with top management's goals.

Does operating income, return on assets, or revenues best measure a subunit's financial goals? 2. Choose the time horizon of each performance measure.

Should the performance measures be calculated for one year or a multiyear time horizon? 3. Choose a definition for each performance measure. Should assets be defined as total assets or net assets?

4. Choose a measurement alternative for each performance measure. Should assets be measured at historical cost or current cost? 5. Choose a target level of performance.

Should all subunits have the same targets such as the same required rate of return on assets? 6. Choose the timing of the feedback.

How often should manufacturing performance reports be sent to management? Diff: 2

Terms: Balanced Scorecard Objective: 1

AACSB: Reflective thinking

14) The executive vice president of Wicker Pen Company wants to establish an accounting-based performance measurement system for the company's new plant. The company has an accounting

information system sufficient to support a fairly sophisticated performance measurement system. The new plant is going to be considered an investment center since its products will be markedly different from others the company currently sells. The new plant will have no internal dealings with other plants within the company.

Required:

What are some of the key steps that should be undertaken in the establishment of an accounting-based performance measurement system? Answer: Key steps include:

1. Choose performance measures that align with top management's financial goals for the plant. They would include those that relate to the plant as an investment center. 2. Choose the time horizon of each performance measure in step 1.

3. Choose a definition of the components in each performance measure in step 1. For example, how should investment be defined?

4. Choose a measurement alternative for each performance measure in step 1. For example, should historical cost or current cost be used to measure investment? 5. Choose a target level of performance. 6. Choose the timing of feedback. Diff: 2

Terms: Balanced Scorecard Objective: 1

AACSB: Reflective thinking

15) Companies are increasingly using nonfinancial measures to evaluate performance. Why? Since these numbers do not come from the company's financial records, why are they used?

Answer: The correct answer will revolve around the objective of providing quality goods to the

corporation's customers. Quality goods bring repeat business and satisfied customers are a business' best advertisement.

The idea is that these nonfinancial measures concentrate on areas and questions that indicate the quality of a particular corporation's products. While some of these items do not come from a companies' financial records, such as defect rates, they are quantifiable and can be verified. Diff: 3

Terms: Balanced Scorecard Objective: 1

AACSB: Reflective thinking

Objective 23.2

1) Managers usually use the term return on investment to evaluate: A) the performance of a subdivision B) a potential project

C) the performance of a subunit D) Both A and C are correct. Answer: D Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Reflective thinking

2) The return on investment is usually considered the most popular approach to incorporating the investment base into a performance measure because:

A) it blends all the ingredients of profitability into a single percentage

B) once determined, there is no need to use it with other measures of performance

C) it is similar to the company's price earnings ratio because a corporation's return on investment appears every day in The Wall Street Journal D) Both A and C are correct. Answer: A Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Reflective thinking

3) Return on investment can be increased by: A) increasing operating assets B) decreasing operating assets C) decreasing revenues

D) Both B and C are correct. Answer: B Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Reflective thinking

4) The ________ method of profitability analysis recognizes the two basic ingredients in profit-making: increasing income per dollar of revenues and using assets to generate more revenues. A) Balanced Scorecard B) Residual-Income C) Dupont

D) Economic Value Added Answer: C Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Reflective thinking

5) During the past twelve months, the Aaron Corporation had a net income of $25,000. What is the amount of the investment if the return on investment is 20%? A) $50,000 B) $100,000 C) $125,000 D) $250,000 Answer: C

Explanation: C) 0.20 = $25,000/x; x = $125,000 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

6) During the past twelve months, the Zenith Corporation had a net income of $78,400 What is the return on investment if the amount of the investment is $560,000? A) 10% B) 12% C) 14% D) 16% Answer: C

Explanation: C) $78,400/$560,000 = 14% Diff: 1

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

7) The Alpha Beta Corporation had the following information for 20X5: Revenue $ 450,000 Operating expenses 335,000 Total assets 575,000

What is the return on investment? A) 10% B) 20% C) 25% D) 78.2% Answer: B

Explanation: B) (450,000 - $335,000)/$575,000 = 20% Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

8) Wacker Company has two regional offices. The data for each are as follows: Maryland New Jersey Revenues $ 290,000 $ 298,000 Operating assets 2,400,000 4,500,000 Net operating income 1,008,000 1,200,000

What is the Maryland Division's return on investment? A) 0.42 B) 0.54 C) 0.96 D) 4.12 Answer: A

Explanation: A) $1,008,000/$2,400,000 = 0.42 Diff: 1

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

9) Thacker Company has two regional offices. The data for each are as follows: Maryland New Jersey Revenues $ 290,000 $ 298,000 Operating assets 2,400,000 4,500,000 Net operating income 1,008,000 1,200,000

What is the return on investment for the New Jersey Division? A) 0.21 B) 0.27 C) 0.48 D) 2.06 Answer: B

Explanation: B) $1,200,000/$4,500,000 = 0.27 Diff: 1

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

Answer the following questions using the information below:

The Cybertronics Corporation reported the following information for its Cyclotron Division:

Revenues $2,000,000 Operating costs 1,200,000 Taxable income 400,000 Operating assets 1,000,000

Income is defined as operating income.

10) What is the Cyclotron Division's investment turnover ratio? A) 2.00 B) 3.33 C) 2.50 D) 0.80 Answer: A

Explanation: A) $2,000,000/$1,000,000 = 2 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

11) What is the Cyclotron Division's return on sales? A) 0.20 B) 0.40 C) 0.50 D) 0.60 Answer: B

Explanation: B) $2,000,000 - $1,200,000 = $800,000; $800,000/$2,000,000 = 0.40 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

12) What is the Cyclotron Division's return on investment? A) 0.2 B) 0.4 C) 0.5 D) 0.8 Answer: D

Explanation: D) $800,000 / $1,000,000 = 0.8 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

Answer the following questions using the information below:

The top management at Munchie Company, a manufacturer of computer games, is attempting to recover from a flood that destroyed some of their accounting records. The main computer system was also severely damaged. The following information was salvaged: Alpha Division Beta Division Gamma Division Sales $5,000,000 (a) $2,300,000 Net operating income $3,000,000 $1.300,000 $ 1,150,000 Operating assets (b) (c) $1,533,333 Return on investment 0.25 0.15 (d) Return on sales (e) 0.10 0.5 Investment turnover (f) (g) 1.5

13) What were the sales for the Beta Division? A) $8,666,667 B) $11,904,760 C) $13,000,000 D) $14,303,600 Answer: C

Explanation: C) 0.10 = $1,300,000/x; x = $13,000,000 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

14) What is the value of the operating assets belonging to the Alpha Division? A) $8,666,667 B) $12,000,000 C) $13,000,000 D) $14,303,600 Answer: B

Explanation: B) $3,000,000/0.25 = $12,000,000 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

15) What is the value of the operating assets belonging to the Beta Division? A) $8,666,667 B) $11,904,760 C) $13,000,000 D) $14,303,600 Answer: A

Explanation: A) .15 = $1,300,000/x; x = $8,666,667 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

16) What is the Gamma Division's return on investment? A) 0.25 B) 0.42 C) 0.60 D) 0.75 Answer: D

Explanation: D) 0.5 × 1.5 = 0.75 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

17) What is the Alpha Division's return on sales? A) 0.25 B) 0.42 C) 0.60 D) 0.75 Answer: C

Explanation: C) $3,000,000/$5,000,000 = 0.60 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

Answer the following questions using the information below:

