Chapter 19

A selling division has an external sales price for an item of $100. The sales force earns a 10% commission on each sale. Variable manufacturing cost of the item is $40 per unit and the full manufacturing cost is $55 per unit. The opportunity cost per unit of making an internal transfer instead of selling externally is ______.

$100 - $10 commission - $40 variable cost = $50

When estimating EVA or residual income (RI) or return on investment (ROI), it is recommended that level of investment (capital or assets employed) be measured as ______.

an average amount for the period

For purposes of evaluating the relative financial performance of investment centers, residual income (RI) (relative to ROI) is limited in terms of ______.

comparing the performance of units of significantly different sizes

An indicator of financial performance of business units (investment centers) that is designed to approximate the unit's economic profit generated by the unit during a given period is called ______.

economic value added (EVA)

Metrics (measures) that represent comprehensive (i.e., summary) short-term financial performance indicators of investment centers include ______.

economic value added (EVA) return on investment (ROI) residual income (RI)

True or false: A unit's cash balance should always be included in its ROI calculation, even if cash is controlled at the firmwide level.

false

The two approaches that can be used in practice to estimate EVA for a business unit (or company as a whole) are the ______ approach.

financing approach and the operating

Two alternative ways to estimate an entity's EVA are the __________ approach and the __________ approach.

financing, operating

Under the concept of controllability, it is appropriate to evaluate the profitability of each investment center ______.

in relation to the level of capital invested in the center

Return on Investment (ROI) for an investment center is ______.

the ratio of some measure of profit to some measure of investment in the business unit

The process of determining the dollar amount of an exchange of a product or service transferred internally within different business units of an organization is called

transfer pricing

When the selling unit has excess capacity and its incremental cost is less than the external price the buying unit would have to pay the ______ method of transfer pricing is desirable.

variable cost

Transfers of products and services between business units is most common in firms with a high degree of

vertical integration

Given beginning-of-year assets of $187,000, and end-of-year assets of $202,000, ROI should be calculated based on assets of ______.

($187,000 + $202.000) ÷ 2 should be used = $194,500

An alternative specification for EVA, where k = divisional cost of capital (i.e., minimum required rate of return for the division) and r = rate of return on capital is ______.

(r - k) x Invested capital

A key question to address in calculating ROI is "which assets to include in the asset base." Which of the following assets should generally be included in the asset base for purposes of calculating the ROI of an investment center?

- Long-lived assets traceable to the business unit - Idle fixed assets that have an alternative use or that are readily salable

When using the variable-cost method of transfer pricing ______.

- a mark-up for profit may or may not be included - either actual cost or standard cost can be used

Both EVA and residual income (RI) ______.

- are absolute performance indicators (i.e., both are expressed in terms of dollars) - motivate goal-congruent behavior on the part of managers - include a deduction for an imputed charge for capital (assets) used during the period

To manipulate short-run financial performance (e.g., ROI), a manager could ______.

- delay planned expenditures on employee training or research & development - inappropriately manipulate revenues - delay needed maintenance expenses to the following accounting period

The primary objectives for transfer prices are to ______.

- motivate managers to put forth a high level of effort - achieve goal congruence - reward managers fairly for their decisions

By including multiple-years in the ROI and residual income (RI) evaluation window ______.

- the disconnect between NPV (net present value) and RI for subsequent financial performance is reduced - there is less incentive to engage in short-term dysfunctional behaviors

Relevant considerations in determining whether a particular transfer price will lead to actions that benefit the firm as a whole include is ______?

- the selling unit currently operating at capacity - the selling unit's out-of-pocket cost less than the external purchase price - there is an external supplier for the good or service in question

True or false: Including multiple years in the ROI and RI evaluation window increases the incentive to engage in dysfunctional short-term behaviors.

False

The ratio of profit to sales is ______.

Return on Sales (ROS)

True or false: Transfers of products and services between business units is most common in firms with a high degree of vertical integration.

True

The imputed charge in a residual income (RI) calculation is determined by multiplying the level of investment in the business unit (or division) by ______.

a desired minimum rate of return

The general transfer-pricing rule can be stated as ______.

incremental out-of-pocket cost + opportunity cost (if any)

Transfer prices in an organization are needed to assess the profitability (financial performance) of business units classified as ______ centers.

investment, profit

A key limitation of residual income (RI) as a measure of divisional financial performance is that RI ______.

is not useful for comparing the relative performance of business units that differ significantly in size

A key limitation of ROI is that this measure (metric) ______.

is subject to managerial manipulation in the short-run

The amount calculated using the general rule for transfer pricing represents the ______ amount the selling division should accept for an internal transfer.

minimum

The term goal congruency, within the context of the transfer-pricing decision, refers to the extent to which the chosen transfer price ______.

motivates decisions on the part of divisional managers that are consistent with top management's goals

One of the components of EVA is "NOPAT" (net operating profit after tax). In this specification, the word "net" is used because ______.

operating profit is reported net of depreciation expense

The minimum transfer price = Incremental cost of the producing division + any __________ __________ to the organization by making an internal transfer.

opportunity cost

The difference between a division's operating income and an imputed charge for the level of investment in the division is referred to as

residual income

Divisional operating income ÷ assets of the business unit =

return on investment

Return on Investment (ROI) equals ______.

return on sales (ROS) × asset turnover (AT)

In a transfer pricing decision (i.e., when deciding whether a producing unit should sell internally or externally), if the producing unit is operating at full capacity the ______.

selling division should give up outside sales if internal sales benefits the organization as a whole

If a selling unit has other sales opportunities but is not operating at full capacity, the transfer price should be set ______.

somewhere between variable cost and market price