CH 11 SMARTBOOK

Marcos Co. is considering a project that will increase residual income by $15,000. The project has a 12% return on investment (ROI) which exceeds the company's 10% required rate of return. Marcos Co. currently has an overall 15% ROI in the department where this project would be implemented. Which of the following statements regarding this potential investment are true? - The project should be accepted because the residual income will help push the project's ROI above the projected 12%. - The department manager may not want to accept the project because it will lower the overall ROI for the department. - The project should be rejected by the company because its ROI is lower than the current departmental ROI. - The project should be accepted by the company because it increases overall residual income.

- The department manager may not want to accept the project because it will lower the overall ROI for the department. - The project should be accepted by the company because it increases overall residual income.

When a transfer has no effect on fixed costs, to be acceptable to the selling division, the transfer price must - cover a reasonable portion of the selling division's fixed costs - equal the product's normal selling price - cover any lost contribution margin due to the transfer - cover any opportunity cost from lost sales - cover the variable costs per unit

- cover any lost contribution margin due to the transfer - cover any opportunity cost from lost sales - cover the variable costs per unit

Disadvantages of decentralization include ______. - spreading innovative ideas may be difficult - defining organization strategy is difficult - clashing objectives between - departments and the organization - lack of coordination

- spreading innovative ideas may be difficult - clashing objectives between departments and the organization - lack of coordination

Drawbacks of using variable or full costing to set transfer prices include - suboptimization that may occur as fixed costs per unit may push the transfer price above market price - a lack of incentive to control costs because they are simply passed to another department - a lack of departmental profit for the supplying department - a lack of cooperation between managers who are being pitted against each other

- suboptimization that may occur as fixed costs per unit may push the transfer price above market price - a lack of incentive to control costs because they are simply passed to another department - a lack of departmental profit for the supplying department

Macey, Inc.'s investment center had average operating assets of $350,000, revenues of $1,050,000 and net operating income of $70,000. Return on investment is

Net operating income ÷ Average operating assets = $70,000 ÷ $350,000 = 20%.

Why is using the gross cost of operating assets when calculating ROI preferable to using the net book value? - Using the gross cost will provide an opportunity for ROI to grow automatically over time as accumulated depreciation increases. - Replacing an existing asset will not automatically decrease ROI - The net book value is rarely used by companies and may not be understood by management.

Replacing an existing asset will not automatically decrease ROI

The ROI formula typically uses - end of year operating assets - average operating assets for the year - average operating and non-operating assets for the year - end of year operating and non-operating assets

average operating assets for the year

Lower-level managers are empowered to make decisions in a ______ organization, which can ________ motivation and job satisfaction.

decentralized, increase

Using net book value (instead of gross cost) to calculate average operating assets ______. - encourages new investment - has no effect on ROI - increases ROI over time

increases ROI over time

Residual income is a measure used to evaluate managers of ______ centers. - cost - investment - profit - profit & investment

investment

ROI is a method used to evaluate - cost and profit centers, but not investment centers - cost, profit, and investment centers - investment centers, but not cost or profit centers - profit and investment centers, but not cost centers

investment centers, but not cost or profit centers

ROI is a method used to evaluate ______. - cost and profit centers, but not investment centers - profit and investment centers, but not cost centers - investment centers, but not cost or profit centers - cost, profit, and investment centers

investment centers, but not cost or profit centers

In order for the buying division to agree to a transfer price when an outside supplier does not exist, the transfer price must be ______ the profit per unit not including the transfer price. - equal to - more than or equal to - less than or equal to

less than or equal to

In order to fully understand how a manager's decisions can affect ROI, both ______ should be computed

margin & turnover

Computing ROI using the expanded model provides additional insights. ROI can be lowered by excessive operating expenses which can depress ______ and excessive operating assets which can depress _______

margin, turnover

When managers are evaluated on residual income, rather than on return on investment (ROI), they will be ______ likely to pursue projects that will benefit the entire company.