The top management at Groundsource Company, a manufacturer of lawn and garden equipment, is attempting to recover from a fire that destroyed some of their accounting records. The main computer system was also severely damaged. The following information was salvaged: Tractor DivisionTiller Division Digger Division Sales $10,000,000 (a) $2,400,000 Net operating income $ 1,000,000 $1,440,000 $ 600,000 Operating assets (b) (c) $ 2,000,000 Return on investment 0.20 0.10 (d) Return on sales (e) 0.12 0.25 Investment turnover (f) (g) 1.2

18) What were the sales for the Tiller Division? A) $9,600,000 B) $12,000,000 C) $15,000,000 D) $15,500,000 Answer: B

Explanation: B) Return on Sales = Net Inc / Sales .12 = $1,440,000 / S

S = $1,440,000 / .12 = $12,000,000 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

19) What is the value of the operating assets belonging to the Tractor Division? A) $ 3,500,000 B) $4,000,000 C) $4,500,000 D) $5,000,000 Answer: D

Explanation: D) ROI = Net Income / Assets Assets = net Income / ROI

Assets = $1,000,000/0.20 = $5,000,000 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

20) What is the value of the operating assets belonging to the Tiller Division? A) $10,000,000 B) $ 12,000,000 C) $ 14,400,000 D) $ 15,000,000 Answer: C

Explanation: C) ROI = Net Income / Assets Assets = Net Income / ROI

Assets = $1,440,000/0.10 = $14,400,000 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

21) What is the Digger Division's return on investment? A) .25 B) .30 C) .45 D) .60 Answer: B

Explanation: B) ROI = Net Income / Net Assets = Return on Sales x Asset Turnover 0.25 × 1.2 = .30

Can Verify by dividing Net Income / Assets = $600,000 / $2,000,000 = .30 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

22) What is the Tractor Division's return on sales? A) 0.10 B) 0.12 C) 0.15 D) 0.20 Answer: A

Explanation: A) $1,000,000/$10,000,000 = 0.10 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

23) What is the Tractor Division's investment turnover? A) .50 B) 1.0 C) 2.0 D) 2.5 Answer: C

Explanation: C) Investment Turnover = Sales / Assets step 1 is to calculate the Assets ROI = Net Income / Assets Assets = net Income / ROI

Assets = $1,000,000/0.20 = $5,000,000

Then Investment Turnover = $10,000,000 / $5,000,000 = 2.0 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

24) What is the Tiller Division's investment turnover? A) .50 B) .833 C) 1.2 D) 1.5 Answer: B

Explanation: B) Return on Investment = Return on Sales x Investment Turnover Investment Turnover = Return on Investment / Return on Sales = .10/.12 = .833 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

25) Costs recognized in particular situations that are NOT recognized by accrual accounting procedures are:

A) opportunity costs B) imputed costs

C) cash accounting costs

D) None of these answers is correct. Answer: B Diff: 1

Terms: imputed cost Objective: 2

AACSB: Reflective thinking

26) A problem with using residual income is that a corporation with a:

A) high investment turnover ratio always has a higher residual income than a corporation with a smaller investment turnover ratio

B) high return on sales always has a higher residual income than a corporation with a smaller return on sales

C) larger dollar amount of assets is likely to have a higher residual income than a corporation with a smaller dollar amount of assets

D) None of these answers is correct. Answer: C Diff: 2

Terms: residual income residual income (RI) Objective: 2

AACSB: Reflective thinking

27) A company which favors the residual income approach wants managers to: A) concentrate on maximizing an absolute amount of dollars B) concentrate on maximizing a percentage return C) maximize the investment turnover ratio D) maximize return on sales Answer: A Diff: 2

Terms: residual income residual income (RI) Objective: 2

AACSB: Reflective thinking

28) Using residual income as a measure of performance rather than return on investment promotes goal congruence because residual income:

A) places importance on the reduction of underperforming assets B) calculates a percentage return rather than an absolute return C) concentrates on maximizing an absolute amount of dollars D) concentrates on maximizing the return on sales Answer: C Diff: 2

Terms: residual income residual income (RI) Objective: 2

AACSB: Reflective thinking

29) Which of the following is the correct formula for return on sales? A) Income / Investment B) Investment / Income C) Income / Revenue D) Revenue / Investment Answer: C Diff: 1

Terms: return on investment Objective: 2

AACSB: Reflective thinking

30) Another name for return on investment is the: A) net present value

B) accounting rate of return C) residual income

D) internal rate of return Answer: B Diff: 1

Terms: return on investment Objective: 2

AACSB: Reflective thinking

Answer the following questions using the information below:

The Bandage Medical Supply Company has two divisions that operate independently of one another. The financial data for the year 2012 reported the following results: North South Sales $6,000,000 $5,000,000 Operating income 1,500,000 1,100,000 Taxable income 1,300,000 750,000 Investment 12,000,000 10,000,000

The company's desired rate of return is 10%. Income is defined as operating income.

31) What are the respective return-on-investment ratios for the North and South Divisions? A) 0.110 and 0.125 B) 0.108 and 0.075 C) 0.125 and 0.110 D) 0.125 and 0.150 Answer: C

Explanation: C) North = $1,500,000/$12,000,000 = 0.125 South = $1,100,000/$10,000,000 = 0.110 Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

32) What are the respective residual incomes for the North and South Divisions? A) $60,000 and $100,000 B) $300,000 and $60,000 C) $300,000 and $100,000

D) $100,000 and a negative $300,000 Answer: C

Explanation: C) North = $1,500,000 - (0.1 × $12,000,000) = $300,000 South = $1,100,000 - (0.1 × $10,000,000) = $100,000 Diff: 2

Terms: residual income residual income (RI) Objective: 2

AACSB: Analytical skills

33) Which division has the best return on investment and which division has the best residual income figure, respectively? A) North, North B) South, South C) North, South D) South, North Answer: A

Explanation: A) North = $1,500,000/$12,000,000 = 0.125 South = $1,100,000/$10,000,000 = 0.110

North = $1,500,000 - (0.1 × $12,000,000) = $300,000 South = $1,100,000 - (0.1 × $10,000,000) = $100,000 Diff: 2

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2

AACSB: Analytical skills

34) After-tax operating income minus the after-tax weighted-average cost of capital multiplied by total assets minus current liabilities equals: A) return on investment B) residual income

C) economic value added

D) weighted-average cost of capital Answer: C Diff: 1

Terms: economic value added (EVA®) Objective: 2

AACSB: Reflective thinking

35) The after-tax average cost of all the long-term funds used by a corporation equals: A) economic value added B) return on investment C) return on equity

D) weighted-average cost of capital Answer: D Diff: 1

Terms: economic value added (EVA®) Objective: 2

AACSB: Reflective thinking

36) A negative feature of defining investment by EXCLUDING the portion of total assets employed that are financed by short-term creditors is that:

A) current liabilities are sometimes difficult to define

B) short-term debt is always more expensive to finance than long-term debt

C) this method encourages managers to use an excessive amount of short-term debt D) this method encourages managers to use an excessive amount of long-term debt Answer: C Diff: 2

Terms: economic value added (EVA®), investment Objective: 2

AACSB: Reflective thinking

37) Springfield Corporation, whose tax rate is 40%, has two sources of funds: long-term debt with a market value of $8,000,000 and an interest rate of 8%, and equity capital with a market value of

$12,000,000 and a cost of equity of 12%. What is Springfield's weighted average cost of capital (WACC)? A) .0480 B) .0800 C) .0912 D) .1000 Answer: C

Explanation: C) [($8,000,000 × (1 - .4) × (.08)) + ($12,000,000 × .12)] / ($8,000,000 + $12,000,000) = .0912 Diff: 2

