Management Accounting, Cdn.

6e (Horngren/Sundem/Stratton/Beaulieu)
Chapter 14 Management Control in Decentralized Organizations
1) Decentralization is the delegation of freedom to make decisions.
Answer: TRUE
Diff: 1
Type: TF
Page Ref: 595
Objective: 1
2) Decentralization is most successful when an organization's segments are relatively independent of one
another.
Answer: TRUE
Diff: 1
Type: TF
Page Ref: 595
Objective: 1
3) Profit centres can exist only in a decentralized organization.
Answer: FALSE
Diff: 1
Type: TF
Page Ref: 596
Objective: 2
4) In designing accounting control systems, top managers must consider the system's impact on
behaviour desired by the organization.
Answer: TRUE
Diff: 1
Type: TF
Page Ref: 595
Objective: 1
5) Transfer prices are the amounts charged by one segment of an organization for a product or service
that it supplies to another segment of the same organization.
Answer: TRUE
Diff: 1
Type: TF
Page Ref: 597
Objective: 3
6) To minimize transfer-pricing problems, organizations will use a variable cost-based transfer price for
all their segments.
Answer: FALSE
Diff: 1
Type: TF
Page Ref: 597
Objective: 3
7) If there is a competitive market for the product or service being transferred internally, using the costbased price as a transfer price will generally lead to the desired goal congruence and managerial effort.
Answer: FALSE
Diff: 1
Type: TF
Page Ref: 597
Objective: 3
8) Dysfunctional behaviour is action taken in congruence with organizational goals.
Answer: FALSE
Diff: 1
Type: TF
Page Ref: 597
Objective: 3
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9) Multinational companies use transfer prices to minimize world-wide income taxes and import duties.
Answer: TRUE
Diff: 1
Type: TF
Page Ref: 603
Objective: 5
10) Incentives do not enhance managerial effort toward goal congruence.
Answer: FALSE
Diff: 1
Type: TF
Page Ref: 605
11) According to agency theory, employment contracts will trade off the following three factors: risk,
incentive and the cost of measuring performance.
Answer: TRUE
Diff: 1
Type: TF
Page Ref: 605
12) Return on investment is a better test of profitability than just the amount of income generated by the
investment.
Answer: TRUE
Diff: 1
Type: TF
Page Ref: 608
Objective: 7
13) The income percentage of revenue is determined by multiplying return on investment by the capital
turnover.
Answer: FALSE
Diff: 1
Type: TF
Page Ref: 608
Objective: 7
14) In measuring the performance of a division manager, stockholders' equity should not be used as the
amount of invested capital.
Answer: TRUE
Diff: 1
Type: TF
Page Ref: 612
Objective: 8
15) In measuring income, either the net book value or the gross book value can be used.
Answer: FALSE
Diff: 1
Type: TF
Page Ref: 608
Objective: 7
16) Which of the following is NOT a benefit of decentralization?
A) Lower-level managers have the best information concerning local conditions and therefore may be able
to make better decisions than their superiors.
B) Managers acquire decision-making ability and other management skills that help them move upward
in the organization, assuring continuity of leadership.
C) Managers enjoy higher status from being independent and thus are better motivated.
D) Managers save time dealing with managers from other segments regarding transfer prices.
Answer: D
Diff: 1
Type: MC
Page Ref: 595
Objective: 1
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Use the following information of the Toro division of Hondo Corporation to answer the next question(s):
Revenues
Variable expenses
Fixed Expenses

$500,000
$250,000
$100,000

Total divisional assets are $800,000. The firm's minimum required rate of return is 10%.
17) Residual income for the Toro division is
A) $50,000.
B) $70,000.
C) $150,000.
D) $170,000.
Answer: B
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
18) Return on investment for the Toro division is
A) 5.34%.
B) 10%.
C) 12.5%.
D) 18.75%.
Answer: D
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
19) Decentralization is most successful when
A) segment autonomy does not exist.
B) established in nonprofit organizations.
C) there is frequent transferring of products between segments.
D) an organization's segments are relatively independent of one another.
Answer: D
Diff: 1
Type: MC
Page Ref: 595
Objective: 1
20) The decision-making power of segment managers is called
A) goal congruence.
B) segment autonomy.
C) managerial effort.
D) segment superiority.
Answer: B
Diff: 1
Type: MC
Page Ref: 595
Objective: 1