more

The main objective of using transfer prices in an organization is to - provide revenue for cost centers in order to provide financial incentives to cost center managers - enable the company to lower its selling prices to more competitive levels - motivate the managers to act in the best interests of the overall company - ensure that managers will act in the best interests of the departments under their control

motivate the managers to act in the best interests of the overall company

Discussions between the buying and selling divisions result in a(n) ______ transfer price

negotiated

The central purpose of an organization are carried out in its (operating/service) departments.

operating

Comparing actual net income to budgeted net income is often done to evaluate the manager of a(n) _______ center.

profit

Any part of an organization whose manager has control over and is accountable for cost, profit, or investments is a(n) _______ center.

responsibility

When the selling division has some idle capacity, but will have to interrupt current sales to supply the buying division, how is the lowest acceptable transfer price calculated? - Total contribution margin on all transferred units ÷ Total units sold and transferred - Variable cost per unit + (Total contribution margin on all transferred unit ÷ Total transferred units) - Variable cost per unit - Variable cost per unit + (Total contribution margin on lost sales ÷ Total transferred units)

Variable cost per unit + (Total contribution margin on lost sales ÷ Total transferred units)

The buying division would be willing to pay up to the amount it expects to make on transferred units ______ outside supplier exists

when no

T/F Adams, Inc. has found that their managers are reluctant to replace old equipment with new, updated equipment. To stop this practice, Adams should compute ROI using assets' net book values.

False

T/F Suboptimization occurs when responsibility center managers make decisions that are in the best interests of their own responsibility center but not the company as a whole.

False

When a department has no idle capacity and will interrupt their current level of sales to regular customers, the lowest acceptable transfer price to supply product to another division is ______.

selling price

Valid criticisms of evaluating performance based on return on investment (ROI) include managers may ______. - reject investment opportunities that are profitable for the company but have a negative impact on a manager's ROI - be put in charge of a business segment that includes committed costs over which a manager has no control - affect ROI by increasing sales or decreasing operating expenses for their division - take actions that increase ROI in the short-run at the expense of long-term performance

- reject investment opportunities that are profitable for the company but have a negative impact on a manager's ROI - be put in charge of a business segment that includes committed costs over which a manager has no control - take actions that increase ROI in the short-run at the expense of long-term performance

In decentralized organizations, decision-making authority is ______. - spread throughout the organization - confined to a few top executives - not granted to the lowest level managers

spread throughout the organization

If the transfer has no effect on fixed cost, the transfer price from the selling division's standpoint must be equal to or greater than the variable cost per unit + (______ ÷ number of units transferred).

total contribution margin on lost sales

Which of the following statements is incorrect regarding responsibility accounting? - Responsibility accounting links lower-level managers' decisions with the outcomes of those decisions. - Responsibility accounting refers to the process of evaluating top management on the decisions made by lower-level managers. - Responsibility accounting holds managers accountable for the revenues and expenses over which they have control. - Responsibility accounting divides the organization into "responsibility centers" to evaluate managers' decisions.

- Responsibility accounting refers to the process of evaluating top management on the decisions made by lower-level managers.

Garnett, Inc. has a required rate of return on new projects of 12%. The Western division of Garnett is currently earning a combined return on investment (ROI) of 14.5% on the projects in its division. Western's manager is considering a project that is projected to earn 13.25%. Which of the following statements regarding the manager's decision are correct? - The project will improve the ROI for the Western division, since it is above the required rate of return that the company has specified. - The manager may decide to reject the project because it will lower the current ROI earned by his division. - Accepting the project is in the best interest of the company as a whole.

- The manager may decide to reject the project because it will lower the current ROI earned by his division. - Accepting the project is in the best interest of the company as a whole.

If the transfer has no effect on fixed cost, the transfer price from the selling division's standpoint must be equal to or greater than the variable cost per unit + (Blank______ ÷ number of units transferred). - net operating income on lost sales - opportunity cost of lost sales - total contribution margin on lost sales

total contribution margin on lost sales

Which of the following ratios are part of the ROI formula? - Net operating income ÷ Sales - Cost of goods sold ÷ Average inventory - Sales on account ÷ Average accounts receivable - Sales ÷ Average operating assets

- Net operating income ÷ Sales - Sales ÷ Average operating assets

Which of the following evaluation measures are used for investment center managers only—not for cost or profit center managers? - Residual income - Return on investment (ROI) - Actual profits compared to budgeted profits - Standard cost variances

- Residual income - Return on investment (ROI)

Given a margin of 12%, sales of $150,000 and average operating assets of $90,000, the ROI is %.

