Managerial Accounting Chapter 11: Performance Management FINAL EXAM

Residual Income is measured in

$

Alaska Services Company, a division of a major oil company, provides various services to the operators of the North Slope oil field in Alaska. Data concerning the most recent year appear below: Sales: $7,500,000 Net Operating Income: $600,000 Average Operating Assets: $5,000,000 1. Compute the margin. 2. Compute the turnover. 3. Compute the return on investment (ROI).

1. Income/Sales = 8% 2. Sales/Assets = 1.5% 3. Income/Assets = 12%

ROI can be calculated as

1. Margin x Turnover 2. Net operating income / average operating assets

Which of the following ratios are part of the ROI formula?

1. Net operating income / Sales 2. Sales / Average Operating assets

What are the General Transfer Pricing Guidelines?

1. Preserves autonomy of division managers (if feasible) 2. Motivates managers to do what it best for the firm. (Goal congruence) 3. Doesn't distort division performance measures as indicators of how well a subunit is performing (E.g., forcing a profit-center manager to sell at cost. (= zero profit)) 4. Legally minimizes taxes when buyer and seller are in different tax jurisdictions.

Residual Income

Income - Investment x Imputed Interest Rate

Minimum transfer price =

Incremental costs of transferred units + Opportunity cost per unit to the division because of the transfer

Net operating income is income before __________ and __________.

Interest, Taxes

Net operating income / Sales

Margin

A transfer will only take place if

Minimum <- Transfer price <- maximum

EBIT is another term for ______.

Net operating income

Return on investment =

Net operating income / Average operating assets

Hannibal Steel Company has a Transport Services Department that provides trucks to haul ore from the company's mine to its two steel mills- the Northern Plant and the Southern Plant. Budgeted costs for the Transport Services Department total $350,000 per year, consisting of $0.25 per ton and variable cost and $300,000 fixed cost. The level of fixed cost is determined by peak-period requirements. During the peak period, the Northern Plant requires 70% of the Transport Services Department's capacity and the Southern Plant requires 30%. During the year, the Transport Services Department actually hauled 130,000 tons of ore to the Northern Plant and 50,000 tons to the Souther Plant. The Transport Services Department incurred $364,000 in cost during the year, of which $54,000 was variable cost and $310,000 was fixed cost. 1. How much of the Transport Services Department's variable costs should be charged to each plant. 2. How much of the Transport Services Department's fixed costs should be charges to each plant. 3. Should any of the Transport Services Department's actual total cost of $364,000 be treated as a spending variance and not charged to the plants?

Northern: Variable cost charges: $32,500 (.25*130,000) Fixed cost charges: $210,000 (300,000*.70) Total charges: $242,500 Southern: Variable cost charges: 12,500 (.25*500,000) Fixed cost charges: $90,000 (300,000*.30) Total charges: $102,500 Total: Variable cost charges: $45,000 Fixed cost charges: $300,000 Total charges: $345,000 Variable Cost: Total actual cost incurred: $54,000 Total charges (above): $45,000 Spending variance: $9,000 Fixed Cost: Total actual cost incurred: $310,000 Total charges (above): $300,000 Spending variance: $10,000 Total: Total actual cost incurred: $364,000 Total charges (above): $345,000 Spending variance: $19,000

Maximum transfer price =

Price available in the external market OR incremental profit earned by buying division because of the transfer

Selling price per unit on the intermediate market: $60 Variance costs per unit: $42 Fixed costs per unit (based on capacity): $8 Capacity in units: 25,000 Sako Company has a Hi-Fi Division that could use this speaker in one of its products. The Hi-Fi Division will need 5,000 speakers per year. It has received a quote of $57 per speaker from another manufacturer. Sako Company evaluates division managers on the basis of divisional profits. a. From the standpoint of the Audio Division, what is the lowest acceptable transfer price for the speakers sold to the Hi-Fi Division? b. From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price for speakers acquired from the Audio Division? c. What is the range of acceptable transfer prices (if any) between the two divisions? If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 5,000 speakers from the Audio Division to the Hi-Fi Division? Why or why not?

Question 1 Assume that Audio Division is selling 20,000 speakers per year to outside customers. a. Minimum TP: $42 b. Maximum TP: $57 c. Range: 42 <- TP <- 57 d. Good for company? Yes, savings of $15 per speaker. Question 2 Assume that Audio Division is selling 22,500 speakers per year to outside customers. a. Minimum TP: $51 ($42+18*2500/5000) b. Maximum TP: $57 c. Range: 51 <- TP <- 57 d. Good for company? Yes, savings of $6 per speaker. Question 3 Assume that Audio Division is selling 25,000 speakers per year to outside customers. a. Minimum TP: $60 b. Maximum TP: $57 c. Range: 6- <- TP <- 57 d. Good for company? No, loss of $3 per speaker.

Why is using the gross cost of operating assets when calculating ROI preferable to using the net book value?

Replace an existing asset will not automatically decrease ROI.

Net operating income - (Average operating assets x Minimum required rate of return)

Residual Income

Net operating income / Average operating assets =

Return on Investment

ROI stands for

Return on Investment

True or false: In strongly decentralized organizations, even the lowest-level managers can make decisions.

True

True or false: When ROI is calculated using the gross cost of assets, replacing a fully depreciated asset with a comparably prices new asset will not adversely affect ROI.

True

Sales / Average operating assets

Turnover

Operating department

a department in which the central purposes of the organization are carried out.

Service department

a department that does not directly engage in operating activities; rather, it provides services or assistance to the operating departments.

Tan Corporation of Japan has two regional divisions with headquarters in Osaka and Yokohama. Selected data on the two divisions follow: Osaka: Sales: $3,000,000 Net operating income: $210,000 Average operating assets: $1,000,000 Yokohama: Sales: $9,000,000 Net operating income: $720,000 Average operating assets: $4,000,000 1. For each division, compute the margin, turnover, and return on investment (ROI). Where necessary, carry computations to two decimal places. 2. Assume that the company evaluates performance using residual income and that the minimum required rate of return for any division is 15%. Compute the residual income for each division.

a. ROI: Osaka: 21% Yakohama: 18% b. Residual Income: Osaka: Income: $210,000 Assets: $1,000,000 Required Rate: 15% Yokohama: Income: $720,000 Assets: $4,000,000 Required Rate: 15% Osaka: $60,000 Yokohama: $120,000

Disadvantages of decentralization include __________.

closing objective between departments and the organization, spreading innovative ideas may be difficult, and lack of coordination

Lower-level management goals that are inconsistent with company goals are a possible disadvantage of ________.

decentralization

An organization in which decision-making authority is spread throughout the organization is ______.

decentralized

Positive RI means ROI is ________ the hurdle rate.

higher

The manager of a __________ center has control over costs, revenue, and investments in operating assets.

investment

Negative RI means ROI is ________ the hurdle rate.

lower

Comparing actual net income to budgeted net income is often done to evaluate the manager of _________ center.

profit

Variable costs

should be charged to operating departments based on how much services they use.

Fixed costs

should be charged to operating departments based on what capacity of services they request to be available.

in decentralized organization, decision-making authority is _______.

spread throughout the organization

Transfer Price

the price at which one division transfer materials to another division (typically to be used as inputs in that divisions manufacturing).