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21) A transfer price exists when two segments of the same organization
A) sell a product to the same customer.
B) sell a service to each other.
C) sell a product in a foreign country.
D) sell the same service to competitors.
Answer: B
Diff: 1
Type: MC
Page Ref: 597
Objective: 3
22) Transfer-pricing systems do NOT exist to
A) communicate data that will lead to goal-congruent decisions.
B) guide managers to make the best possible decision for their segment.
C) evaluate segment performance.
D) motivate both the selling manager and the buying manager toward goal-congruent behaviour.
Answer: B
Diff: 1
Type: MC
Page Ref: 597
Objective: 3
23) Which of the following is NOT a method of establishing a transfer price?
A) Full cost-based pricing less a profit markup
B) Market-based pricing
C) Negotiated pricing
D) Variable cost-based pricing
Answer: A
Diff: 1
Type: MC
Page Ref: 597
Objective: 3
24) Assuming a company uses a cost-based pricing system for transfer pricing, which of the following is
not a possible definition of cost?
A) Variable cost
B) Full cost
C) Actual cost
D) Fixed cost
Answer: D
Diff: 1
Type: MC
Page Ref: 597
Objective: 3
25) The use of which cost is recommended for transfer-pricing purposes?
A) Standard cost
B) Actual cost
C) Fixed cost
D) Sunk cost
Answer: A
Diff: 1
Type: MC
Page Ref: 595
Objective: 3

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26) Any action taken in conflict with organizational goals is called

A) congruent behaviour.
B) managerial effort.
C) dysfunctional behaviour.
D) negotiating.
Answer: C
Diff: 1
Type: MC
Page Ref: 605
Good, Inc.'s records reveal the following:

Market price of finished component to outsiders

Variable costs per component
Contribution margin per component

Division A
$24
12
$ 12

Total contribution for 30,000 components

Division B
Sales price of finished product
Variable costs:
Division A (1 component @ $12)
Variable costs: Division B
Assembly
Packaging
Contribution margin per unit

$360,000

$38
$12
$8
10

18

Total contribution for 30,000 units

30
$ 8
$240,000

The variable cost of Division B will be incurred whether it buys from Division A or from an outside
supplier.
27) If Division A wants to transfer the components to Division B for $30 each, the manager of Division B
would
A) not want to buy from Division A, as the same component could be purchased at the market price of
$24.
B) buy from Division A, as this would be in the best interest of the company as a whole.
C) buy from Division A as long as Division A could supply a large enough quantity to make it profitable
to Division B.
D) probably ask Division A's manager to split the difference between the $30 and the market price of $24
to arrive at a transfer price of $27.
Answer: A
Diff: 2
Type: MC
Page Ref: 597
Objective: 3

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28) The highest price that Division B would want to pay Division A for the components would be
A) $12.
B) $24.
C) $18.
D) $38.
Answer: B
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
29) If Division A is working at full capacity, the best transfer price from the viewpoint of the company as
a whole would be
A) $12.
B) $18.
C) $30.
D) $24.
Answer: D
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
30) If Division A is working at full capacity, the lowest price it would be willing to accept from Division B
would be
A) $12.
B) $18.
C) $24.
D) $30.
Answer: C
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
31) If Division A is NOT at full capacity, the lowest price at which it would be willing to sell to Division B
would be
A) $24.
B) $18.
C) $12.
D) $38.
Answer: C
Diff: 2
Type: MC
Page Ref: 597
Objective: 3

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Buchmiller Company's records reveal the following:

Market price of finished part to outsiders

Variable costs per part
Contribution margin per part

Division X
$50
34
$ 16

Total contribution for 40,000 components

$640,000

Division Y
Sales price of finished product
Variable costs:
Division X (1 part @ $34)
Variable costs: Division B
Processing
Packaging
Contribution margin per unit

$70
$34
$18
8

26

Total contribution for 40,000 units

60
$ 10
$400,000

The variable costs of Division Y will be incurred whether it buys from Division X or from an outside
supplier.
32) If Division X wants to transfer the parts to Division Y for $54, the manager of Division Y would
A) not want to buy from Division X, as the same product could be purchased at the market price of $50.
B) buy from Division X, as this would be in the best interest of the company as a whole.
C) buy the part from Division X as long as Division X could supply a large enough quantity to make it
profitable to Division Y.
D) probably ask Division X's manager to split the difference between the $54 and the market price of $50
to arrive at a transfer price of $52.
Answer: A
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
33) The highest price that Division Y would want to pay to Division A for the parts would be
A) $34.
B) $16.
C) $50.
D) $44.
Answer: C
Diff: 2
Type: MC
Page Ref: 597
Objective: 3

