Cost Accounting - Chapter 19 - Strategic Performance Measurement

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

$194,500 Reason: Average assets ($187,000 + $202.000) ÷ 2 should be used.

Measurement issues when ROI is used to evaluate the relative performance of such units include ______.

1. use of different depreciation methods 2. the use of NBV for assets

RI

RI uses accrual accounting data (in both the numerator and the denominator) and as such is not an approximation of a unit's economic profit during a given period.

ROI

ROI uses accrual accounting data (in both the numerator and the denominator) and as such is not an approximation of a unit's economic profit during a given period.

When calculating ROI, the general principle for shared assets is that they should be ______.

allocated to business units on the basis of the relative usage of each asset by the various business units "sharing" the asset

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 Reason: This is because the "income" earned (however defined) relates to a period of time. For consistency, the level of capital employed should be some type of average amount during that same period.

For any given period, the ROI of an investment center is calculated by multiplying the return on sales by the

asset turnover

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)

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

financing ; operating

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 and operating appraoch

The use of ROI (Return on Investment) to evaluate the short-run financial performance of business-unit managers might not motivate decisions that enhance the value of the firm as a whole. This situation is most apt to exist ______.

for highly profitable business units, as measured by ROI Reason: The issue is an example of a goal congruency problem: by taking on a new investment that may benefit the firm as a whole, the short-term financial performance (ROI) of a high-performing unit may suffer.

Historical cost without a reduction for accumulated depreciation is ______.

gross book value

For any given division (investment center) in an organization, the book value of current assets plus the net book value (NBV) of long-lived assets is the ______ of divisional assets.

historical cost

Asset Turnover

the amount of sales generated by the business unit, including internal sales, divided by the level of assets invested in the center

A key criterion for including an asset in a business unit's ROI calculation is ______.

the degree to which the unit controls the asset

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 ROI = profit/assets

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

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 ______.

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

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 Reason: This formulates the fact that according to EVA there is no measure of return on capital (r x invested capital) until there is a recovery of the cost of capital provided (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?

1. Long-lived assets traceable to the business unit 2. Idle fixed assets that have an alternative use or that are readily salable

Measurement issues associated with the use of return on investment (ROI) for evaluating the relative performance of investment centers within an organization include ______.

1. different inventory cost-flow assumptions across business units 2. whether each unit uses the same criteria for expensing vs. capitalizing (and subsequently depreciating) certain expenditures

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

1. either actual cost or standard cost can be used 2. a mark-up for profit may or may not be included

Both EVA and residual income (RI) ______.

1. motivate goal-congruent behavior on the part of managers 2. are absolute performance indicators (i.e., both are expressed in terms of dollars) 3. include a deduction for an imputed charge for capital (assets) used during the period

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

1. return on investment (ROI) 2. residual income (RI) 3. economic value added (EVA)

The primary objectives for transfer prices are to ______.

1. reward managers fairly for their decisions 2. achieve goal congruence 3. motivate managers to put forth a high level of effort

When there are transfers of goods and services between business units within the firm, without a transfer pricing system in place, it would be impossible to determine ______ investment centers.

1. the amount of EVA (economic value added) by 2. the amount of residual income (RI) generated by 3. the asset turnover (AT) for each 4. the return on investment (ROI) for

Residual income (RI) is ______.

1. the dollar difference between income of a business unit and an imputed charge for invested assets in the unit 2. income earned after the unit has "paid" a charge for the funds invested in the unit Reason: RI is equal to income earned by the division after (not before) the unit has "paid" a charge for the level of invested capital in the unit.

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

1. there is an external supplier for the good or service in question 2. the selling unit currently operating at capacity 3. the selling unit's out-of-pocket cost less than the external purchase price

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

1. there is less incentive to engage in short-term dysfunctional behaviors 2. the disconnect between NPV (net present value) and RI for subsequent financial performance is reduced

EVA

EVA is a measure of an investment center's economic income during a period. EVA is calculated as Sales less operating expenses (including taxes) less financing expenses (cost of capital x amount of capital employed).

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

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

False

By including multiple years in the ROI and residual income (RI) evaluation window, there is less incentive to engage in short-term dysfunctional behaviors because ................

Reason: The level of invested capital is an integral component of both ROI and RI and, as such, would have to be estimated for each accounting period in the chosen multi-period evaluation "window."

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

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 Reason: This is consistent with the principle of "controllability," whereby the financial performance of subunits is evaluated based on factors over which the manager of the unit exercises control or broad decision authority.

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 estimated price that could be received from the sale of an asset is the ______.

liquidation value

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

minimum

EVA for a given business unit (investment center) during a given period can be estimated as NOPAT (after-tax cash operating income, less depreciation) ______

minus (k x average invested capital), where k = WACC

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

Residual Income

profit generated by the business unit less an imputed charge for the level of capital employed by the business unit

A common way to allocate shared asset costs across business units is to allocate these costs based on ______.

relative peak demand for the assets by the various business units

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

The ratio of profit to sales is ______.

return on sales (ROS)

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