# Cornerstones of Managerial Accounting Study Set 5

## Quiz 12 :Performance Evaluation and Decentralization

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is residual income? What is EVA? How does EVA differ from the general definition of residual income?
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Residual income: The excess of operating income over the minimum rate of return is residual income or the excess of income earned over the expected rate of return.
EVA (Economic value added) : The excess of operating income after tax over dollar cost of capital employed.
In general sense, EVA is residual income with minimum rate of return equal to actual cost of capital for business. But in some cases minimum rate of return differs as company is desired or some other reasons.

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are margin and turnover? Explain how these concepts can improve the evaluation of an investment center.
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Margin is the ratio of operating income to sales. This ratio valuates the percentage of operating income generated from each dollar of sale.
For example if the margin percentage is 15, it can be said that $0.15 operating income has been generated from sale amount$ 1.00
Turnover is found by dividing sales with average operating assets.
It explains the amount of sale generated from every dollar invested in operating asset.
This ratio shows how effectively the operating assets are utilized in generating sales.
By breaking ROI into margin and turnover, more information is available to assess the performance of an investment. Knowing the margin and turnover gives an idea as to why the ROI may change from one period to the next.
Margin ratio is used to know the percentage of operating income in sales and turnover is used to know how much sales is generated from investment made in operating assets.

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Briefly explain three common transfer pricing policies used by organizations.
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Transfer price:
It is a price charged by the selling division for produced goods to the buying division of that company. The price charged for the transferred good affects both
• The cost of the buying division
• The revenues of the selling division
The three common transfer-pricing policies used by the organization are as follows:
1. The first policy is a market price wherein the transfer price is equal to the price at which the product is sold in the competitive market outside the organization.
2. The second policy is a cost based price where the transfer price is equal to the products cost plus a markup above cost.
3. The third policy is a negotiated price where the transfer price is equal to an amount that is negotiated between the buyers and sellers of its product.

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Discuss the differences between centralized and decentralized decision making.
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Division A manufactures an aircraft engine component with unit variable product cost of $38 and market price of$50. Division A incurs shipping costs of $3 per unit for sales to outside parties only. Division B uses this component in the manufacture of its own engine production activities. Top management allows negotiated transfer pricing. Refer to the information above. If Division A is operating at less than full capacity, the minimum transfer price (the floor of the bargaining range) is Multiple Choice Answer: Tags Choose question tag responsibility center in which a manager is responsible for revenues, costs, and investments is a(n) Multiple Choice Answer: Tags Choose question tag key difference between residual income and EVA is that EVA Multiple Choice Answer: Tags Choose question tag practice of delegating authority to division-level managers by top management is Multiple Choice Answer: Tags Choose question tag sales and average operating assets for Year 2 are identical to their values in Year 1, yet operating income is higher, Year 2 turnover (compared with Year 1 turnover) will Multiple Choice Answer: Tags Choose question tag Division A manufactures an aircraft engine component with unit variable product cost of$38 and market price of $50. Division A incurs shipping costs of$3 per unit for sales to outside parties only. Division B uses this component in the manufacture of its own engine production activities. Top management allows negotiated transfer pricing. Refer to the information above. If Division A is operating at full capacity, the maximum transfer price (the ceiling of the bargaining range) is
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residual income or EVA ever be negative? What is the meaning of negative residual income or EVA?
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responsibility center in which a manager is responsible only for costs is a(n)
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Explain why firms choose to decentralize.
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ROI for a division is 15% and the company's minimum required cost of capital is 18%, then
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is decentralization?
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sales and average operating assets for Year 2 are identical to their values in Year 1, yet operating income is higher, Year 2 return on investment (compared with Year 1 ROI) will
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Which of the following is not a reason for decentralizing?
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Appendix 12A ) What is the Balanced Scorecard?
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is a transfer price?
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are the three benefits of ROI? Explain how each benefit can lead to improved profitability.
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