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34) If Division X is working at full capacity, the best transfer price from the viewpoint of the company as a
whole would be
A) $70.
B) $34.
C) $16.
D) $50.
Answer: D
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
35) If Division X is working at full capacity, the lowest price it would be willing to accept from Division Y
would be
A) $34.
B) $50.
C) $16.
D) $44.
Answer: B
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
36) If Division X is NOT at full capacity, the lowest price at which it would be willing to sell to Division Y
would be
A) $50.
B) $34.
C) $16.
D) $44.
Answer: B
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
37) The formal and informal performance-based rewards that enhance managerial effort toward
organizational goals are referred to as
A) feedback.
B) evaluations.
C) incentives.
D) risks.
Answer: C
Diff: 1
Type: MC
Page Ref: 597
Objective: 3

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The Pen and Pencil Divisions are part of the same company. Currently the Pencil Division buys a part
ingredient from Pen for $96. The Pen Division wants to increase the price of the part it sells to Pencil by
$24 to $120. The manager of Pencil has stated that it cannot afford to go that high, as it will decrease the
division's profit to near zero. Pencil can buy the part from an outside supplier for $112. The cost data for
the Pen Division is as follows:
Direct materials
Direct labour
Variable overhead
Fixed overhead

$34.00
50.00
10.00
9.60

If Pen ceases to produce the parts for Pencil, it will be able to avoid one-third of the fixed manufacturing
overhead. The Pen Division has excess capacity but no alternative uses for its facilities.
38) From the standpoint of the company as a whole, should Pencil continue to buy from Pen or start to
buy from the outside supplier?
A) Buy from Pen Division, because the company's profit would be $14.80 per unit larger.
B) Buy from Pen Division, because the company's profit would be $8.00 per unit larger.
C) Buy from an outside supplier.
D) None of the above.
Answer: A
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
39) What is the maximum transfer price that should be charged?
A) $120.00
B) $112.00
C) $97.20
D) $103.60
Answer: B
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
40) What is the minimum transfer price that should be charged?
A) $120.00
B) $112.00
C) $97.20
D) $94.00
Answer: C
Diff: 2
Type: MC
Page Ref: 597
Objective: 3

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The Ink and Paper Divisions are part of the same company. Currently the Paper Division buys a part
ingredient from Ink for $192. The Ink Division wants to increase the price of the part it sells to Paper by
$48 to $240. The manager of Paper has stated that it cannot afford to go that high, as it will decrease the
division's profit to near zero. Paper can buy the part from an outside supplier for $224. The cost data for
the Ink Division is as follows:
Direct materials
Direct labour
Variable overhead
Fixed overhead

$68.00
100.00
20.00
19.20

If Ink ceases to produce the parts for Paper, it will be able to avoid one-third of the fixed manufacturing
overhead. The Ink Division has excess capacity but no alternative uses for its facilities.
41) From the standpoint of the company as a whole, should Paper continue to buy from Ink or start to buy
from the outside supplier?
A) Buy from Ink Division, because the company's profit would be $29.60 per unit larger.
B) Buy from Ink Division, because the company's profit would be $16.00 per unit larger.
C) Buy from an outside supplier.
D) None of the above.
Answer: A
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
42) What is the maximum transfer price that should be charged?
A) $240.00
B) $224.00
C) $194.40
D) $207.20
Answer: B
Diff: 2
Type: MC
Page Ref: 597
Objective: 3
43) What is the minimum transfer price that should be charged?
A) $240.00
B) $224.00
C) $194.40
D) $188.00
Answer: C
Diff: 2
Type: MC
Page Ref: 597
Objective: 3

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44) According to agency theory, employment contracts will trade off the following three factors:
A) incentive, risk and cost of measuring performance.
B) cost-benefit, risk and uncontrollable factors.
C) goal congruence, incentive and risk.
D) cost of measuring performance, cost-benefit and risk.
Answer: A
Diff: 1
Type: MC
Page Ref: 605
The following information is available for the Berger Company:
Sales
Invested capital
ROI

$4,000,000
1,250,000
10 percent

45) What is the capital turnover?

A) 3.2000
B) 0.1000
C) 0.3125
D) None of the above.
Answer: A
Diff: 1
Type: MC
Page Ref: 612
Objective: 8
46) What is the Net income?
A) $2,750,000
B) $1,250,000
C) $125,000
D) $400,000
Answer: C
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
47) What is the income percentage of revenue?
A) 10.000 percent
B) 3.125 percent
C) 1.000 percent
D) None of the above.
Answer: B
Diff: 1
Type: MC
Page Ref: 608
Objective: 7

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The following information is available for the Peppercorn Company:

Sales
Invested capital
ROI

$1,000,000
625,000
10 percent

48) What is the capital turnover?