18,000/90,0000 20%

Carlos, Inc. requires a minimum rate of return of 10% on its average operating assets. The housewares department currently has average operating assets of $200,000 and a net operating income of $24,000. The department's residual income is $

24,000−(0.10×200,000) = 4,000

Net Operating Income

Margin x Sales

Residual income=

NOI - (Average operating assets × Minimum rate of return)

ROI less than min % of return

Negative residual income

Return on investment = ______. - Net operating income ÷ Average operating assets - Net operating income ÷ Segment revenue - Average operating assets ÷ Net operating income - Segment revenue ÷ Net operating income

Net operating income ÷ Average operating assets

Which of the following business segments would not be considered a cost center? - Personnel department - Retail outlet - Manufacturing facilities - Accounting department

Retail outlet

T/F In strongly decentralized organizations, even the lowest-level managers can make decisions.

TRUE

If a transfer within a company would result in higher overall profits for the company, there is _____ a range of transfer prices where both divisions would have higher profits if they are able to negotiate a price.

always

When a buying division has no outside supplier available to them, the highest transfer price they should be willing to pay is the ______. - variable cost of the transferred units - contribution margin of the transferred units - price the selling division charges to other customers - amount they will make on the sale of the transferred units

amount they will make on the sale of the transferred units

Operating departments should be charged service department ______ costs.

budgeted

The service department remains responsible for any differences between the budgeted and actual costs of their department when operating departments are charged the service department's _______ costs.

budgeted

Operating divisions are charged service department's variable costs, using ______. - budgeted rate and actual activity - actual rate and budgeted activity - actual rate and actual activity - budgeted rate and budgeted activity

budgeted rate and actual activity

The cost of making capacity available for use is represented by service department __________ costs which should be charged to operating departments in predetermined lump-sum amounts.

fixed

The three methods commonly used for transfer pricing are

negotiation, full cost, market price

ROI greater than min % of return

positive residual income

Any part of an organization whose manager has control over and is accountable for cost, profit, or investments is a(n) _________ center

responsibility

Lower-level managers' decision-making authority can be linked to the outcomes of those decisions through accounting systems

responsibility

The activity that causes the service department's cost should be the basis for assigning ______ costs to operating departments.

variable

ROI = min%

zero

Which of the following are disadvantages of decentralization? - Coordination among departments may be lacking. - Lower-level managers may make decisions without understanding the big picture. - Lower-level managers may have objectives that differ from the objectives of the entire organization. - The layers of required approvals and decisions often cause slow customer response time. - Decision-making authority is removed from those with the most detailed information about the day-to-day operations.

- Coordination among departments may be lacking. - Lower-level managers may make decisions without understanding the big picture. - Lower-level managers may have objectives that differ from the objectives of the entire organization.

A company can increase its return on investment (ROI) by ______. - increasing sales - borrowing additional funds - reducing operating expenses - increasing operating assets

- increasing sales - reducing operating expenses

ROI can be calculated as ______. - margin × turnover - net operating income ÷ average operating assets - average operating assets ÷ net operating income - margin ÷ turnover

- margin × turnover - net operating income ÷ average operating assets

Which of the following methods is not commonly used to set transfer prices?

Arbitration cost

T/F When ROI is calculated using the gross cost of assets, replacing a fully depreciated asset with a comparably priced new asset will not adversely affect ROI.

