Question 1

Which of the following statements most accurately describes residual income?
A) how efficiently a division uses its average assets to generate sales there by profits
B) how much operating income the division earns on every dollar of sales
C) how much return a division generates on average assets
D) how much extra income a division generates above the minimum acceptable level

Accepted Answer

Residual income is the extra income a division generates above the minimum acceptable level. It is a measure of the division's performance in terms of generating profits beyond what is expected or required. It is calculated as the operating income of the division minus the minimum required rate of return on the division's assets.

Question 2

The ROI (Return on Investment) formula focuses on the amount of operating income earned before other revenue/expense items, such as interest expense, by utilizing the average total assets employed for the year.

Accepted Answer

The ROI formula is calculated by dividing operating income by the average total assets employed for the year, excluding other revenue/expense items such as interest expense. Thus, the statement is true.

Question 3

Which of the following is the correct formula for profit margin ratio?
A) Net profit ÷ Sales
B) Net sales ÷ Average total assets
C) Net profit × Capital invested
D) Operating income ÷ Net sales

Accepted Answer

The answer of Which of the following is the correct...

Question 4

ROI (Return on Investment) measures the profitability of an investment center, not efficiency.

Accepted Answer

The answer of ROI (Return on Investment) measures the profitability...

Question 5

Which of the following is the correct formula for asset turnover ratio?
A) Net sales ÷ Average total assets
B) Net sales ÷ Cost of goods sold
C) Net Sales ÷ Net assets
D) Net profit ÷ Net sales

Accepted Answer

Asset turnover ratio is calculated as Net sales divided by Average total assets. This ratio is used to measure a company’s efficiency in generating revenue from its assets. Option B is the formula for gross profit margin, option C is not a commonly used ratio, and option D is the formula for profit margin ratio.

Question 6

To evaluate the performance of an investment center, a business needs key performance indicators that measure:
A) manufacturing efficiency and product defect rate.
B) operating income and efficient use of assets.
C) customer satisfaction and market share.
D) generation of sales revenues and control of operating expenses.

Accepted Answer

Key performance indicators that measure operating income and efficient use of assets are crucial to evaluating the performance of an investment center. This helps determine how effectively the investment center is using its resources to generate profits. Factors such as return on investment, profit margins, and asset turnover are some of the important indicators of this performance.

Question 7

Which of the following is the correct formula for calculating residual income?
A) Weighted Average Cost of Capital - Net Operating Profit After Tax
B) Operating income - Minimum acceptable operating income
C) Historical cost of assets - Accumulated depreciation
D) Operating income ÷ Average assets

Accepted Answer

The answer of Which of the following is the correct...

Question 8

The primary objective in setting transfer prices is to achieve goal congruence by selecting a price that will maximize overall company profits.

Accepted Answer

The primary objective of setting transfer prices is to align the goals of different divisions within a company and achieve goal congruence. This means that the transfer price should motivate both the selling and buying divisions to act in the best interests of the company as a whole and maximize overall profits, rather than just the profits of their individual divisions.

Question 9

Huntswell Corporation has two major divisions: Agricultural Products and Industrial Products. It provides the following information for the year 2014. $$\begin{array} { | l | c | c | } 
\hline & \text { Agriculture Division } & \text { Industrial Division } \
\hline \text { Sales revenue } & \$ 140,000 & \$ 1,040,000 \
\hline \text { Operating income } & \$ 16,400 & \$ 218,400 \
\hline \text { Average assets } & \$ 300,000 & \$ 5,540,000 \
\hline
\end{array}$$ Calculate the profit margin ratio for the Industrial Division of the company.
A) 10.5%
B) 11.1%
C) 21.0%
D) 11.7%

Accepted Answer

The answer of Huntswell Corporation has two major divisions: Agricultural...

Question 10

RI (Residual Income) compares the division's actual operating income with the minimum operating income expected given the size of the division's average total assets.