A) 1.600
B) 0.100
C) 0.625
D) None of the above.
Answer: A
Diff: 2
Type: MC
Page Ref: 612
Objective: 8
49) What is the net income?
A) $375,000
B) $625,000
C) $62,500
D) $200,000
Answer: C
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
50) What is the income percentage of revenue?
A) 10.00 percent
B) 6.25 percent
C) 1.00 percent
D) None of the above.
Answer: B
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
51) A measure of income or profit divided by the investment required to obtain that income or profit is
called
A) return on sales.
B) capital turnover.
C) return on investment.
D) residual income.
Answer: C
Diff: 2
Type: MC
Page Ref: 608
Objective: 7

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52) One way to determine ROI is to multiply income percentage of revenue by

A) income percentage of revenue.
B) capital turnover.
C) residual income.
D) cost of capital.
Answer: B
Diff: 1
Type: MC
Page Ref: 608
Objective: 7
53) An improvement in either capital turnover or income percentage of revenue , without changing the
other, will also improve the
A) residual income.
B) cost of capital.
C) net book value.
D) rate of return on invested capital.
Answer: D
Diff: 1
Type: MC
Page Ref: 608
Objective: 7
54) The result of the calculation, which divides income by revenue is called
A) income percentage of revenue.
B) residual income.
C) capital turnover.
D) return on investment.
Answer: A
Diff: 1
Type: MC
Page Ref: 608
Objective: 7
55) Which of the following changes would increase return on investment?
A) An increase in expenses and a decrease in sales at the same time
B) An increase in assets
C) A decrease in sales revenue
D) A decrease in expenses
Answer: D
Diff: 1
Type: MC
Page Ref: 608
Objective: 7
56) Residual income is defined as
A) net income less "imputed" interest.
B) sales less expenses.
C) income divided by revenue.
D) being the same as ROI.
Answer: A
Diff: 1
Type: MC
Page Ref: 608
Objective: 7

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The following information pertains to Jordan Company:

Invested capital
Net income
Sales
Imputed interest rate

$1,000,000
200,000
2,000,000
12 percent

57) The income percentage of revenue is

A) 100 percent.
B) 10 percent.
C) 500 percent.
D) 20 percent.
Answer: B
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
58) The capital turnover is
A) 2.
B) 5.
C) 10.
D) 1.
Answer: A
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
59) The return on investment is
A) 10 percent.
B) 50 percent.
C) 20 percent.
D) 12 percent.
Answer: C
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
60) The residual income is
A) $200,000.
B) $120,000.
C) $ 80,000.
D) $240,000.
Answer: C
Diff: 2
Type: MC
Page Ref: 608
Objective: 7

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The following information pertains to Wolfe Company

Total assets
Total current liabilities
Total expenses
Total liabilities
Total revenues

$200,000
40,000
240,000
60,000
320,000

61) The income percentage of revenue is

A) 75 percent.
B) 25 percent.
C) 200 percent.
D) 40 percent.
Answer: B
Diff: 2
Type: MC
Page Ref: 612
Objective: 8
62) If invested capital is defined as total assets, the capital turnover is
A) 0.625.
B) 0.160.
C) 0.400.
D) 1.600.
Answer: D
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
63) Which of the following is NOT a possible definition of invested capital?
A) Total assets.
B) Total assets less current liabilities.
C) Total assets less long-term liabilities.
D) Total assets less total liabilities.
Answer: C
Diff: 1
Type: MC
Page Ref: 612
Objective: 8
64) Which of the following definitions of invested capital is NOT recommended for measuring the
performance of division managers?
A) Total assets
B) Total assets less total liabilities
C) Total assets employed
D) Total assets less current liabilities
Answer: B
Diff: 1
Type: MC
Page Ref: 612
Objective: 8

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65) The original cost of an asset less any accumulated depreciated is referred to as
A) net book value.
B) a net asset.
C) gross book value.
D) current cost.
Answer: A
Diff: 1
Type: MC
Page Ref: 612
Objective: 8
66) The joint formulation by a manager and his or her superior of a set of goals and plans for achieving
the goals for a forthcoming period is known as
A) capital budgeting.
B) managerial effort.
C) management by opinion.
D) management by objectives.
Answer: D
Diff: 1
Type: MC
Page Ref: 612
Objective: 8
The following information pertains to Wolfe Company
Total assets
Total current liabilities
Total expenses
Total liabilities
Total revenues

$200,000
40,000
240,000
60,000
320,000

67) If invested capital is defined as total assets, the return on investment is

A) 160 percent.
B) 25 percent.
C) 57 percent.
D) 40 percent.
Answer: D
Diff: 2
Type: MC
Page Ref: 612
Objective: 8
68) If invested capital is defined as total assets, and the imputed interest rate is 8 percent, the residual
income is
A) $16,000.
B) $64,000.
C) $80,000.
D) $ 6,400.
Answer: B
Diff: 2
Type: MC
Page Ref: 612
Objective: 8