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

38) Springfield Corporation, whose tax rate is 40%, has two sources of funds: long-term debt with a market value of $8,000,000 and an interest rate of 8%, and equity capital with a market value of

$12,000,000 and a cost of equity of 12%. Springfield has two operating divisions, the Blue division and the Gold division, with the following financial measures for the current year: Total Assets Current Liabilities Operating Income Blue Div. $9,500,000 $2,800,000 $1,055,000 Gold Div. $11,000,000 $2,200,000 $1,200,000 What is Economic Value Added (EVA®) for the Blue Division? A) -$233,400 B) $21,960 C) $188,600 D) $433,960 Answer: B

Explanation: B) WACC = [($8,000,000 × (1 - .4) × (.08)) + ($12,000,000 × .12)] / ($8,000,000 + $12,000,000) = .0912 EVA = ($1,055,000 × (1 - .4)) - (($9,500,000 - $2,800,000) × .0912) = $21,960 Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

39) Springfield Corporation, whose tax rate is 40%, has two sources of funds: long-term debt with a market value of $8,000,000 and an interest rate of 8%, and equity capital with a market value of $12,000,000 and a cost of equity of 12%. Springfield's after-tax cost of debt is: A) .0320 B) .0480 C) .0800 D) .0912 Answer: B

Explanation: B) .08 × (1 - .4) = .048 Diff: 2

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

40) Springfield Corporation, whose tax rate is 40%, has two sources of funds: long-term debt with a market value of $8,000,000 and an interest rate of 8%, and equity capital with a market value of

$12,000,000 and a cost of equity of 12%. Springfield has two operating divisions, the Blue division and the Gold division, with the following financial measures for the current year: Total Assets Current Liabilities Operating Income Blue Div. $9,500,000 $2,800,000 $1,055,000 Gold Div. $11,000,000 $2,200,000 $1,200,000 Calculate EVA® for the Gold Division. A) ($283,200) B) ($82,560) C) $196,800 D) $397,440 Answer: B

Explanation: B) WACC = [($8,000,000 × (1 - .4) × (.08)) + ($12,000,000 × .12)] / ($8,000,000 + $12,000,000) = .0912 EVA = ($1,200,000 × (1 - .4)) - (($11,000,000 - $2,200,000) × .0912) = ($82,560) Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

Answer the following questions using the information below:

Waldorf Company has two sources of funds: long-term debt with a market and book value of $5 million issued at an interest rate of 12%, and equity capital that has a market value of $4 million (book value of $2 million). Waldorf Company has profit centers in the following locations with the following operating incomes, total assets, and current liabilities. The cost of equity capital is 12%, while the tax rate is 25%. Operating Income Assets Current Liabilities St. Louis $ 480,000 $ 2,000,000 $ 100,000 Cedar Rapids $600,000 $ 4,000,000 $ 300,000 Wichita $1,020,000 $6,000,000 $600,000 41) What is the EVA® for St. Louis? A) $127,870 B) $163,730 C) $196,270 D) $360,000 Answer: B

Explanation: B) WACC = [(.12 × (1 - .25) × $5,000,000) + (0.12 × $4,000,000)]/$9,000,000 = 0.1033 St. Louis (EVA®) = ($480,000 × (1 - .25)) - [0.1033 × ($2,000,000 - $100,000)] = $360,000 - $196,270= $163,730 Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

42) What is the EVA® for Cedar Rapids? A) $67,790 B) $110,000 C) $117,000 D) $152,500 Answer: A

Explanation: A) Cedar Rapids (EVA®) = ($600,000 × (1 - .25)) - [0.1033 × ($4,000,000 - $300,000)] = $450,000 - $382,210= $67,790 Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

43) What is the EVA® for Wichita? A) $225,000 B) $765,000 C) $207,180 D) $557,820 Answer: C

Explanation: C) Wichita (EVA®) = ($1,020,000 × .75) - [(0.1033 × ($6,000,000 - $600,000)] = $765,000 - $557,820 = 207,180 Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

Answer the following questions using the information below:

Coldbrook Company has two sources of funds: long-term debt with a market and book value of $15 million issued at an interest rate of 10%, and equity capital that has a market value of $9 million (book value of $5 million). Coldbrook Company has profit centers in the following locations with the following operating incomes, total assets, and current liabilities. The cost of equity capital is 15%, while the tax rate is 30%. Operating Income Assets Current Liabilities Bish Bash Falls $ 815,000 $ 3,750,000 $ 800,000 Brooksville $1,100,000 $ 5,000,000 $ 1,200,000 Stonybrook $2,450,000 $9,250,000 $3,180,000 44) What is the EVA® for Bish Bash Falls? A) $338,563 B) $305,000 C) $275,500 D) $255,500 Answer: C

Explanation: C) WACC = [(.10 × (1 - .30) × $15,000,000) + (0.15 × $9,000,000)]/$24,000,000 = 0.100 Bish Bash Falls (EVA®) = ($815,000 × (1 - .30)) - [0.100 × ($3,750,000 - $800,000)] = $570,500 - $295,000 = $275,500 Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

45) What is the EVA® for Brooksville? A) $476,250 B) $428,000 C) $415,525 D) $390,000 Answer: D

Explanation: D) WACC = [(.10 × (1 - .30) × $15,000,000) + (0.15 × $9,000,000)]/$24,000,000 = 0.100 Brooksville (EVA®) = ($1,100,000 × (1 - .30)) - [0.100 × ($5,000,000 - $1,200,000)] = $770,000 - $380,000 =$390,000 Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

46) What is the EVA® for Stonybrook? A) $1,108,000 B) $ 1,168,700 C) $ 1,315,063 D) $1,403,063 Answer: A

Explanation: A) WACC = [(.10 × (1 - .30) × $15,000,000) + (0.15 × $9,000,000)]/$24,000,000 = 0.100 Stonybrook (EVA®) = ($2,450,000 × (1 - .30)) - [0.100 × ($9,250,000 - $3,180,000)] = $1,715,000 - $607,000 =$1,108,000 Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

47) A major weakness of comparing two companies using only operating incomes as the basis of

comparison is this method ignores differences in the size of the investment required to earn the operating income.

Answer: TRUE Diff: 1

Terms: return on investment (ROI), investment Objective: 2

AACSB: Analytical skills

48) Return on investment is also called the accrual accounting rate of return. Answer: TRUE Diff: 1

Terms: return on investment (ROI) Objective: 2

AACSB: Reflective thinking

49) Return on sales is calculated by dividing revenues by income. Answer: FALSE

Explanation: Return on sales is calculated as income divided by revenues. Diff: 1

Terms: return on investment (ROI) Objective: 2

AACSB: Reflective thinking

50) Investment turnover is calculated as revenue divided by investment. Answer: TRUE Diff: 1

Terms: return on investment (ROI) Objective: 2

AACSB: Reflective thinking

51) The three alternatives for increasing return on investment include increasing assets such as receivables, increasing revenues, and decreasing costs. (In all cases assume that all other items stay the same.) Answer: FALSE

Explanation: Increasing receivables does not increase return on investment. Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Reflective thinking

52) The residual income method is the most popular performance measure when measuring performance in an investment center. Answer: FALSE

Explanation: Return on investment is the most popular performance measure when measuring performance in an investment center. Diff: 1

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2

AACSB: Analytical skills

53) To evaluate overall aggregate performance, return on investment and residual income measures are more appropriate than return on sales. Answer: TRUE Diff: 2

