Question 1

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 is calculated as Operating Income divided by Average Total Assets. The Boat Division has a higher operating income, but ROI depends on both income and asset usage. The Trailer Division may have a higher ROI if it uses its assets more efficiently.

Question 2

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

Accepted Answer

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

Question 3

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

Accepted Answer

Key performance indicators that measure operating income and efficient use of assets are the most relevant for evaluating the performance of an investment center. This is because an investment center is responsible for generating revenue and managing its own resources to maximize profit. Manufacturing efficiency, product defect rate, customer satisfaction, and market share may be important for other areas of the business, but they do not directly relate to the performance of an investment center. Similarly, the generation of sales revenues and control of operating expenses are important financial metrics that directly relate to the performance of an investment center.

Question 4

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 two entities within the same company, such as between a parent company and its subsidiary, and not between the company and its customers.

Question 5

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 average total assets, and does not take into account other revenue/expense items such as interest expense.

Question 6

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

Accepted Answer

Setting transfer prices that maximize overall company profits ensures that the goals of the different divisions or segments within the company are aligned with the overall objectives of the company, which is known as goal congruence.

Question 7

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

Accepted Answer

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

Question 8

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

Accepted Answer

Residual income is more likely to lead to goal congruence than return on investment because it focuses on the profitability of the division after deducting the cost of capital, which is the opportunity cost of funds. This means that managers are encouraged to make decisions that increase the division's profitability above the cost of capital, which is aligned with the company's goal of maximizing shareholder wealth. Return on investment, on the other hand, only considers profitability and investment, which may lead to decisions that are not in the best interest of the company as a whole.

Question 9

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

Accepted Answer

Return on investment (ROI) is calculated by dividing the operating profit over a period of time by the average total assets that were used to generate those earnings. This formula (C) is considered the most appropriate for measuring the return on investment because it takes both profitability and asset management into account. The other options, while helpful in analyzing a company's financial performance, do not provide a comprehensive picture of ROI.

Question 10

Which of the following statements most accurately describes residual income?

Accepted Answer

Residual income is the additional income that a division generates above the minimum acceptable level of return on investment. It is calculated by subtracting the minimum acceptable rate of return from the division's operating income. Residual income is a measure of how effectively a division is using its assets to generate profits.

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

Residual Income (RI) is a performance measure that considers both the division's operating income and its average total assets, but it also incorporates the top management's target rate of return.

Question 12

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.

Accepted Answer

The answer of Parkinson Company provides the following financial information:...

Question 13

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.

Accepted Answer

Residual income is calculated as Operating Income - (Target Rate of Return * Average Total Assets). For the Agriculture division: $46,400 - (0.14 * $300,000) = $46,400 - $42,000 = $4,400.

Question 14

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.

Accepted Answer

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

Question 15

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 16

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 17

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

This statement is true. Residual Income compares the actual operating income of a division with the minimum operating income expected based on the size of the division's average total assets. This helps in evaluating the performance of the division and determining if it is generating more income than it should based on the assets being used.

Question 18

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

Accepted Answer

The asset turnover ratio measures a company's ability to generate sales revenue from its assets. The formula for asset turnover ratio is net sales divided by average total assets. Options B and C are incorrect as they do not consider the total assets of the company. Option D is incorrect as it is calculating the profit margin ratio, which is the net profit divided by net sales.

Question 19

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

Accepted Answer

Return on Investment (ROI) is calculated as Profit margin ratio × Asset turnover ratio. The profit margin ratio measures the net profit earned on sales, while the asset turnover ratio measures the efficiency of the use of assets to generate sales. Therefore, multiplying these two ratios together gives an accurate measure of the return on investment for a business.

Question 20

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?

Accepted Answer

Trailer Division uses its assets more efficiently than Boat Division because it has higher ROI.

Quiz 7: Cost Allocation and Responsibility Accounting