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69) If invested capital is defined as total assets, a project earning an ROI of 12 percent should be
A) accepted.
B) rejected.
C) rejected if the cost of capital is greater than 12 percent.
D) rejected if the desired rate of return is less than 12 percent.
Answer: C
Diff: 2
Type: MC
Page Ref: 612
Objective: 8
70) If invested capital is defined as total assets minus current liabilities, the residual income at an imputed
interest rate of 9 percent is
A) $65,600.
B) $80,000.
C) $18,000.
D) $14,400.
Answer: A
Diff: 2
Type: MC
Page Ref: 612
Objective: 8
71) If invested capital is defined as total assets minus current liabilities, a project earning an ROI of 30
percent should be
A) accepted.
B) rejected.
C) rejected if the cost of capital is less than 30 percent.
D) rejected if the desired rate of return is greater than 30 percent.
Answer: D
Diff: 2
Type: MC
Page Ref: 612
Objective: 8
The following information pertains to Baltic Company:
Total assets
Total current liabilities
Total expenses
Total liabilities
Total revenues

$400,000
80,000
480,000
120,000
640,000

72) If invested capital is defined as stockholders' equity, the capital turnover is

A) 0.44.
B) 2.29.
C) 0.57.
D) 1.75.
Answer: B
Diff: 2
Type: MC
Page Ref: 612
Objective: 8

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73) If invested capital is defined as stockholders' equity, the return on investment is

A) 175 percent.
B) 57 percent.
C) 229 percent.
D) 44 percent.
Answer: B
Diff: 2
Type: MC
Page Ref: 612
Objective: 8
74) If invested capital is defined as stockholders' equity, a project earning an ROI of 10 percent should be
A) accepted.
B) rejected.
C) accepted if the desired rate of return is less than 10 percent.
D) rejected if the cost of capital is greater than 10 percent.
Answer: C
Diff: 2
Type: MC
Page Ref: 612
Objective: 8
75) If invested capital is defined as stockholders' equity, the residual income at an imputed interest rate of
15 percent is
A) $118,000.
B) $160,000.
C) $24,000.
D) $42,000.
Answer: A
Diff: 2
Type: MC
Page Ref: 612
Objective: 8
The asset section of the January 1, 20X7 balance sheet of Murphy Company includes a machine, which
was acquired on January 1, 20X1. The machine's original cost was $1,000,000, and the estimated life was
determined to be 10 years. The estimated residual value was zero, and the straight-line method of
depreciation was chosen.
76) The book value of the machine as of January 1, 20X7 is
A) $1,000,000.
B) $900,000.
C) $500,000.
D) $400,000.
Answer: D
Diff: 2
Type: MC
Page Ref: 612
Objective: 8

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77) If operating income BEFORE amortization is $280,000, the rate of return on gross book value for 20X7
is
A) 18 percent.
B) 28 percent.
C) 45 percent.
D) 70 percent.
Answer: A
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
78) If operating income AFTER amortization is $160,000, the rate of return on average net book value for
19X1 is
A) 6.3 percent.
B) 32.0 percent.
C) 16.8 percent.
D) 16.0 percent.
Answer: C
Diff: 2
Type: MC
Page Ref: 608
Objective: 7
79) The delegation of freedom to make decisions.
Answer: Decentralization
Diff: 1
Type: SA Page Ref: 595
Objective: 1
80) The decision-making power of segment managers.
Answer: Segment autonomy
Diff: 1
Type: SA Page Ref: 595
Objective: 1
81) The amount charged by one segment of an organization for a product or service that it supplies to
another segment of the same organization.
Answer: Transfer price
Diff: 1
Type: SA Page Ref: 597
Objective: 3
82) Any action taken in conflict with organizational goals.
Answer: Dysfunctional behaviour
Diff: 1
Type: SA Page Ref: 605
83) Those formal and informal performance-based rewards that enhance managerial effort toward
organizational goals.
Answer: Incentives
Diff: 1
Type: SA Page Ref: 605

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84) A theory used to describe the formal choices of performance measures and rewards.
Answer: Agency theory
Diff: 1
Type: SA Page Ref: 605
85) A measure of income or profit divided by the investment required to obtain that income or profit.
Answer: Return on investment
Diff: 1
Type: SA Page Ref: 608
Objective: 7
86) Income divided by revenue.
Answer: Income percentage of revenue
Diff: 1
Type: SA Page Ref: 608
Objective: 7
87) Revenue divided by invested capital.
Answer: Capital turnover
Diff: 1
Type: SA Page Ref: 608
Objective: 7
88) Net income less "imputed" interest.
Answer: Residual income
Diff: 1
Type: SA Page Ref: 608
Objective: 7
89) What a firm must pay to acquire more capital, whether or not it actually has to acquire more capital to
take on a project.
Answer: Cost of capital
Diff: 1
Type: SA Page Ref: 612
Objective: 8
90) The original cost of an asset less any accumulated depreciation.
Answer: Net book value
Diff: 1
Type: SA Page Ref: 612
Objective: 8