True

Decision-making authority lies mostly with higher-level managers in strongly ______ organizations. - diversified - segregated - centralized - decentralized

centralized

Decision-making authority lies mostly with higher-level managers in strongly ________ organizations

centralized

Service departments, such as the accounting department, are generally considered ________ centers, while sales offices are often considered ______ centers

cost, profit

When allocating fixed costs of service departments, the fact that operating departments do not need the peak level of service every period ______. - does not impact the total allocation of costs - lowers the overall allocation based on the number of months peak service is not required - causes the allocation to increase in some months and decrease in others

does not impact the total allocation of costs

Net operating income is income before __________ and _________ .

interests, and taxes

The manager of a(n)________ center has control over costs, revenue, and investments in operating assets.

investment

If cost is used as a transfer price, the only division with an opportunity to make a profit on the transfer is the division that

makes the final sale to an outside party

EBIT is another term for

net operating income

Comparing actual net income to budgeted net income is often done to evaluate the manager of a(n)_______ center

profit

When a manager accepts a project because the net operating income from the investment exceeds the minimum acceptable profit based on required rate of return, the investment was evaluated based on

residual income

The fundamental objective in setting transfer prices is to motivate managers to act in the best interest of ______.

the overall company

Using the market price to set transfer prices may not be the best approach when

the selling division has idle capacity

Managers of cost centers are evaluated on ______ in their responsibility center. -revenues, costs and the use of investment funds -their ability to control costs -revenues and costs incurred

their ability to control costs

The amount that one division charges when it sells goods or services to another division of the same company is called a(n)______ price.

transfer

The price charged when one segment of a company provides goods or services to another segment of the same company is the ______ price.

transfer

What are some of the pitfalls of allocating fixed costs on a variable allocation base, such as departmental sales? - Departments with higher or improving sales will be allocated a larger percentage of the costs, thus shifting costs to their departments. - Costs allocated to one department are heavily influenced by what happens in other departments. - Departments with higher sales are able to shift the costs to less profitable departments.

- Departments with higher or improving sales will be allocated a larger percentage of the costs, thus shifting costs to their departments. - Costs allocated to one department are heavily influenced by what happens in other departments.

Operating assets include ______. - accounts receivable - land held for investment - equipment - inventory - investments in bonds

- accounts receivable - equipment - inventory

Negotiated transfer prices ______. -use manager expertise in weighing the costs and benefits of the transfer - ensure that all common costs will be covered - are consistent with decentralization - ensure that the supplying division will receive a market price - preserve the autonomy of the divisions

- are consistent with decentralization - preserve the autonomy of the divisions - use manager expertise in weighing the costs and benefits of the transfer

Which of the following is not a characteristic of decentralization? - Decentralization allows top management to concentrate on bigger issues such as overall strategy. - Decentralization puts decision-making authority in the hands of those with the most information on day-to-day operations. - Decentralization helps to train lower-level managers for higher level positions. - Decentralization reduces how accountable lower-level managers are for the outcomes of their decisions.

Decentralization reduces how accountable lower-level managers are for the outcomes of their decisions.

T/F How managers are evaluated has no impact on transfer price negotiations.

False

Assume the selling division has no idle capacity and must give up outside sales, but does not lose anything by selling internally rather than outside. In addition, the buying division has an accurate assessment of how much it costs the company for the transfer to take place. Under this situation, which pricing method is being used?

Market price

Net operating income ÷ Average operating assets =

ROI (Return on Investment)

Which of the following statements is not a weakness of using return on investment (ROI) to evaluate performance? - It may be difficult to assess the performance of a manager who takes over an existing business segment. - Managers may reject investment opportunities that would benefit the entire company but negatively affect the manager. - ROI does not include the investment in nonoperating assets, such as land held for investment or stock in other companies. - Managers may increase ROI in a way that is inconsistent with company strategy.

ROI does not include the investment in nonoperating assets, such as land held for investment or stock in other companies.

When a manager is evaluated on residual income, an investment is acceptable when ______. - net operating income for the investment is above the minimum required return on average operating assets - it generates any positive net operating income - net operating income for the new investment is above the current return on average operating assets - the return on investment of the new project equals or exceeds current ROI

net operating income for the investment is above the minimum required return on average operating assets

Which of the following is not one of the three primary types of responsibility centers? - cost - sales - profit - investment

sales

When responsibility center managers forego additional companywide profits by making decisions not in the best interest of the overall company, _________ occurs.

suboptimization