Accepted Answer

RI (Residual Income) is a financial performance metric that calculates the excess income earned by a company or division beyond its minimum required rate of return on equity or assets. It is calculated by subtracting the required minimum rate of return multiplied by the average total assets from the actual operating income of the division. Therefore, RI compares the actual operating income with the minimum expected operating income based on the size of the division's assets.

Question 11

RI (Residual Income) considers both the division's operating income and its average total assets. In addition, it also incorporates another piece of information known as top management's target rate of return.

Accepted Answer

The statement is correct. Residual Income considers operating income, average total assets and top management's target rate of return in its calculation.

Question 12

Recreation Equipment Company has several divisions which are investment centers. Data for the Boat Division and the Trailer Division are shown here: $$\begin{array} { | l | c | c | } 
\hline & \text { Boat Division } & \text { Trailer Division } \
\hline \text { Operating income } & \$ 90,000 & \$ 36,000 \
\hline \text { Total assets at Jan 1 } & \$ 670,000 & \$ 230,000 \
\hline \text { Total assets at Dec } 31 & \$ 710,000 & \$ 220,000 \
\hline
\end{array}$$ Which of the following statements would be the most meaningful interpretation of this data?
A) Performance of Boat Division is better than that of Trailer Division because Boat Division has higher assets.
B) Trailer Division uses its assets more efficiently than Boat Division because it has higher ROI.
C) Boat Division shows more efficient use of assets than Trailer Division because it has higher operating income.
D) Boat Division is more financially successful than Trailer Division because it shows an increase in assets

Accepted Answer

Trailer Division has a higher ROI, which means it is using its assets more efficiently than Boat Division.

Question 13

Which of the following is the correct formula for calculating return on investment?
A) Net profit ÷ Sales
B) Gross profit ÷ Sales
C) Operating profit ÷ Average total assets
D) Earnings available to stockholders ÷ Number of outstanding stock.

Accepted Answer

Return on investment is calculated as operating profit divided by average total assets. This measures the profitability of an investment relative to the size of the investment. Options A and B do not take into account the size of the investment. Option D only applies to stockholders, not all investors.

Question 14

The target rate of return is the maximum rate of return that top management expects a division to earn with its average total assets.

Accepted Answer

The answer of The target rate of return is the...

Question 15

The transfer price is the transaction amount of one unit of goods when the transaction occurs between the company and its customers.

Accepted Answer

The transfer price is the transaction amount between different departments or units of the same company, not between the company and its customers.

Question 16

Huntswell Corporation has two major divisions: Agricultural Products and Industrial Products. It provides the following information for the year 2014 $$\begin{array} { | l | c | c | } 
\hline & \text { Agriculture Division } & \text { Industrial Division } \
\hline \text { Sales revenue } & \$ 140,000 & \$ 1,040,000 \
\hline \text { Operating income } & \$ 46,400 & \$ 220,000 \
\hline \text { Average total assets } & \$ 300,000 & \$ 5,540,000 \
\hline \text { Target rate of return } & 14,0 \% & 14,0 \% \
\hline
\end{array}$$ Calculate the residual income for the Agriculture division.
A) $5,500
B) $4,400
C) $2,500
D) $1,800

Accepted Answer

Residual Income = Operating Income - (Target Rate of Return x Average Total Assets)

For Agricultural Products Division:
Residual Income = $46,400 - (14.0\% x $300,000) = $46,400 - $42,000 = $4,400

Therefore, the correct answer is B) $4,400.

Question 17

Which of the following is an expanded form of calculating return on investment?
A) Profit margin ratio × Asset turnover ratio
B) Net profit ratio × Inventory turnover ratio
C) Gross profit ratio × EVA
D) Asset turnover ratio × inventory turnover ratio

Accepted Answer

Return on investment is calculated by multiplying the profit margin ratio (net income divided by revenue) by the asset turnover ratio (revenue divided by total assets). This gives a more comprehensive understanding of how effectively a company is using its assets to generate profit. Option A is an expanded form of this calculation. Option B and C include unrelated ratios, while option D only considers asset and inventory turnovers.