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2

AACSB: Analytical skills

54) Required rate of return multiplied by the investment is the imputed cost of the investment. Answer: TRUE

Explanation: Required rate of return multiplied by the investment is the imputed cost of the investment. Diff: 1

Terms: imputed cost Objective: 2

AACSB: Reflective thinking

55) Imputed costs are costs recognized in particular situations that are NOT usually recognized by accrual accounting procedures. Answer: TRUE Diff: 2

Terms: imputed cost Objective: 2

AACSB: Reflective thinking

56) The objective of maximizing return on investment may induce managers of highly profitable divisions to reject projects that from the viewpoint of the overall organization should be accepted. Answer: TRUE Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

57) Goal congruence is more likely to be promoted by using return on investment rather than residual income as a measure of a subunit's managerial performance. Answer: FALSE

Explanation: Goal congruence is more likely to be promoted by using residual income rather than return on investment. Diff: 2

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2

AACSB: Analytical skills

58) Economic value added, unlike residual income, charges managers for the costs of their investments in long-term assets and working capital. Answer: FALSE

Explanation: Both economic value added and residual income charge managers for the costs of their investments in long-term capital. Diff: 2

Terms: economic value added (EVA®), residual income (RI) Objective: 2

AACSB: Reflective thinking

59) Companies that adopt the Economic Value Added concept define investment as total assets employed minus current liabilities. Answer: TRUE Diff: 2

Terms: economic value added (EVA®) Objective: 2

AACSB: Reflective thinking

60) In an Economic Added Value calculation, the corporate charge for a division's investment is based on a weighted average of the after-tax interest rate on the firm's debt and the cost of the firm's equity. Answer: TRUE

Explanation: In an Economic Added Value calculation, the corporate charge for a division's investment is based on a weighted average of the after-tax interest rate on the firm's debt and the cost of the firm's equity. Diff: 2

Terms: economic value added (EVA®) Objective: 2

AACSB: Reflective thinking

61) In an Economic Value Added calculation, the measure of the invested capital for a division would be that division's assets minus that division's liabilities. Answer: FALSE

Explanation: In an Economic Value Added calculation, the measure of the invested capital for a division would be that division's assets minus that division's current liabilities. Diff: 2

Terms: economic value added (EVA®) Objective: 2

AACSB: Reflective thinking

62) In an Economic Value Added calculation, the appropriate measure of a division's profit would be that division's pre-tax operating income. Answer: FALSE

Explanation: In an Economic Value Added calculation, the appropriate measure of a division's profit would be that division's after tax operating income. Diff: 2

Terms: economic value added (EVA®) Objective: 2

AACSB: Reflective thinking

63) Museum Corporation uses the investment center concept for the museums that it manages. Select operating data for three of its museums for 2012 are as follows: St. Louis Dallas Miami Revenue $1,200,000 $1,500,000 $1,800,000 Operating assets 600,000 500,000 700,000 Net operating income 102,000 112,000 118,000 Required:

a. Compute the return on investment for each division.

b. Which museum manager is doing best based only on ROI? Why?

c. What other factors should be included when evaluating the managers? Answer:

a. St. Louis = $102,000/$600,000 = 0.170 Dallas = $112,000/$500,000 = 0.224 Miami = $118,000/$700,000 = 0.169

b. Dallas was doing the best because the ROI was the highest, and compared to Miami, was doing better with fewer assets.

c. At a minimum, the company should consider examining the DuPont method, residual income, and the age of operating assets. Diff: 2

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2

AACSB: Analytical skills

) Consolidated Gas Supply Corporation uses the investment center concept for the gasoline stations that it manages in the city. Consolidated has a 15% required rate of return on investment in order for a branch station to be viable. Select operating data for three of its stations for 200X are as follows: Hickory Maple Street Oak Street Street Revenue $17,000,000 $13,500,000 $15,000,000 Operating assets 7,000,000 7,000,000 5,000,000 Net operating income 960,000 1,150,000 910,000 Required:

a. Compute the return on investment for each station.

b. Which station manager is doing best based only on ROI? Why?

c. Are any of the stations in danger of being closed due to lack of performance? d. What other factors should be included when evaluating the managers? Answer:

a. Maple = $960,000/$7,000,000 = 0.137 Oak = $1,150,000/$7,000,000 = 0.1 Hickory = $910,000/$5,0,000 = 0.182

b. Hickory Street was doing the best because the ROI was the highest.

c. Maple Street is in danger of being shut down because it is only making a return on its investment base of 13.7%. This is less than the required rate of return of 15%.

d. At a minimum, the company should consider examining the DuPont method, residual income, and the age of operating assets. Diff: 2

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2

AACSB: Analytical skills

65) Kase Tractor Company allows its divisions to operate as autonomous units. The operating data for 20X5 follow: Plows Tractors Combines Revenues $2,250,000 $500,000 $4,800,000 Accounts receivable 800,000 152,500 1,435,000 Operating assets 1,000,000 400,000 1,750,000 Net operating income 220,000 60,000 480,000 Taxable income 165,000 90,000 385,000 Required:

a. Compute the investment turnover for each division. b. Compute the return on sales for each division.

c. Compute the return on investment for each division. d. Which division manager is doing best? Why?

e. What other factors should be included when evaluating the managers?

For parts (b) and (c) income is defined as operating income.

Answer:

a. Investment turnover: Plows = $2,250,000/$1,000,000 = 2.25 Tractors = $500,000/$400,000 = 1.25 Combines = $4,800,000/$1,750,000 = 2.74

b. Return on Sales: Plows = $220,000/$2,250,000 = 0.10 Tractors = $60,000/$500,000 = 0.12 Combines = $480,000/$4,800,000 = 0.10

c. ROI: Plows = 2.25 × 0.10 = 0.225 Tractors = 1.25 × 0.12 = 0.150 Combines = 2.74 × 0.10 = 0.274

d. Combines' manager had the best performance because he had the highest investment turnover, which offset his second-best return on sales.

e. Residual income should be considered and noncontrollable factors such as the age of the assets. Diff: 2

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

66) Provide the missing data for the following situations: Red Division White Division Blue Division Sales $? $10,000,000 $? Net operating income $200,000 $400,000 $288,000 Operating assets $? $? $1,600,000 Return on investment 0.16 0.10 ? Return on sales 0.04 ? 0.12 Investment turnover ? ? 1.5 Answer: Red Division: ROI = ROS × IT 0.16 = 0.04 × IT IT = 4.0

ROS = Income/Sales 0.04 = $200,000/Sales Sales = $5,000,000

IT = Sales/OA 4 = $5,000,000/OA OA = $1,250,000

White Division:

ROS = $400,000/$10,000,000 = 0.04

IT = ROI/ROS = 0.10/0.04 = 2.5

OA = S/IT = $10,000,000/2.5 = $4,000,000

Blue Division: Sales = IT × OA = 1.5 × $1,600,000 = $2,400,000

ROI = 0.12 × 1.5 = 0.18 Diff: 3

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

67) Hargrave Products has three divisions, which operate autonomously. Their results for 20X5 were as follows: East West International Sales $30,000,000 $40,000,000 $50,000,000 Cost of goods sold 15,000,000 25,000,000 37,000,000 Operating income 4,500,000 4,750,000 5,000,000 Investment base 30,000,000 30,500,000 31,000,000 The company's desired rate of return is 15%.

Required:

a. Compute each division's ROI. Round to three decimal places. b. Compute each division's residual income.

Answer:

a. East ROI = $4,500,000/$30,000,000 = 0.150 West ROI = $4,750,000/$30,500,000 = 0.156 International = $5,000,000/$31,000,000 = 0.161 b. East West International Investment base $30,000,000 $30,500,000 $31,000,000 Minimum rate × 0.15 × 0.15 × 0.15 Minimum return $ 4,500,000 $ 4,575,000 $ 4,650,000 Operating Income $4,500,000 $4,750,000 $5,000,000 Minimum return 4,500,000 4,575,000 4,650,000 Residual income $ 0 $ 175,000 $ 350,000 Diff: 2

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2

AACSB: Analytical skills

68) Batman Abstract Company has three divisions that operate autonomously. Their results for 20X5 are as follows: Riddler Joker Penguin Sales $5,000,000 $7,000,000 $10,000,000 Contribution margin 1,440,000 1,700,000 3,500,000 Operating income 1,000,000 1,750,000 2,520,000 Investment base 9,000,000 10,000,000 14,000,000 The company's desired rate of return is 20%.

Required:

a. Compute each division's ROI.

b. Compute each division's residual income.

c. Rank each division by both ROI and residual income. d. Which division had the best performance in 20X5? Why?

Answer: a. Riddler ROI = $1,000,000/$9,000,000 = 0.111 Joker ROI = $1,750,000/$10,000,000 = 0.175 Penguin ROI = $2,520,000/$14,000,000 = 0.180 b. Riddler Joker Penguin Investment base $9,000,000 $10,000,000 $14,000,000 Minimum rate × 0.20 × 0.20 × 0.20 Minimum return $1,800,000 $2,000,000 $2,800,000 Income $1,000,000 $1,750,000 $2,520,000 Minimum return 1,800,000 2,000,000 2,800,000 Residual income $(800,000) $(250,000) $(280,000) c. ROI Rank: Penguin # 1 Joker # 2 Riddler # 3 RI Rank: Joker #1 Penguin #2 Riddler #3 d. As to which division was the best, it is difficult to determine without knowing what the results are being used to evaluate. If management is measuring only the return of capital, the Penguin Division has the highest ranking, although not much ahead of Joker. However, Penguin does have a substantially higher income level. As to meeting management's expectations of residual income, all divisions fall short of the goal with Joker being slightly ahead of Penguin. Diff: 3

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2

AACSB: Analytical skills

69) Coptermagic Company supplies helicopters to corporate clients. Coptermagic has two sources of funds: long term debt with a market and book value of $32 million issued at an interest rate of 10%, and equity capital that has a market value of $18 million (book value of $8 million). The cost of equity capital for Coptermagic is 15%, and its tax rate is 30%. Coptermagic has profit centers in four divisions that operate autonomously. The company's results for 2008 are as follows: Operating Current Income Assets Liabilities New York $1,750,000 $11,500,000 $2,500,000 Chicago 2,400,000 9,000,000 3,500,000 Dalllas 4,675,000 27,500,000 9,500,000 Los Angeles 4,200,000 25,000,000 8,000,000 Required:

a. Compute Coptermagic's weighted average cost of capital. b. Compute each division's Economic Value Added. c. Rank the divisions by EVA.

Answer: a. WACC = [(.10 x (1 - .30) x $32,000,000) + (.15 x $18,000,000)] / $50,000,000 = 9.88 % b. New York (EVA) = [($1,750,000 x (1 - .30)] - [0.0988 x ($11,500,000 - $2,500,000)] = $1,225,000 - $8,200 = $335,800 Chicago (EVA) = [($2,400,000 x (1 - .30)] - [0.0988 x ($9,000,000 - $3,500,000)] = $1,680,000 - $543,400 = $1,136,600 Dallas (EVA) = [($4,675,000 x (1 - .30)] - [0.0988 x ($27,500,000 - $9,500,000)] = $3,272,500 - $1,788,400 = $1,494,100 Los Angeles (EVA) = [($4,2000,000 x (1 - .30)] - [0.0988 x ($25,000,000 - $8,000,000)] = $2,940,00 - $1,679,600 = $1,260,400 c. Rank: Dallas # 1 Los Angeles # 2 Chicago # 3 New York #4 Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Analytical skills

70) Bob's Cellular Phone Company uses ROI to measure divisional performance. Annual ROI

calculations for each division have traditionally employed the ending amount of invested capital along with annual operating income and net revenue. The Dupont method is generally used. The company's Phone Accessories Division had the following results for the last two years:

20X5 ROI = ($2,000,000/$20,000,000) × ($20,000,000/$10,000,000) = 0.20 20X6 ROI = ($2,400,000/$25,000,000) × ($25,000,000/$15,000,000) = 0.16

Corporate management was disappointed in the performance of the division for 20X6, since it had made an additional investment in the division that was budgeted for a 23% ROI.

Required:

a. Discuss some factors that may have contributed to the decrease in ROI for 20X6. b. Would there have been any substantial difference if average capital had been used?

Answer:

a. While sales increased by 25%, net income only increased by 20%. This may indicate that expenses increased more than they should have. Apparently, the expected marginal net income from the new investment was $1,150,000 ($5,000,000 × 0.23), and either sales were too low or expenses too high for the new products. But this calculation is somewhat hypothetical since we do not know expected sales. Start-up costs may have also contributed to the increased expenses of the first year's operations. An increase in investment also contributed to the decline in return on investment.

b. Using average capital: = ($10,000,000 + $15,000,000)/2 = $12,500,000

ROI = $2,400,000/$12,500,000 = 0.192

Using average capital would have improved the ROI from 16% to over 19%. This would still have been a disappointment to management because the total ROI fell below expectations. Perhaps it is unreasonable to expect a new investment to achieve its target ROI in the first year of operations. Diff: 3

Terms: return on investment (ROI) Objective: 2

AACSB: Analytical skills

71) The economic value added concept has attracted considerable attention in recent years. Explain the attractiveness of this number as a measure of performance.

Answer: The attractiveness of economic value added at the divisional level is primarily the fact that it allows managers to incorporate the cost of capital in decisions at the divisional level. Diff: 3

Terms: economic value added (EVA®) Objective: 2

AACSB: Reflective thinking

Objective 23.3

Answer the following questions using the information below:

Ruth Cleaning Products manufactures home cleaning products. The company has two divisions, Bleach and Cleanser. Because of different accounting methods and inflation rates, the company is considering multiple evaluation measures. The following information is provided for 20X5: ASSETS INCOME Book value Current value Book value Current value Bleach $225,000 $300,000 $150,000 $155,000 Cleanser $450,000 $250,000 $100,000 $105,000 The company is currently using a 15% required rate of return.

1) What are Bleach's and Cleanser's return on investment based on book values, respectively? A) 0.22; 0.67 B) 0.42; 0.52 C) 0.52; 0.42 D) 0.67; 0.22 Answer: D Explanation:

D) Book value ROI:

Bleach: $150,000/$225,000 = 0.67 Cleanser: $100,000/$450,000 = 0.22 Diff: 2

Terms: return on investment (ROI) Objective: 3

AACSB: Analytical skills

2) What are Bleach's and Cleanser's return on investment based on current values, respectively? A) 0.22; 0.67 B) 0.42; 0.52 C) 0.52; 0.42 D) 0.67; 0.22 Answer: C Explanation: C) Current ROI:

Bleach: $155,000 / $300,000 = 0.52 Cleanser: $105,000 / $250,000 = 0.42 Diff: 2

Terms: return on investment (ROI), current cost Objective: 3

AACSB: Analytical skills

3) What are Bleach's and Cleanser's residual incomes based on book values, respectively? A) $116,250; $32,500 B) $110,000; $67,500 C) $67,500; $110,000 D) $37,500; $116,250 Answer: A Explanation: A) Book value RI:

Bleach: $150,000 - ($225,000 × 0.15) = $116,250 Cleanser: $100,000 - ($450,000 × 0.15) = $32,500 Diff: 2

Terms: residual income residual income (RI) Objective: 3

AACSB: Analytical skills

Answer the following questions using the information below:

Carriage Incorporated manufactures horse carriages. The company has two divisions, Wheels and Assembly. Because of different accounting methods and inflation rates, the company is considering multiple evaluation measures. The following information is provided for 2009: ASSETS INCOME Book value Current value Book value Current value Wheels $485,000 $550,000 $120,000 $140,000 Assembly $750,000 $1,200,000 $160,000 $172,500 The company is currently using a 12% required rate of return.

