Deck 16: Performance Evaluation and Compensation

Question 1

Division A of a firm produces a single product, which is sold only to Division B. Division A has a total investment of $1,000,000, while Division B has a total investment of $2,000,000. Division A annually sells 100,000 units of its product to Division B for $5 per unit and earns $150,000 in operating income. Division B currently earns $250,000. If Division A raises its selling price to $6 per unit and nothing else changes:

A)Division A's ROI will increase to 20%
B)The firm's overall ROI will rise
C)The firm's overall ROI will fall
D)The firm's overall ROI will remain unchanged

Answer 1

D

Question 2

Residual income measures a company's profits given a required rate of return.

Answer 2

True

Question 3

Return on investment can be decomposed into two ratios: investment turnover and return on sales.

Answer 3

True

Question 4

Technical details about complex manufacturing processes are examples of specific
knowledge.

Question 5

In a profit centre, managers' primary goal is to maximize revenues.

Question 6

If manufacturing departments are only responsible for production decisions, they are considered cost centres.

Question 7

KNY Corporation reported operating income of $80,000 and average operating assets of $120,000 in a recent accounting period. Which of the following transactions would definitely increase KNY's return on investment?

A)Increasing product prices
B)Switching suppliers for raw materials
C)Collecting accounts receivable
D)Decreasing research and development expense

Question 8

Responsibility accounting is the process of using financial information to justify pay increases and promotions for managers.

Question 9

Which of the following responsibility centres can be evaluated using residual income?

A)Cost centres
B)Profit centres
C)Revenue centres
D)Investment centres

Question 10

Return on investment is typically calculated as net income divided by total sales.

Question 11

Residual income is calculated as:

A)Operating income - (required rate of return × average operating assets)
B)Net income - (required rate of return × average operating assets)
C)Operating income - (required rate of return × average equity)
D)Net income - (required rate of return × average equity)

Question 12

Compensation contracts can be based on accounting and / or non-accounting measurements.

Question 13

THN Corporation reported operating income of $30,000, revenue of $50,000, and average operating assets of $40,000 for a recent year. Which of the following is true?

A)THN has an adequate return on investment
B)THN's return on sales was 1.67
C)THN's return on investment was 75%
D)THN's return on sales was 80%

Question 14

A segment with an ROI of 30% has an income of $84,000. The company's required rate of return on segment investments is 18%. The segment's residual income is:

A)$50,400
B)$25,200
C)$26,712
D)$33,600

Question 15

Executive compensation is typically set by the shareholders at the annual meeting.

Question 16

Economic value added can be measured so that it reduces most of the problems that arise under residual income.

Question 17

Choices about decision-making authority and about organizational structure are often related.

Question 18

A transfer price is required only when goods or services are transferred between cost centres in the same organization.

Question 19

Investment centre managers are held responsible only for their costs.

Question 20

Return on investment cannot be used effectively to evaluate profit centres because it motivates managers to make suboptimal decisions from the viewpoint of the organizations' owners.

Question 21

Basing executive compensation on accounting earnings:
I) Is a popular practice in Canada
II) Is sharply criticized because of potential negative long-term effects
III) Leads to unbiased accounting practices

A)I and II only
B)I and III only
C)II and III only
D)I, II, and III

Question 22

Among the responsibility centres listed, which type of responsibility centre is most likely to use growth in sales as a performance measure?

A)Cost
B)Profit
C)Revenue
D)Investment

Question 23

Decision-making based on general knowledge is more likely to occur in this type of organization:

A)Centralized
B)Decentralized
C)Effective
D)Ineffective

Question 24

Stock-based compensation has been used to encourage:

A)Focus on long-range results
B)Focus on short-term results
C)Higher compensation for executives
D)Lower compensation for executives

Question 25

St. John's Division has a required rate of return of 15%. The weighted average cost of capital is 10%. Information for St. John's Divisions operations over the past 2 years follows: 20x5 20x4
Current assets $120,000 $100,000
Property, plant and equipment (cost)300,000 280,000
Accumulated amortization 80,000 60,000
Current liabilities 90,000 70,000
Long-term debt 85,000 80,000
Pretax operating income 52,800 48,900
Income tax rate 30% 30%
What was the St. John's Division ROI for 20x5 (rounded to nearest 0.1%)?