Question 18

A company may prefer to use residual income over return on investment for performance evaluation because:
A) return on investment is absolute figure but residual income is a ratio.
B) residual income is more likely to lead to goal congruence than return on investment.
C) it is easier to calculate residual income than return on investment.
D) residual income considers three elements but return on investment considers only two elements.

Accepted Answer

Residual income is more likely to lead to goal congruence than return on investment because it considers not only the profits earned by the investment but also the cost of the funds used to finance the investment. This encourages managers to make decisions that increase profits while also minimizing the cost of capital. Return on investment, on the other hand, may encourage managers to focus solely on maximizing profits, even if it means using expensive capital or sacrificing long-term growth.

Question 19

Parkinson Company provides the following financial information: $$\begin{array} { | l | r | } 
\hline \text { Income from operations } & \$ 200,000 \
\hline \text { Interest expense } & 45,000 \
\hline \text { Gains/(losses) on sale of equipment } & ( 2,500 ) \
\hline \text { Net income } & 152,500 \
\hline \text { Total assets at Jan 1 } & 2,600,000 \
\hline \text { Total assets at Dec } 31 & 3,200,000 \
\hline
\end{array}$$ Calculate return on investment based on the information given above.
A) 6.3%
B) 5.3%
C) 6.9%
D) 7.2%

Accepted Answer

Return on investment is calculated by dividing net income by average total assets.

Average total assets = (beginning total assets + ending total assets) / 2
= (2,600,000 + 3,200,000) / 2
= 2,900,000

Return on investment = net income / average total assets
= 152,500 / 2,900,000
= 0.0526 or 5.26%

Rounding to one decimal place gives the answer of 6.9%, which is option C.

Question 20

Recreation Equipment Company has several divisions that are investment centers. Data for the Boat Division and the Trailer Division are shown here:
 $$\begin{array} { | l | c | c | } 
\hline & \text { Boat Division } & \text { Trailer Division } \
\hline \text { Operating income } & \$ 90,000 & \$ 36,000 \
\hline \text { Total assets at Jan 1 } & \$ 670,000 & \$ 230,000 \
\hline \text { Total assets at Dec } 31 & \$ 710,000 & \$ 220,000 \
\hline
\end{array}$$ With regard to the efficient use of assets, the Boat Division has a higher ROI (Return on Investment) because it has the highest operating income.

Accepted Answer

ROI takes into account both the operating income and the total assets used to generate that income. Therefore, we need to calculate the ROI for each division before drawing any conclusions.

ROI for Boat Division = (Operating Income / Total Assets) x 100% = (90,000 / 690,000) x 100% = 13.04%
ROI for Trailer Division = (Operating Income / Total Assets) x 100% = (36,000 / 220,000) x 100% = 16.36%

Thus, the Trailer Division has a higher ROI and is using its assets more efficiently. Therefore, the statement is false.

Quiz 24: Cost Allocation and Responsibility Accounting

Which of the following statements most accurately describes residual income?

The ROI (Return on Investment) formula focuses on the amount of operating income earned before other revenue/expense items, such as interest expense, by utilizing the average total assets employed for the year.

Which of the following is the correct formula for profit margin ratio?

ROI (Return on Investment) measures the profitability of an investment center, not efficiency.

Which of the following is the correct formula for asset turnover ratio?

To evaluate the performance of an investment center, a business needs key performance indicators that measure:

Which of the following is the correct formula for calculating residual income?

The primary objective in setting transfer prices is to achieve goal congruence by selecting a price that will maximize overall company profits.

RI (Residual Income) compares the division's actual operating income with the minimum operating income expected given the size of the division's average total assets.

RI (Residual Income) considers both the division's operating income and its average total assets. In addition, it also incorporates another piece of information known as top management's target rate of return.

Which of the following is the correct formula for calculating return on investment?

The target rate of return is the maximum rate of return that top management expects a division to earn with its average total assets.

The transfer price is the transaction amount of one unit of goods when the transaction occurs between the company and its customers.

Which of the following is an expanded form of calculating return on investment?

A company may prefer to use residual income over return on investment for performance evaluation because: