Garrison 11ce SM Ch11 Final PDF

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Chapter 11Reporting for ControlDiscussion Case (30 minutes)MPC’s previous manufacturing strategy was focused on high-volume production of a limited range of paper grades. The goal of this strategy was to keep the machines running constantly to maximize the number of tonnes produced. Changeovers were...

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Chapter 11 Reporting ffor or Control

Discussion Case (30 minutes) MPC’s previous manufacturing strategy was focused on high-volume production of a limited range of paper grades. The goal of this strategy was to keep the machines running constantly to maximize the number of tonnes produced. Changeovers were avoided because they lowered equipment utilization. Maximizing tonnes produced and minimizing changeovers helped spread the high fixed costs of paper manufacturing across more units of output. The new manufacturing strategy is focused on low-volume production of a wide range of products. The goals of this strategy are to increase the number of paper grades manufactured, decrease changeover times, and increase yields across non-standard grades. While MPC realizes that its new strategy will decrease its equipment utilization, it will still strive to optimize the utilization of its high fixed cost resources within the confines of flexible production. In an economist’s terms the old strategy focused on economies of scale while the new strategy focuses on economies of scope. Employees focus on improving those measures that are used to evaluate their performance. Therefore, strategically-aligned performance measures will channel employee effort towards improving those aspects of performance that are most important to obtaining strategic objectives. If a company changes its strategy but continues to evaluate employee performance using measures that do not support the new strategy, it will be motivating its employees to make decisions that promote the old strategy, not the new strategy. And if employees make decisions that promote the new strategy, their performance measures will suffer. Some performance measures that would be appropriate for MPC’s old strategy include: equipment utilization percentage, number of tonnes of paper produced, and cost per tonne produced. These performance measures would not support MPC’s new strategy because they would discourage increasing the range of paper grades produced, increasing the © McGraw-Hill Education Ltd. 2018. All rights reserved. Solutions Manual, Chapter 11

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number of changeovers performed, and decreasing the batch size produced per run. Some performance measures that would suit the new strategy include number of employee training hours to support manufacturing flexibility, average changeover time, average manufacturing yield, number of grades of paper produced, time to fill orders, customer satisfaction with the variety of paper grades offered, revenues and contribution margin per unit.

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Managerial Accounting, 11th Canadian Edition

Solutions to Questions 11-1 In a decentralized organization, decision-making authority isn’t confined to a few top executives, but rather is spread throughout the organization with lower-level managers and other employees empowered to make decisions. 11-2 A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. Examples of segments include departments, operations, sales territories, divisions, product lines, and so forth. 11-3 Under the contribution approach, costs are assigned to a segment if and only if the costs are traceable to the segment (i.e., could be avoided if the segment were eliminated). Common costs are not allocated to segments under the contribution approach. 11-4 The contribution margin is the difference between sales revenue and variable expenses. The segment margin is the amount remaining after deducting traceable fixed expenses from the contribution margin. The contribution margin is useful as a planning tool for many decisions, including those in which fixed costs don’t change. The segment margin is useful in assessing the overall profitability of a segment. 11-5 If common costs were allocated to segments, then the costs of segments would be overstated and their margins would be understated. As a consequence, some segments may appear to be unprofitable and managers may be tempted to eliminate them. If a segment were eliminated because of the existence of arbitrarily allocated common costs, the overall profit of the company would decline by the amount of the segment margin because the common cost would remain. The common cost that had been allocated to the segment would then be reallocated to the remaining segments— making them appear less profitable. 11-6 There are often limits to how far down an organization a cost can be traced. Therefore, costs that are traceable to a segment may become common as that segment is divided into smaller segment units. For example, the costs of national TV and print advertising might be traceable to a specific product line, but be a

common cost of the geographic sales territories in which that product line is sold. 11-7 Three inappropriate methods for assigning traceable costs are: treating traceable fixed costs as indirect, using the wrong allocation base and arbitrarily dividing common costs among segments. Each of these practices is inappropriate because they can lead to distorted segment costs and consequently, distorted segment margins. 11-8 A cost center manager has control over cost, but not revenue or the use of investment funds. A profit center manager has control over both cost and revenue. An investment center manager has control over cost and revenue and the use of investment funds. To evaluate cost centre performance, standard cost variances and flexible budget variances are often used. Profit centre managers are often evaluated by comparing actual profit to targeted or budgeted profit. Investment centre managers are usually evaluated using return on investment or residual income measures. 11-9 Margin refers to the ratio of operating income to total sales. Turnover refers to the ratio of total sales to average operating assets. The product of the two numbers is the ROI. 11-10 Return on investment (ROI) can be improved by increasing sales, reducing operating expenses or reducing operating assets. 11-11 Residual income is the operating income an investment center earns above the company’s minimum required rate of return on operating assets. 11-12 If ROI is used to evaluate performance, a manager of an investment center may reject a profitable investment opportunity whose rate of return exceeds the company’s required rate of return but whose rate of return is less than the investment center’s current ROI. The residual income approach overcomes this problem since any project whose rate of return exceeds the company’s minimum required rate of return will result in an increase in residual income. © McGraw-Hill Education Ltd. 2018. All rights reserved.

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11-13 No, residual income should not be used to compare the performance of divisions of different sizes. The reason is that larger divisions should, other factors held constant, produce more residual income since they have a larger asset base with which to generate profits. However, it is appropriate to compare the percentage growth in residual income (e.g., year-over-year) for divisions of different sizes. 11-14 The four groups of measures typically included on a balanced scorecard are: learning and growth; internal business process; customer; and financial.

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Managerial Accounting, 11th Canadian Edition

Foundational Exerc Exercises ises 1. Last year’s margin is:

Margin = =

Net operating income Sales $200,000 = 20% $1,000,000

2. Last year’s turnover is: Turnover = =

Sales Average operating assets $1,000,000 = 1.6 $625,000

3. Last year’s return on investment (ROI) is: ROI = Margin × Turnover = 20% × 1.6 = 32%

4. The margin for this year’s investment opportunity is:

Margin = =

Net operating income Sales $30,000 = 15% $200,000

5. The turnover for this year’s investment opportunity is: Turnover = =

Sales Average operating assets $200,000 = 1.67 (rounded) $120,000

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Foundational Exerc Exercises ises (continued) 6. The ROI for this year’s investment opportunity is: ROI = Margin × Turnover = 15% × 1.67 = 25% (rounded)

7, 8, and 9. If the company pursues the investment opportunity, this year’s margin, turnover, and ROI would be: Margin =

Net operating income Sales

=

$200,000 + $30,000 $1,000,000 + $200,000

=

$230,000 = 19.2% (rounded) $1,200,000

Turnover =

Sales Average operating assets

=

$1,000,000 + $200,000 $625,000 + $120,000

=

$1,200,000 = 1.61 (rounded) $745,000

ROI = Margin × Turnover = 19.2% × 1.61 = 30.9% (rounded) 10. The CEO would not pursue the investment opportunity because it lowers her ROI from 32% to 30.9%. The owners of the company would want the CEO to pursue the investment opportunity because its ROI of 25% exceeds the company’s minimum required rate of return of 15%.

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Managerial Accounting, 11th Canadian Edition

Foundational Exerc Exercises ises (continued) 11. Last year’s residual income is: Average operating assets....................... Net operating income............................ Minimum required return: 15% × $625,000................................ Residual income....................................

$625,000 $200,000 93,750 $106,250

12. The residual income for this year’s investment opportunity is: Average operating assets....................... Net operating income............................ Minimum required return: 15% × $120,000................................ Residual income....................................

$120,000 $30,000 18,000 $12,000

13. If the company pursues the investment opportunity, this year’s residual income will be: Average operating assets....................... Net operating income............................ Minimum required return: 15% × $745,000................................ Residual income....................................

$745,000 $230,000 111,750 $118,250

14. The CEO would pursue the investment opportunity because it would raise her residual income by $12,000. 15. The CEO and the company would not want to pursue this investment opportunity because it does not exceed the minimum required return: Average operating assets....................... $120,000 Net operating income............................ $10,000 Minimum required return: 15% × $120,000................................ 18,000 Residual income.................................... $ (8,000)

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Exerc Exercise ise 11-1 (10 minutes)

Sales*................................... Variable expenses**.............. Contribution margin............... Traceable fixed expenses........ Product line segment margin. . Common fixed expenses not traceable to products........... Net operating income.............

Total Company Weedban Greengrow $300,000 $90,000 $210,000 183,000 36,000 147,000 117,000 54,000 63,000 66,000 45,000 21,000 51,000 $ 9,000 $ 42,000 33,000 $ 18,000

*

Weedban: 15,000 units × $6.00 per unit = $90,000. Greengrow: 28,000 units × $7.50 per unit = $210,000. ** Weedban: 15,000 units × $2.40 per unit = $36,000. Greengrow: 28,000 units × $5.25 per unit = $147,000.

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Managerial Accounting, 11th Canadian Edition

Exerc Exercise ise 11-2 (20 minutes) 1. Sales................................. Variable expenses (52%, 30%, 40%).......... Contribution margin........... Traceable fixed expenses. . . Geographic market segment margin................... Common fixed expenses not traceable to geographic markets*............ Operating income (loss)..... *$1,305,000 – $1,150,000

Total Geographic Market Company South Central North $2,000,000 $600,000 $800,000 $600,000 792,000 1,208,000 1,150,000 58,000

312,000 288,000 320,000

240,000 560,000 530,000

240,000 360,000 300,000

$(32,000) $ 30,000

$60,000

155,000 $ (97,000 ) = $155,000

2. Incremental sales ($800,000 × 15%).................... Contribution margin ratio ($560,000 ÷ $800,000).. Incremental contribution margin........................... Less incremental advertising expense................... Incremental operating income.............................. Yes, the advertising program should be initiated.

$120,000 × 70% 84,000 25,000 $ 59,000

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Ex Exer er erci ci cise se 1111-3 3 (20 minutes) 1. $75,000 × 40% CM ratio = $30,000 increased contribution margin in Vancouver. Since the fixed costs in the office and in the company as a whole will not change, the entire $30,000 would result in increased operating income for the company. It is incorrect to multiply the $75,000 increase in sales by Vancouver’s 25% segment margin ratio. This approach assumes that the segment’s traceable fixed expenses increase in proportion to sales, but if they did, they would not be fixed. 2. a. The segmented income statement follows:

Total Company Amount % Sales........................ $800,000 100.0 Variable expenses...............420,000 52.5 Contribution margin...................380,000 47.5 Traceable fixed expenses...............168,000 21.0 Office segment margin...................212,000 26.5 Common fixed expenses not traceable to segments...............120,000 15.0 Operating income.............. $ 92,000 11.5

Segments Toronto Vancouver Amount % Amount % $200,000 100 $600,000 100 60,000

30

360,000

60

140,000

70

240,000

40

78,000

39

90,000

15

$ 62,000

31

$150,000

25

b. The segment margin ratio rises and falls as sales rise and fall due to the presence of fixed costs. The fixed expenses are spread over a larger base as sales increase. In contrast to the segment ratio, the contribution margin ratio is stable so long as there is no change in either variable expenses or the selling price of a unit of service.