A)11.2%
B)13.2%
C)15.5%
D)16.0%

Question 26

How are research and development costs treated for financial reporting and for economic value added (EVA)calculations? Financial Reporting EVA

A)Capitalized Capitalized
B)Expensed Expensed
C)Capitalized Expensed
D)Expensed Capitalized

Question 27

Efficiency measures, such as number of new products developed, may be more useful than financial measures in:

A)Profit centres
B)Discretionary cost centres
C)Revenue centres
D)Investment centres

Question 28

The Shannon Division of the Wasson Widget Co. requires a 12% rate of return. During a recent year Shannon had a net income of $400,000 and a residual income of $250,000. What was its ROI?

A)32%
B)15%
C)12%
D)26%

Question 29

St. John's Division has a required rate of return of 15%. The weighted average cost of capital is 10%. Information for St. John's Divisions operations over the past 2 years follows: 20x5 20x4
Current assets $120,000 $100,000
Property, plant and equipment (cost)300,000 280,000
Accumulated amortization 80,000 60,000
Current liabilities 90,000 70,000
Long-term debt 85,000 80,000
Pretax operating income 52,800 48,900
Income tax rate 30% 30%
What was the St. John's Division EVA for 20x5?

A)$3,960
B)$11,960
C)$20,460
D)$27,800

Question 30

Budgets can be used to evaluate managerial performance in:
I) Cost centres
II) Profit centres
III) Investment centres

A)II only
B)I and II only
C)II and III only
D)I, II, and III

Question 31

Managers are held responsible for revenues in:
I) Revenue centres
II) Profit centres
III) Investment centres

A)I and III only
B)II and III only
C)I only
D)I, II, and III

Question 32

Which of the following best describes "general knowledge" in a decision-making context?

A)Detailed information about manufacturing processes
B)Customer lists and preferences kept by individual departments in retail sales
C)Knowledge that is easily transferred between employees
D)Knowledge that can be obtained only outside the organization

Question 33

An advantage of centralized decision making is:

A)More motivated employees
B)More rapid decision-making in all contexts
C)Greater effectiveness in volatile environments
D)Less monitoring of decisions

Question 34

To protect shareholders from excessive compensation practices, executive compensation packages are best set by:

A)The board of directors
B)A committee of primarily outside members of the board of directors
C)A committee of top management employees
D)The external auditors

Question 35

The Eastern Division of WDY Corporation reported net income of $2,500, operating income of $4,000, average equity of $24,000, and average operating assets of $30,000 in a recent accounting period. If Eastern's required rate of return is 12%, its residual income was

A)380
B)$(380)
C)$400
D)$1,100

Question 36

A corporate accounting department would most often be considered a:

A)Cost centre, because it is typically a high cost operation
B)Cost centre, because its costs can be controlled by upper management
C)Revenue centre, if accountants have input in pricing decisions
D)Cost centre, because it is a support service

Question 37

Economic value added uses "adjusted after-tax operating income" as one of its inputs. One purpose of using after-tax income, rather than operating income, is to:

A)Encourage managers to file tax reports
B)Encourage managers to minimize taxes
C)Improve information reported to the SEC
D)Remove bias from the EVA calculation

Question 38

St. John's Division has a required rate of return of 15%. The weighted average cost of capital is 10%. Information for St. John's Divisions operations over the past 2 years follows: 20x5 20x4
Current assets $120,000 $100,000
Property, plant and equipment (cost)300,000 280,000
Accumulated amortization 80,000 60,000
Current liabilities 90,000 70,000
Long-term debt 85,000 80,000
Pretax operating income 52,800 48,900
Income tax rate 30% 30%
What was the St. John's Division residual income for 20x5?

A)$(12,540)
B)$3,300
C)$15,300
D)$19,800

Question 39

Which type of knowledge is most costly to transfer within an organization?

A)Centralized
B)Decentralized
C)Financial
D)Specific

Question 40

Responsibility accounting includes:
I) Monitoring primarily for mistakes
II) Assigning authority to subunit managers
III) Measuring the performance of subunit managers

A)I and II only
B)I and III only
C)II and III only
D)I, II, and III

Question 41

The Machining Division has a capacity of 2,000 units. Its sales and cost data are: Selling price per unit $100
Variable manufacturing costs per unit $25
Variable administrative costs per unit $5
Total fixed manufacturing overhead $20,000
Total fixed administrative costs $5,000
Return on Investment is:

A)The same as residual income
B)Net operating income divided by average operating assets
C)A nonfinancial measure of performance
D)Net operating income minus average operating assets X cost of capital

Question 42

Bellingham Division has a required rate of return by corporate headquarters of 20%. The weighted average cost of capital is 12%. You are given the following information for Bellingham's operations for a two-year period: 2005 2004
Current assets $ 50,000 $ 60,000
Long-term assets 200,000 204,000
Accumulated amortization 60,000 44,000
Current liabilities 40,000 20,000
Long-term debt 100,000 140,000
Operating income for the year 19,000 21,000
Tax rate 40% 40%
The average investment to be used in the EVA computation for 2005 was:

A)$257,000
B)$227,000
C)$279,000
D)$175,000

Question 43

The manager in a profit centre is responsible for:

A)Investments
B)Only revenues
C)Only the costs of production or services
D)Both costs and revenues

Question 44

Bellingham Division has a required rate of return by corporate headquarters of 20%. The weighted average cost of capital is 12%. You are given the following information for Bellingham's operations for a two-year period: 2005 2004
Current assets $ 50,000 $ 60,000
Long-term assets 200,000 204,000
Accumulated amortization 60,000 44,000
Current liabilities 40,000 20,000
Long-term debt 100,000 140,000
Operating income for the year 19,000 21,000
Tax rate 40% 40%
The after-tax income for 2005 was:

A)$47,500
B)$11,400
C)$7,600
D)$31,667

Question 45

In responsibility accounting, information is used to:
I) Measure performance
II) Produce financial statements for external users
III) Motivate managers to perform well

A)I only
B)I and II only
C)II and III only
D)I and III only

Question 46

Bellingham Division has a required rate of return by corporate headquarters of 20%. The weighted average cost of capital is 12%. You are given the following information for Bellingham's operations for a two-year period: 2005 2004
Current assets $ 50,000 $ 60,000
Long-term assets 200,000 204,000
Accumulated amortization 60,000 44,000
Current liabilities 40,000 20,000
Long-term debt 100,000 140,000
Operating income for the year 19,000 21,000
Tax rate 40% 40%
The residual income for 2005 was:

A)($21,000)
B)($22,000)
C)($14,000)
D)$1,000

Question 47

Teresa's Taco Co. had the following results during the most recent year: Sales $500,000; Residual income $5,000; investment turnover 2.5; and a required rate of return of 15%. The operating (pretax)income was:

A)$30,500
B)$192,500
C)$35,000
D)$16,250

Question 48

Teresa's Taco Co. had the following results during the most recent year: Sales $500,000; Residual income $5,000; investment turnover 2.5; and a required rate of return of 15%. The capital investment was:

A)$1,250,000
B)$75,000
C)$170,000
D)$200,000

Question 49

Specific knowledge is:

A)Not necessary in today's business operations
B)Not very costly to transfer
C)The same as general knowledge
D)Detailed technical knowledge about specific processes

Question 50

Bellingham Division has a required rate of return by corporate headquarters of 20%. The weighted average cost of capital is 12%. You are given the following information for Bellingham's operations for a two-year period: 2005 2004
Current assets $ 50,000 $ 60,000
Long-term assets 200,000 204,000
Accumulated amortization 60,000 44,000
Current liabilities 40,000 20,000
Long-term debt 100,000 140,000
Operating income for the year 19,000 21,000
Tax rate 40% 40%
The EVA for 2005 was:

A)($18,600)
B)($12,840)
C)($9,600)
D)($6,600)

Question 51

Teresa's Taco Co. had the following results during the most recent year: Sales $500,000; Residual income $5,000; investment turnover 2.5; and a required rate of return of 15%. The return on investment was:

A)15.4%
B)21.67%
C)15.25%
D)17.5%

Question 52

Thurston, Inc. experienced a 14% rate of return on average investment of $1,000,000. If the required rate of return is 12%, then residual income is:

A)$20,000
B)$40,000
C)$120,000
D)$140,000

Question 53

For 2005, Aberdeen's return on sales was 10% and its investment turnover was 2.0. Return on investment for 2005 was:

A)5%
B)10%
C)12%
D)20%

Question 54

A business segment that has responsibility for both revenues and expenses is called a(n)

A)Administrative centre
B)Investment centre
C)Profit centre
D)Revenue centre

Question 55

The Machining Division has a capacity of 2,000 units. Its sales and cost data are: Selling price per unit $100
Variable manufacturing costs per unit $25
Variable administrative costs per unit $5
Total fixed manufacturing overhead $20,000
Total fixed administrative costs $5,000
Residual income is:

A)The same as return on investment
B)A nonfinancial measure of performance
C)Net operating income minus a required rate of return X average operating assets
D)Sales divided by net operating income

Question 56

The location of decision authority in an organization depends on:

A)The size of the organization
B)Whether specific or general knowledge is most important in successful decision-making
C)Whether the organization is for-profit or not-for-profit
D)Whether the organization uses a lot of technology

Question 57

Teresa's Taco Co. had the following results during the most recent year: Sales $500,000; Residual income $5,000; investment turnover 2.5; and a required rate of return of 15%. The return on sales was:

A)7%
B)6)1%
C)38.5%
D)3)25%

Question 58

Suppose an office building is owned for which long-term leases have been signed, the tenants pay utilities and operating costs, and straight-line amortization is taken. The rate of return on the book value of this investment can be expected to:

A)Increase over time
B)Remain constant over time
C)Decrease over timed
D)Vary randomly over time

Question 59

For 2006, Aberdeen's return on investment was 26% and its investment turnover was 2.0. Return on sales for 2006 was:

A)10%
B)13%
C)24%
D)26%

Question 60

Bellingham Division has a required rate of return by corporate headquarters of 20%. The weighted average cost of capital is 12%. You are given the following information for Bellingham's operations for a two-year period: 2005 2004
Current assets $ 50,000 $ 60,000
Long-term assets 200,000 204,000
Accumulated amortization 60,000 44,000
Current liabilities 40,000 20,000
Long-term debt 100,000 140,000
Operating income for the year 19,000 21,000
Tax rate 40% 40%
The ROI for 2005 was:

A)9)3%
B)10.0%
C)3)7%
D)20.0%

Question 61

Compare and contrast return on investment, residual income, and economic value added. Which method is best for evaluating investment centre managers? Explain your reasoning.

Question 62

Following is information for the Krishnan Company's three business divisions:
Division A Division B Division C
Pretax operating income $800,000 $400,000 $600,000
Current assets 80,000 60,000 80,000
Long-term assets 3,200,000 2,600,000 1,600,000
Current liabilities 400,000 200,000 300,000
Krishnan's tax rate for the divisions is 30%, and its after-tax weighted-average cost of capital (WACC)for each segment is 12%. The WACC is also used as a required rate of return.
a)Determine the division with the highest ROI. Show your calculations.
b)Determine the division with the highest residual income. Show your calculations.
c)Determine the segment with the highest EVA. Show your calculations.
d)Compare and contrast these three performance measures and their influence on managers.
e)Why is it better to use multiple measures for evaluating manager performance rather than a single measure such as ROI or EVA?

Question 63

Managers often make choices about the location of decision-making responsibility. What is the relationship between the type of knowledge that is important in the organization and the location of decision-making authority?

Question 64

Why might some organizations use both ROI and EVA in their performance measures for bonus-based compensation?

Question 65

(CMA)Responsibility accounting defines an operating centre that is responsible for revenue and costs as a(n):

A)Profit centre
B)Revenue centre
C)Division
D)Investment centre

Question 66

Indicate whether each of the following is more descriptive of centralized (C)or decentralized (D)decision-making.
____ 1. Decision-makers may not fully understand organizational goals and strategies
____ 2. Decisions are more easily made for the benefit of the overall organization
____ 3. Decisions are made by individuals with the greatest knowledge
____ 4. Good for organizations with stable and less complex operations
____ 5. Lack of coordination among subunits may lead to duplication in efforts
____ 6. Although less monitoring of decisions is usually needed, more monitoring of employee effort is necessary.
____ 7. Managers are motivated more often through incentive contracting rather than by monitoring
____ 8. Poor quality decisions due to lack of information
____ 9. More timely decision-making
____ 10. Upper management can focus on organizational strategies