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91) Define decentralization and identify its expected benefits and costs.
Answer: Decentralization is the delegation of the freedom to make decisions. The lower in the
organization that this freedom exists, the greater the decentralization. Some of the benefits of
decentralization are:
1. Lower-level managers have the best information concerning local conditions and therefore may be
able to make better decisions than their superiors.
2. Managers acquire decision-making ability and other management skills that help them move upward
in the organization, assuring continuity of leadership.
3. Managers enjoy higher status from being independent and thus are better motivated.
Decentralization is not without its costs, which include:
1. Managers may make decisions that are not in the organization's best interests.
2. Managers tend to duplicate services that might be less expensive if centralized.
3. Costs of accumulating and processing information frequently rise, because responsibility accounting
reports are needed for top management to learn about and evaluate decentralized units and their
managers.
4. Managers may waste time dickering with other units about goods or services one unit provides to the
other.
Diff: 2
Type: SA Page Ref: 595
Objective: 1

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92) The Produce and Can Divisions are part of the same company. Currently the Can Division buys a
part from Produce for $24. The Produce Division wants to increase the price of the part it sells to Can by
$6 to $30. The manager of Can has stated that it cannot afford to go that high, as it will decrease the
division's profit to near zero. Can Division can buy the part from an outside supplier for $28. The cost
data for the Produce Division is as follows:
Direct materials
Direct labour
Variable overhead
Fixed overhead

$ 8.50
12.50
2.50
2.40

Required:
a. If Produce ceases to produce the parts for Can, it will be able to avoid one-third of the fixed
manufacturing overhead. The Produce Division has excess capacity but no alternative uses for its
facilities. From the standpoint of the company as a whole, should Can continue to buy from Produce or
start to buy from the outside supplier?
b. What should the transfer price for the part be?
Answer:
a. The Produce Division's avoidable costs are as follows:
Direct materials
Direct labour
Variable overhead
Fixed overhead

$ 8.50
12.50
2.50
0.80 ($2.40/3)
$24.30 - $28.00 = $(3.70)

The company would lose $3.70 per unit if the Produce Division ceased to produce the part.
b. The transfer price should be negotiated between the Can and Produce Divisions and should fall
between the total avoidable cost of $24.30 and the market price of $28.
Diff: 3
Type: ES
Page Ref: 597
Objective: 3

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93) The Denim Division of Jean, Inc. manufactures sweat denim jeans. The zippers used in production are
presently purchased from an outside supplier at a cost of $7.00 each. A division of Jean, Inc. called the
Zipper Division has just begun producing a similar zipper, which can be used by the Denim Division.
Current per unit cost data for the zipper produced by the Zipper Division are as follows:
Direct material
Direct labour
Variable manufacturing overhead
Fixed manufacturing overhead
Variable selling expenses
Fixed selling expenses

$2.20
1.60
.50
.20
.40
.30

Required:
a. What is the minimum transfer price that the Zipper Division should charge the Denim Division for
each zipper?
b. What is the maximum transfer price that the Denim Division should be willing to pay for each
zipper?
Answer:
a. The minimum transfer price should be the total of all variable costs per unit as follows:
$2.20 + $1.60 + $0.50 + $0.40 = $4.70 per zipper
b. The maximum transfer price should be equal to the market price of $7.00 per zipper.
Diff: 3
Type: ES
Page Ref: 597
Objective: 3
94) Explain how the linking of rewards to responsibility centre results affects incentives and risk.
Answer: Managers tend to focus their efforts in areas where their performance affects rewards. The more
objective the measures of performance, the more likely the manager will provide effort. If individuals
believe there is no connection between their behaviour and their measure of performance, they will not
see how to alter their performance to affect their rewards.
Ideally, rewards should be based on managerial performance; but, in practice, the rewards usually
depend on the financial results in the manager's responsibility centre. Managerial performance and
responsibility centre results are certainly related, but factors beyond a manager's control also affect
results. The greater the influence of noncontrollable factors on responsibility centre results, the more
problems there are in using the results to represent a manager's performance.
According to agency theory, employment contracts will trade off three factors: risk, incentive and the cost
of measuring performance. Both top management and the manager to be hired need to agree to an
employment contract that includes specification of a performance measure and how it will affect rewards.
Diff: 3
Type: ES
Page Ref: 605

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95) The following information is available for the Colwell Company:

Sales
Invested capital
ROI

$5,000,000
2,000,000
8 percent

Compute:
a. capital turnover.
b. net income.
c. income percentage of revenue.
Answer:
a. $5,000,000/$2,000,000 = 2.50
b. 8 percent = X/$2,000,000 X = 8 percent $2,000,000 = $160,000
c. $160,000/$5,000,000 = 3.2 percent
Diff: 3
Type: ES
Page Ref: 605
Objective: 7
96) Inman Company has two fabric divisions, Cotton and Wool. The following information is available:

Revenue
Income
Invested capital
Cost of capital

Cotton
$100,000
15,000
50,000
10 percent

Wool
$500,000
180,000
300,000
12 percent

Compute the following for each division:

a. ROI.
b. income percentage of revenue.
c. capital turnover.
d. residual income.
Answer:
a. Cotton: $15,000/$50,000 = 30 percent
Wool: $180,000/$300,000 = 60 percent
b.

Cotton: $15,000/$100,000 = 15 percent

Wool: $180,000/$500,000 = 36 percent

c.

Cotton: $100,000/$50,000 = 2.00

Wool: $500,000/$300,000 = 1.67

d. Cotton: $15,000 - ($50,000 10 percent) = $10,000

Wool: $180,000 - ($300,000 12 percent) = $144,000
Diff: 3
Type: ES
Page Ref: 605
Objective: 7

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97) The following data are available for the three divisions of Pomeroy Company:

Income
Revenue
ROI
Invested capital
Income percentage
of revenue
Cost of capital
Capital turnover
Residual income

Division A
(a)
(b)
15 percent
$300,000

Division B
$90,000
(e)
(f)
(g)

Division C
(i)
$168,000
12 percent
$70,000

8 percent
12 percent
(c)
(d)

9 percent
(h)
2.5
$30,000

(j)
10 percent
(k)
(l)

Required: Provide the missing data.

Answer:
a. $300,000 15 percent = $45,000
b. $45,000/8 percent = $562,500
c. $562,500/$300,000 = 1.875
d. $45,000 - ($300,000 12 percent) = $9,000
e. $90,000/9 percent = $1,000,000
f. $90,000/$400,000 = 22.5 percent (g must be calculated first)
g. $1,000,000/2.5 = $400,000
h. $90,000 - $30,000 = $60,000 = $400,000 cost of capital
$60,000/$400,000 = 15 percent
i. $70,000 12 percent = $8,400
j.
$8,400/$168,000 = 5 percent
k. $168,000/$70,000 = 2.4
l. $8,400 - ($70,000 10 percent) = $(1,400)
Diff: 3
Type: ES
Page Ref: 608
Objective: 7

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98) The Hooper Company has gathered the following information:

Revenue
Expenses
Total assets
Total current liabilities
Total liabilities

$ 500,000
300,000
1,000,000
200,000
400,000

Compute:
a. ROI assuming invested capital is equal to total assets.
b. ROI assuming invested capital is equal to total assets minus current liabilities.
c. ROI assuming invested capital is equal to stockholders' equity.
Answer:
a. $500,000 - $300,000 = $200,000 net income
$200,000/$1,000,000 = 20 percent
b. $200,000/($1,000,000 - $200,000) = 25 percent
c. $200,000/($1,000,000 - $400,000) = 33.3 percent
Diff: 3
Type: ES
Page Ref: 608
Objective: 7

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99) The Duncan Company provided the following information:

Cost of machine$600,000
Life in years
Residual value
Amortization method

3 yrs.
zero
straight-line

The operating income before amortization during each of the three years the machine was in use was
$300,000.
Compute:
a. the rate of return on the average investment for each of the three years using the net book value.
b. the rate of return on the average investment for each of the three years using the gross book value.
Answer: $600,000/3 years = $200,000 amortization per year
a.

Year
1
2
3

Amort.
$300,000
$300,000
$300,000

b.
Year
Amort.
1
$300,000
2
$300,000
3
$300,000
Diff: 3
Type: ES
Objective: 7

Avg.
Income
before
Amort.
$200,000
$200,000
$200,000

Income
$100,000
$100,000
$100,000

Income
before
Amort.
Income
$200,000
$100,000
$200,000
$100,000
$200,000
$100,000
Page Ref: 608

Net
Rate
Book
of
Value
Return
$500,000 20.0 percent
$300,000 33.0 percent
$100,000 100.0 percent
Gross
Book
Value
$600,000
$600,000
$600,000

Rate
of
Return
16.7 percent
16.7 percent
16.7 percent

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100) The Middleton Division of TTR Enterprises expects the following results for 2006:
Revenues
Variable costs
Contribution margin
Fixed expenses
Divisional income

$500,000
200,000
$300,000
180,000
$120,000

Total divisional assets are $1,000,000.

a. Calculate profit margin, asset turnover, and ROI for the division.
b. Calculate residual income for the division using a minimum required return of 10%.
Answer:
a.
ROI = Divisional Income/Divisional Investment
= $120,000/$1,000,000 = 12%
ROI = Profit Margin x Asset Turnover
= (Divisional Income/Net Sales) x (Net Sales/Operating Assets)
= 24 % x 50% = 12%
b.
Residual Income:
Divisional Income
Less: Minimum required return
($1,000,000 x 10%)
Residual Income
Diff: 3
Type: ES
Page Ref: 608
Objective: 7

$120,000
100,000
$ 20,000

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101) Raymer Incorporated has just formed a new division and the following four investment
opportunities are available to the division. The firm requires a minimum return of 20 percent.
Investment
Opportunity

Income

Investment

$ 80,000

$200,000

2
3

120,000
80,000

600,000
500,000

50,000

200,000

a. If you were the division manager and your evaluation was based on ROI, which investment
opportunities would you accept?
b. If your evaluation was based on RI, which investment opportunities would you accept?
c. If you were president, which projects would you want the division to accept and which performance
measure would you use to encourage this action?
Answer:
a.
Investment
Opportunity
Income
Investment
ROI
1

$ 80,000

$200,000

40%

120,000

600,000

20%

80,000

500,000

16%

50,000

200,000

25%

If the division manager accepts only project 1, his ROI will be 40%. Accepting any of the other projects
would lower his ROI. For example, if the divisional manager accepts project 1 and project 4, his ROI
would drop from 40% to 32.5%, calculated as follows:
ROI = ($80,000 + $50,000)/($200,000 + $200,000) = 32.5%
b.
If the divisional manager is evaluated based on RI, he or she would accept any project that has a return of
20% or more since the firm uses a required return of 20% when calculating RI. Therefore, the manager
would accept projects 1, 2, and 4.
c.
The president of the firm would want the division to accept any project with a return in excess of the
firm's required return of 20%. Using RI would encourage the divisional manager to take this action.
Diff: 3
Type: ES
Page Ref: 608
Objective: 7
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102) Crickmore Industries has two divisions, the D division and the J division. Information about a
component that the D division produces is as follows:
Revenue
Variable manufacturing costs
Fixed manufacturing overhead
Expected sales in units

$100 per unit

$25 per unit
$15 per unit
7,000 units

The D division can produce up to 8,000 components per year. The J division needs 500 units of the
component for a product it manufactures.
a. Determine the minimum transfer price that the D division would accept.
b. Determine the maximum transfer price that the manager of the J division would pay.
c. How would your answers to requirements [A] and [B] above, change if the D division did not have
excess capacity?
Answer:
a.
The lower boundary of the bargaining range would be the selling division's variable cost of $25. This
would be the minimum amount the selling division would accept.
b.
The upper boundary of the range would be $100 (the amount the buying division would pay an outside
supplier).
c.
If the D division could sell 8,000 units to outside customers for $100 each, the D division would have to
receive $100 per unit from the J division.
If the D division sells to the J division, it foregoes $100 per unit from outside customers. Therefore, to be
as well off, the D division must receive $100 per unit from the J division.
Diff: 3
Type: ES
Page Ref: 599
Objective: 4

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103) Stirton Industries is a decentralized company that evaluates its divisions based on ROI.
Division R has the capacity to make 10,000 units of a product. Division R's variable costs are $60 per unit.
Division J can use the product as a component in one of its products. Division J would incur $40 of
variable costs to convert the component into its own product, which sells for $200.
The following requirements are independent of each other.
a. Division R can sell all that it produces for $120 each. Division J needs 1,000 units. What is the correct
transfer price?
b. Division R can sell 8,000 units at $150 each. Any excess capacity will be unused unless the units are
purchased by the J division, which could use up to 1,000 units. Determine the floor and ceiling of the
bargaining range.
Answer:
a.
The transfer price would be the market price of $120 each.
If division R sells to division J, it would forego $120 per unit; therefore, to be as well off, division R must
receive $120 per unit from division J. Division J would pay the market price of $120 whether it purchased
the component from division R or from an outside supplier.
b.
The floor of the bargaining range is $60 per unit (division R's variable cost to produce the component).
The ceiling of the range would be the lower of:
a. the buying division's outside purchase price ($150), or
b. the transfer price that results in a zero contribution margin on the goods for the buying division ($200
- $40 variable cost = $160).
The ceiling would be $150 (the amount division J would pay to acquire the component from an outside
supplier).
Diff: 3
Type: ES
Page Ref: 599
Objective: 4

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