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Managerial Accounting, 11th Canadian Edition

Ex Exer er erci ci cise se 1111-4 4 (15 minutes) 1. The company should focus its campaign on Landscaping Clients. The computations are: Construction Landscaping Clients Clients Increased sales................................... $70,000 $60,000 Market CM ratio.................................. × 35% × 50% Incremental contribution margin.......... $24,500 $30,000 Less cost of the campaign................... 8,000 8,000 Increased segment margin and operating income for the company as a whole....................................... $16,500 $22,000 2. The $90,000 in traceable fixed expenses in the previous exercise is now partly traceable and partly common. When we segment Vancouver by market, only $72,000 remains a traceable fixed expense. This amount represents costs such as advertising and salaries that arise because of the existence of the construction and landscaping market segments. The remaining $18,000 ($90,000 – $72,000) is a common cost when Vancouver is segmented by market. This amount would include such costs as the salary of the manager of the Vancouver office that could not be avoided by eliminating either of the two market segments.

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Exerc Exercise ise 11-5 (10 minutes) The completed segmented income statement should appear as follows:

Sales............................................... Variable expenses............................. Contribution margin.......................... Traceable fixed expenses.................. Territorial segment margin................ Common fixed expenses................... Net operating income.......................

Total Company Amount % $500,000 100.0 270,000 54.0 230,000 46.0 130,000 26.0 100,000 20.0 90,000 18.0 $  10,000 2.0

Divisions North South Amount % Amount $300,000 100.0 $200,000 150,000 50.0 120,000 150,000 50.0 80,000 80,000 26.7 50,000 $ 70,000 23.3 $30,000

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Managerial Accounting, 11th Canadian Edition

% 100.0 60.0 40.0 25.0 15.0

Exerc Exercise ise 11-6 (10 minutes) 1. A responsibility centre is any part of an organization for which a manager is accountable for performance. 2. A profit centre is a business segment where the manager has control over revenue and cost. 3. An investment centre manager is held responsible for the residual income of the segment. 4. A cost centre is often evaluated using flexible budget variances. 5. Investment centre managers are responsible for initiating investment proposals.

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Exerc Exercise ise 11-7 (15 minutes) 1. ROI computations: ROI = Operating Income × Sales

Sales__________ Average operating assets

Eastern Division: ($70,000/$800,000) × ($800,000/$300,000) 8.75% × 2.67 = 23.3% Western Division: ($115,000/$1,850,000) × ($1,850,000/$400,000) 6.22% × 4.63 = 28.8% 2. The manager of the Western Division seems to be doing the better job. Although her margin is about 2.5 percentage points lower than the margin of the Eastern Division, her turnover is higher (a turnover of 4.63, as compared to a turnover of 2.67 for the Eastern Division). The greater turnover more than offsets the lower margin, resulting in a 28.7% ROI, as compared to a 23.3% ROI for the other division. Notice that if you look at margin alone, then the Eastern Division appears to be the strongest division. This fact underscores the importance of looking at turnover as well as at margin in evaluating performance in an investment center.

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Managerial Accounting, 11th Canadian Edition

Exerc Exercise ise 11-8 (15 minutes) 1. ROI computations: ROI = Operating Income ×

Sales

Sales

Average operating assets

Perth: ($630,000/$9,000,000) × ($9,000,000/$3,000,000) 7% × 3 = 21% Darwin: ($1,800,000/$20,000,000) × ($20,000,000/$10,000,000) 9% × 2 = 18% 2. Average operating assets (a)............... Operating income............................... Minimum required return on average operating assets—16% × (a)............ Residual income.................................

Perth Darwin $3,000,000 $10,000,000 $630,000 $1,800,000 480,000 $150,000

1,600,000 $ 200,000

3. No, the Darwin Division is simply larger than the Perth Division and for this reason one would expect that it would have a greater amount of residual income. Residual income can’t be used to compare the performance of divisions of different sizes. Larger divisions will almost always look better. In fact, in the case above, Darwin does not appear to be as well managed as Perth. Note from Part (1) that Darwin has only an 18% ROI as compared to 21% for Perth

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Ex Exer er erci ci cise se 1111-9 9 (15 minutes)

Sales.......