4) What are Wheels's and Assembly's return on investment based on book values, respectively? A) 0.21; 0.25 B) 0.25; 0.21 C) 0.14; 0.25 D) 0.25; 0.14 Answer: B Explanation:

B) Book value ROI:

Wheels: $120,000/$485,000 = 0.25 Assembly: $160,000/$750,000 = 0.21 Diff: 2

Terms: return on investment (ROI) Objective: 3

AACSB: Analytical skills

5) What are Wheels's and Assembly's return on investment based on current values, respectively? A) 0.21; 0.25 B) 0.25; 0.21 C) 0.14; 0.25 D) 0.25; 0.14 Answer: D Explanation:

D) Book value ROI:

Wheels: $140,000/$550,000 = 0.25 Assembly: $172,500/$1,200,000 = 0.14 Diff: 2

Terms: return on investment (ROI), current cost Objective: 3

AACSB: Analytical skills

6) What are Wheels's and Assembly's residual incomes based on book values, respectively? A) $74,000; $28,500 B) $61,800; $70,000 C) $63,500; $59.500 D) $28,500; $74,000 Answer: B Explanation: B) Book value RI:

Wheels: $120,000 - ($485,000 × 0.12) = $61,800 Assembly: $160,000 - ($750,000 × 0.12) = $70,000 Diff: 2

Terms: residual income residual income (RI) Objective: 3

AACSB: Analytical skills

7) The cost today of purchasing an asset identical to the one currently held is called a(n): A) actual cost B) current cost C) dual cost D) fixed cost Answer: B Diff: 2

Terms: current cost Objective: 3

AACSB: Reflective thinking

8) Residual income calculations are similar to EVA® calculations because in each calculation there is a charge for the division's invested capital which is deducted from a measure of that division's profit. Answer: TRUE Diff: 2

Terms: residual income, economic value added (EVA®) Objective: 2, 3

AACSB: Analytical skills

9) Current cost return on investment is a better measure of the current economic returns from an investment than historical cost return on investment. Answer: TRUE Diff: 2

Terms: current cost, return on investment (ROI) Objective: 3

AACSB: Reflective thinking

10) A firm will see a difference in the return on investment amount depending if they use historical cost or current cost valuation methods for the assets. Answer: TRUE Diff: 2

Terms: return on investment Objective: 3

AACSB: Analytical skills

11) Using net book value as an investment base is consistent with the amount of total assets shown in the conventional balance sheet. Answer: TRUE

Explanation: Using net book value as an investment base is consistent with the amount of total assets shown in the conventional balance sheet. Diff: 2

Terms: return on investment Objective: 3

AACSB: Analytical skills

12) Using net book value as an investment base will result in a lower ROI than using gross book value as an investment base. Answer: FALSE

Explanation: Using gross book value as an investment base will result in a lower ROI than using net book value as an investment base. Diff: 2

Terms: return on investment Objective: 3

AACSB: Reflective thinking

13) When using the historical cost of assets for calculation of return on investment, is it better to use the gross book value of the assets or the net book value of the assets ? Discuss.

Answer: Although the most frequently used measure of assets by companies is the net book value, there are advantages and disadvantages of each option.

Those who use the net book value will note that it is consistent with the assets shown in the

conventional balance sheet, and that it is consistent with the income computations that include deductions for depreciation expense.

Those who favor using the gross book value calculation will note that it is more likely to be able to compare ROI across the subunits. Diff: 3

Terms: return on investment (ROI) Objective: 3

AACSB: Reflective thinking

Objective 23.4

1) When managers set and measure target levels of performance

A) historical-cost-based accounting measures are usually adequate for evaluating economic returns on new investments.

B) historical-cost ROIs cannot be used to evaluate current performance.

C) the timing of feedback is not dependent on the sophistication of the organization’s information technology.

D) the timing of feedback depends on the specific level of management receiving the feedback. Answer: D Diff: 2

Terms: return on investment Objective: 4

AACSB: Reflective thinking

Objective 23.5

1) If a company is a multinational company with operations in several different countries, one way to achieve comparability of historical-cost based ROIs for facilities in different countries is to: A) restate the results of operations using the cash basis method of accounting B) use GAAP for all reporting and calculations C) restate the results of all operations in dollars D) All of these answers are correct. Answer: C Diff: 2

Terms: return on investment (ROI) Objective: 5

AACSB: Multiculturalism and diversity

2) Which of the following statements is true?

A) The economic, legal, political, social, and cultural environments differ across countries.

B) Governments in some countries may impose controls and limit selling prices of a company's products. C) Because of advances in telecommunications and transportation, the availability of materials and skilled labor does not differ significantly across countries. D) Both A and B are correct. Answer: D Diff: 2

Terms: Balanced Scorecard Objective: 5

AACSB: Multiculturalism and diversity

3) ________ and ________ would be uncontrollable factors that a firm would need to consider when evaluating the return on investment of an international division. A) Manager's experience; currency stability B) Manager's compensation; political climate C) Required rate of return; legal requirements D) Custom duties; cultural environment Answer: D Diff: 2

Terms: return on investment Objective: 5

AACSB: Multiculturalism and diversity

4) In performance evaluations:

A) the performance of the division prior to the manager assuming control should be considered B) economic conditions for the specific industry should not be considered

C) to have an effective and fair evaluation, a manager should be evaluated over several time periods D) Both A and C are correct. Answer: D Diff: 2

Terms: Balanced Scorecard Objective: 5

AACSB: Reflective thinking

5) Comparing the performance of divisions of a multinational company operating in different countries is difficult due to the differences in economic, legal, political, social, and cultural environments. Answer: TRUE Diff: 1

Terms: Balanced Scorecard Objective: 5

AACSB: Multiculturalism and diversity

6) One way to achieve greater comparability of historical cost-based ROIs for a company's foreign division is to restate performance in dollars. Answer: TRUE Diff: 2

Terms: return on investment (ROI) Objective: 5

AACSB: Multiculturalism and diversity

7) Discuss the issues and complications that may arise when multinational corporations conduct performance measurement and comparisons among divisions located in different countries.

Answer: There are wide differences in legal, political, social, and cultural environments among countries. Many governments impose price and import/export controls on various products.

Availability of materials and skilled labor as well as power, transportation, and communication grids are likely to create significant issues.

Divisions operating in different countries account for their performance in different currencies. The exchange rates will fluctuate and there will be differences and effects as a result of levels of inflation, which will need to be reconciled with adjustments to the measurement criteria established. Diff: 3

Terms: performance measure Objective: 5

AACSB: Multiculturalism and diversity

Objective 23.6

1) A problem with rewarding managers only on the basis of residual income is that: A) residual income is difficult to measure

B) on occasion the items in the residual income calculation are not quantifiable C) residual income can depend on items over which the manager has little control D) All of these answers are correct. Answer: C Diff: 2

Terms: residual income residual income (RI) Objective: 6

AACSB: Reflective thinking

2) ________ describes contexts in which an employee prefers to exert less effort than the effort that the owner wants because the employee's effort cannot be accurately monitored and enforced. A) Goal congruence B) Moral hazard

C) Management compensation D) Incentive compensation Answer: B Diff: 1

Terms: moral hazard Objective: 6

AACSB: Reflective thinking

3) Tying performance measures more closely to a manager's efforts: A) encourages the use of nonfinancial measures B) results in a strict use of financial ratios

C) results in the salary component of compensation dominating the total compensation package D) Both A and C are correct. Answer: A Diff: 2

Terms: Balanced Scorecard Objective: 6

AACSB: Reflective thinking

4) Relative performance evaluation: A) is called benchmarking

B) filters out the effect of common noncontrollable factors C) results in managers having no incentive to help one another D) All of these answers are correct. Answer: D Diff: 2

Terms: benchmarking Objective: 6

AACSB: Reflective thinking

5) Team incentives encourage cooperation by:

A) forcing people to work together on difficult tasks B) improving morale

C) letting individuals help one another as they strive toward a common goal D) rewarding all teams the same amount Answer: C Diff: 1

Terms: Balanced Scorecard Objective: 6

AACSB: Communication

6) Many manufacturing, marketing, and design problems require employees with multiple skills; therefore, teams are used and the members have the added encouragement of: A) individual incentives B) management incentives C) morale incentives D) team incentives Answer: D Diff: 1

Terms: Balanced Scorecard Objective: 6

AACSB: Reflective thinking

7) Designers of executive compensation plans emphasize which of the following factors? A) achievement of organizational goals B) administrative ease

C) the probability that the executives affected by the plan will perceive the plan as fair D) All of these answers are correct. Answer: D Diff: 2

Terms: Balanced Scorecard Objective: 6

AACSB: Reflective thinking

8) The situation in which an employee prefers to exert less effort compared with the effort desired by the owner because the employee's effort CANNOT accurately be monitored and enforced is known as a(n): A) incentive B) moral hazard C) objective D) imputed cost Answer: B Diff: 1

Terms: moral hazard Objective: 6

AACSB: Reflective thinking

9) An important consideration in designing compensation arrangements is the tradeoff between creating incentives and imposing risks. Answer: TRUE Diff: 1

Terms: moral hazard Objective: 6

AACSB: Analytical skills

10) Moral hazard describes contexts in which an employee prefers to exert less effort than the effort that the owner wants because the employee's effort CANNOT be accurately monitored and enforced. Answer: TRUE Diff: 1

Terms: moral hazard Objective: 6

AACSB: Ethical reasoning

11) Another term for benchmarking is a relative performance evaluation. Answer: TRUE Diff: 1

Terms: benchmarking Objective: 6

AACSB: Reflective thinking

12) Evaluating an executive's performance using the annual return on investment would sharpen an executive's long-run focus. Answer: FALSE

Explanation: Using return on investment is a short-run tool. Diff: 2

Terms: return on investment (ROI) Objective: 6

AACSB: Analytical skills

13) Managers only employ one task as a part of their job, and thus evaluation of how well they do is simple to accomplish. Answer: FALSE

Explanation: Managers employ many tasks as a part of their job, and thus evaluation of how well they do is difficult to accomplish. Diff: 2

Terms: Balanced Scorecard Objective: 6

AACSB: Analytical skills

14) The only criticism of team-based compensation is that the incentives for individual employees to excel are diminished, harming overall performance. Answer: FALSE

Explanation: An additional criticism is that there can be problems managing team members who are not productive contributors to the team's success but who, nevertheless, share in the team's rewards. Diff: 2

Terms: Balanced Scorecard Objective: 6

AACSB: Analytical skills

15) The Coffee Division of American Products is planning the 20X5 operating budget. Average operating assets of $1,500,000 will be used during the year and unit selling prices are expected to average $100 each. Variable costs of the division are budgeted at $400,000, while fixed costs are set at $250,000. The company's required rate of return is 18%.

Required:

a. Compute the sales volume necessary to achieve a 20% ROI.

b. The division manager receives a bonus of 50% of residual income. What is his anticipated bonus for 20X5, assuming he achieves the 20% ROI from part (a)?

Answer: a. Target operating income = 0.20 × $1,500,000 = $300,000 Operating income $300,000 Variable costs 400,000 Fixed costs 250,000 Target revenues $950,000 Sales volume = $950,000/$100 = 9,500 units b. Asset base $1,500,000 Minimum rate × 0.18 Required return $ 270,000 Target operating income $ 300,000 Required return 270,000 Residual income $ 30,000 Bonus = $30,000 × 0.50 = $15,000 Diff: 3

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2, 6

AACSB: Analytical skills

16) LaserLife Printer Cartridge Company is a decentralized organization with several autonomous divisions. The division managers are evaluated, in part, on the basis of the change in their return on invested assets. Operating results for the Packer Division for 20X5 are budgeted as follows: Sales $5,000,000 Less variable costs 2,500,000 Contribution margin 2,500,000 Less fixed expenses 1,800,000 Net operating income $ 700,000 Operating assets for the division are currently $3,600,000. For 20X5, the division can add a new product line for an investment of $600,000. The new product line will generate sales of $1,600,000 and will incur fixed expenses of $600,000 annually. Variable costs of the new product will average 60% of the selling price.

Required:

a. What is the effect on ROI of accepting the new product line?

b. If the company's required rate of return is 6% and residual income is used to evaluate managers, would this encourage the division to accept the new product line? Explain and show computations.

Answer: a. New investment: Sales $1,600,000 Variable costs $960,000 Fixed costs 600,000 1,560,000 Operating income $ 40,000 Current ROI = $700,000/$3,600,000 = 0.194

New investment ROI = $40,000/$600,000 = 0.067 Combined ROI = $740,000/$4,200,000 = 0.176

Accepting the new product line will reduce the division's ROI. This would make the manager reluctant to make the investment. b. Investment $600,000 Minimum return × 0.06 Required amount $ 36,000 Income $ 40,000 Required amount 36,000 Residual income $ 4,000 The manager would accept the investment because income is increased by $4,000. Diff: 2

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2, 6

AACSB: Analytical skills

17) Capital Investments has three divisions. Each division's required rate of return is 15%. Planned operating results for 20X5 are as follows: Division Operating income Investment A $15,000,000 $100,000,000 B $25,000,000 $125,000,000 C $11,000,000 $ 50,000,000 The company is planning an expansion, which will require each division to increase its investments by $25,000,000 and its income by $4,500,000.

Required:

a. Compute the current ROI for each division.

b. Compute the current residual income for each division.

c. Rank the divisions according to their current ROIs and residual incomes.

d. Determine the effects after adding the new project to each division's ROI and residual income.

e. Assuming the managers are evaluated on either ROI or residual income, which divisions are pleased with the expansion and which ones are unhappy?

Answer:

a. A ROI = $15,000,000/$100,000,000 = 0.15 B ROI = $25,000,000/$125,000,000 = 0.20 C ROI = $11,000,000/$50,000,000 = 0.22

b. A RI = $15,000,000 - ($100,000,000 × 0.15) = $ 0 B RI = $25,000,000 - ($125,000,000 × 0.15)= $6,250,000 C RI = $11,000,000 - ($50,000,000 × 0.15)= $3,500,000

c. ROI Rank: 1. C RI Rank: 1. B 2. B 2. C 3. A 3. A

d. A ROI = $19,500,000/$125,000,000 = 0.156 B ROI = $29,500,000/$150,000,000 = 0.197 C ROI = $15,500,000/$75,000,000 = 0.207

A RI = $19,500,000 - ($125,000,000 x 0.15)= $ 750,000 B RI = $29,500,000 - ($150,000,000 x 0.15)= $7,000,000 C RI = $15,500,000 - ($75,000,000 x 0.15)= $4,250,000

e. Everyone would be pleased if residual income was used because residual incomes increase with the expansion. However, it would be difficult to evaluate each division on a comparative basis because each division's investment base is different.

Only the manager of Division A is pleased with the new investment if ROI is used because that is the only division with an increased ROI. In the case of additional investments that are required by corporate management, residual income may be the best to use for evaluating each manager individually, but not collectively. Diff: 3

Terms: return on investment (ROI), residual income residual income (RI) Objective: 2, 6

AACSB: Analytical skills

18) R&D Storage is a small, but diversified, moving and storage company. In recent years, its corporate income has declined to unacceptable levels. To change the direction of the company, the board of directors hired a new chief executive officer. She is currently considering three alternative ways to reward division managers for performance. They are:

1. Give each manager a competitive salary with no bonus for performance.

2. Give each manager a base salary with the largest portion being a bonus based on performance, ROI being the yardstick.

3. Give each manager a base salary with a bonus based on comparative performance with the other divisions.

Required:

Evaluate each of the ideas, giving strengths and weaknesses. Answer:

1. Opportunities for salary increases might be decided via other means such as improvements in

employee motivation, cost savings ideas, or improved management skills. This method will fit some types of situations and managers better than the bonus methods, but should not be used in situations where a high degree of motivation is desired.

2. The second idea is good for motivating a manager to improve the performance of each given division. A weakness in this method occurs when managers make decisions that maximize return on investment in the short run because they have no intent to stay with the company over a long period of time.

3. The third method is great for motivating managers to compete with each other. However, some reward should be available for the lowest rated manager if that manager's performance is, in fact, above the company's standard for performance. Suboptimization is a potential problem with this approach if the winning manager's bonus is substantially above everyone else's bonus. Diff: 2

Terms: return on investment (ROI), balanced scorecard Objective: 6

AACSB: Analytical skills

Objective 23.7

1) Which of the following is a difference between a diagnostic control system and an interactive control system?

A) A diagnostic control system focuses on meeting expectations, while an interactive control system focuses on standards of ethical behavior.

B) A diagnostic control system focuses on standards of ethical behavior while an interactive control system focus on meeting expectations.

C) A diagnostic control system focuses on meeting expectations, while an interactive control system focuses on organizational attention and learning on key strategic issues.

D) A diagnostic control system focuses on organizational attention and learning on key strategic issues, while an interactive control system focuses on meeting expectations. Answer: C Diff: 2

Terms: diagnostic control systems, interactive control systems Objective: 7

AACSB: Reflective thinking

2) A part of a control system that focuses on meeting expectations is known as a(n): A) diagnostic control system B) boundary system C) belief system

D) interactive control system Answer: A Diff: 2

Terms: diagnostic control, boundary, belief, and interactive control systems Objective: 7

AACSB: Reflective thinking

3) A part of a control system that describes standards of behavior and codes of conduct expected of all employees, especially actions that are off-limits, is known as a(n): A) diagnostic control system B) boundary system C) belief system

D) interactive control system Answer: B Diff: 2

Terms: diagnostic control, boundary, belief, and interactive control systems Objective: 7

AACSB: Ethical reasoning

4) A part of a control system that articulates the mission, purpose, and core values of a company is known as a(n):

A) diagnostic control system B) boundary system C) belief system

D) interactive control system Answer: C Diff: 2

Terms: diagnostic control, boundary, belief, and interactive control systems Objective: 7

AACSB: Communication

5) A part of a control system that attempts to focus an organization's attention and learning on key strategic issues is known as a(n): A) diagnostic control system B) boundary system C) belief system

D) interactive control system Answer: D Diff: 2

Terms: diagnostic control, boundary, belief, and interactive control systems Objective: 7

AACSB: Reflective thinking

6) Managers use ________ to create an ongoing dialog around the organization's key strategic issues to personally involve themselves in subordinates' decision-making activities. A) diagnostic control systems B) boundary systems C) belief systems

D) interactive control systems Answer: D Diff: 2

Terms: diagnostic control, boundary, belief, and interactive control systems Objective: 7

AACSB: Communication

7) \"Levers of control,\" in addition to a diagnostic control system, are needed in an organization because: A) diagnostic controls have been found to lead to poor financial performance B) diagnostic controls have no place in a Balanced Scorecard system

C) pressure to perform on diagnostic controls may lead to unethical behavior D) they are mandated by the Financial Accounting Standards Board Answer: C Diff: 3

Terms: diagnostic control, boundary, belief, and interactive control systems Objective: 7

AACSB: Reflective thinking

8) Examples of \"cooking the books\" are understated assets and overstated liabilities. Answer: FALSE

Explanation: Cooking the books is overstating assets and understating liabilities. Diff: 1

Terms: moral hazard Objective: 7

AACSB: Reflective thinking

9) Residual income is a better evaluation method than return on investment because it has a lower required rate of return for the company projects than return on investment does. Answer: FALSE

Explanation: A company can make a decision using the same required rate of return with either return on investment or residual income. Diff: 1

Terms: residual income, return on investment (ROI) Objective: 7

AACSB: Reflective thinking

10) An interactive control system is a formal information system that managers use to focus organization attention and learning on key strategic issues. Answer: TRUE Diff: 2

Terms: interactive control system Objective: 7

AACSB: Communication

11) Boundary systems describe standards of behavior and codes of conduct expected of all employees, especially actions that are off-limits. Answer: TRUE Diff: 2

Terms: boundary systems Objective: 7

AACSB: Ethical reasoning

12) The \"four levers\" of control are diagnostic control systems, boundary systems, belief systems, and interactive control systems. Answer: TRUE

Explanation: The \"four levers\" of control are diagnostic control systems, boundary systems, belief systems, and interactive control systems. Diff: 2

Terms: levers of control Objective: 7

AACSB: Reflective thinking

13) Measures which monitor critical performance variables that help managers track progress toward achieving a company's strategic goals are collectively called diagnostic control systems. Answer: TRUE Diff: 2

Terms: diagnostic control systems Objective: 7

AACSB: Reflective thinking

14) Briefly explain each of the four levels of control. Why does a company need to implement more than a diagnostic control system?

Answer: The four levers of control are diagnostic control systems, boundary systems, belief systems, and interactive control systems. Companies must strive for performance, behave ethically, inspire employees, and respond to strategic threats and opportunities in the environment. Diagnostic control systems involve measures that help a company to diagnose whether or not a company is performing according to expectations. Boundary systems describe standards of behavior and codes of conduct expected of all employees, especially actions that are off-limits. Belief systems articulate the mission, purpose, and core values of a company. Interactive control systems are formal information systems that managers use to focus organization attention and learning on key strategic issues.

The \"levers of control,\" in addition to diagnostic control systems, are needed since the pressure to perform on diagnostic goals can be so strong that management might take steps to cut corners and make their performance look better than it really is. In addition, diagnostic systems might focus management too much on meeting short term goals that organization learning and attention to key strategic issues might be inadequate for the future. Diff: 2

Terms: diagnostic control, boundary, belief, and interactive control systems Objective: 7

AACSB: Reflective thinking

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