Question 67

Clark and Lana are product managers at SML Corporation. They are considering two potential investments, data for which are estimated below:
Project A Project B
Operating income $ 600 $ 750
Adjusted after-tax operating income 500 700
Adjusted total assets 1,000 3,500
Average operating assets 1,200 4,000
Current liabilities 800 500
Revenue 1,000 1,200
SML's weighted average cost of capital, which also serves as its required rate of return, is 12%.
If Clark and Lana can invest in only one project, which should they choose? Why?

Question 68

Horse Stables Inc. has operations in Edmonton and Calgary, Alberta. Each geographic location has the following responsibility centres: horse boarding, riding lessons, horse sales, and administrative support. The director at each location is responsible for decisions regarding investments in facilities, horses, and any other type of investments. In addition, the directors make operating decisions such as advertising, hiring, and evaluating personnel. Department heads for the responsibility centres are responsible for daily operating decisions.
Identify the type of responsibility centre for each of the following: the two geographic locations and each of the responsibility centres-horse boarding, riding lessons, horse sales, and administrative support. Explain your classifications.

Question 69

Why should executive compensation in public companies be set by an independent compensation committee of the board of directors?

Question 70

Centralized organizations may decide to decentralize their decision-making authority once they begin operations in foreign countries. Explain why this occurs.

Question 71

Delta Division had the following results for the year just ended:
Sales $375,000
Variable costs 225,000
Fixed costs 120,000
Total operational assets 150,000
Delta is considering a new product line that would involve the following:
Sales $75,000
Variable costs 45,000
Fixed costs 23,250
Total operational assets 37,500
Delta's parent company, Omega, Inc., has a company-wide ROI of 14% and pays bonuses based on divisional ROI.
a)Determine the effect on Delta's ROI if it introduces the new product line. Would Delta's managers be encouraged to introduce the new product line?
b)Determine the effect on Omega's ROI if Delta introduces the new product line. Would the top managers of Omega want to introduce the new product line?
c)Assume a required rate of return of 10% on operational assets invested in each division. Determine the effect on Delta's residual income if it introduces the new product. Would Delta's managers be encouraged to introduce the new product line?

Question 72

Use appropriate information from the list below to calculate the amounts indicated.
Operating income $ 50,000
Adjusted after-tax operating income 35,000
Adjusted total assets 80,000
Average operating assets 90,000
Current liabilities 15,000
Revenue 120,000
Weighted average cost of capital 10%
a)Calculate return on investment
b)Calculate residual income
c)Calculate economic value added

Question 73

Two divisions of Interspatial Company report summary results as follows:
Pluto Mars
Sales $800,000 $900,000
Operating income $100,000 $150,000
Average investment $200,000 $400,000
a)Calculate the return on investment for each division and then break it down into the return on sales and investment turnover.
b)What is the residual income for each division if the required rate of return is 20%?

Question 74

The manager in a cost centre is responsible for:

A)Investments
B)Only revenues
C)Only the costs of production or services
D)Both costs and revenues

Question 75

Indicate whether each item listed below is most closely associated with: (A)return on investment, (B)residual income, or (C)economic value added. Each numbered item has only one correct answer.
____ 1. Adjustments incorporated in calculations are a matter of management judgment
____ 2. Components motivate managers to increase sales
____ 3. Discourages managers from investing in projects that may harm divisional results but may enhance overall organizational results
____ 4. Does not incorporate measurements of risk
____ 5. Does not penalize project investments with lower returns than current returns
____ 6. Easily compared with external benchmarks
____ 7. Incorporates weighted average cost of capital
____ 8. Larger subunits are more likely to report better results
____ 9. Measures the dollar amount of profits given a required rate of return
____ 10. Research and development costs are often capitalized in its calculation

Question 76

(CMA)The segment operating margin less imputed (estimated)interest on the assets used by the investment centre is known as:

A)Return on investment
B)Residual income
C)Operating income
D)Return on assets