Sample/practice exam 10 February, questions and answers PDF

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Chapter 12 - Performance Evaluation and Decentralization 1. The practice of delegating decision-making authority to lower levels of management in a company is called centralization. a. True b. False ANSWER: False RATIONALE: The practice of delegating decision-making authority to lower levels of management in a company is called decentralization.

2. In a decentralized company, overall profit margins can mask inefficiencies within the various subdivisions. a. True b. False ANSWER: False 3. Decentralization is usually achieved by creating units called divisions. a. True b. False ANSWER: True 4. A production department within the factory, such as assembly, is an example of a profit center. a. True b. False ANSWER: False 5. In a decentralized company, central management is able to focus on strategic planning and decision making. a. True b. False ANSWER: True 6. Turnover is the most common measure of performance for an investment center. a. True b. False ANSWER: False RATIONALE: Return on investment (ROI) is the most common measure of performance for an investment center. 7. Return on investment (ROI) can be calculated by multiplying margin times turnover. a. True b. False ANSWER: True

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Chapter 12 - Performance Evaluation and Decentralization 8. Turnover is the ratio of sales to average operating assets. a. True b. False ANSWER: True 9. Decreasing inventories leads to a reduction in return on investment (ROI). a. True b. False ANSWER: False 10. Residual income is sometimes used to overcome the tendency of ROI to discourage investments that are profitable for the company, but that lower the division's ROI. a. True b. False ANSWER: True 11. Unlike ROI, residual income does not encourage a short-run orientation. a. True b. False ANSWER: False 12. Economic value added (EVA) is similar to ROI in that it links net income to capital employed. a. True b. False ANSWER: True 13. A key feature of economic value added (EVA) is that it emphasizes after-tax operating income and the actual cost of capital. a. True b. False ANSWER: True 14. Residual income is the difference between operating income and the product of the hurdle rate and the company's average operating assets. a. True b. False ANSWER:

True

RATIONALE:

Residual income is the difference between operating income and the minimum dollar return required on a company's operating assets: RI = operating income − (minimum rate of return [hurdle rate] × average operating assets)

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Chapter 12 - Performance Evaluation and Decentralization 15. In calculating residual income, the minimum rate of return is set by top management and is the same as the hurdle rate used for return on investment. a. True b. False ANSWER: True 16. The use of residual income encourages managers to accept any project that earns above the minimum rate. a. True b. False ANSWER: True 17. The direct comparison of the performance of two different investment centers is difficult using residual income because residual income is an absolute measure. a. True b. False ANSWER: True RATIONALE: Another problem with residual income is that, unlike ROI, it is an absolute measure of profitability. Thus, direct comparison of the performance of two different investment centers becomes difficult, since the level of investment may differ.

18. Economic value added is just a specific way of calculating residual income. a. True b. False ANSWER: True RATIONALE: A specific way of calculating residual income is economic value added. 19. The net income reduced by the total annual cost of capital is equal to the economic value added. a. True b. False ANSWER:

True

RATIONALE: Economic value added (EVA) is after-tax operating income minus the total annual cost of capital. 20. Basically, EVA is residual income with the cost of capital equal to the actual cost of capital for the firm (as opposed to some minimum rate of return desired by the company for other reasons). a. True b. False ANSWER: True

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Chapter 12 - Performance Evaluation and Decentralization 21. Using EVA to calculate residual income, the dollar cost of capital employed is the actual percentage cost of capital multiplied by the total capital employed. a. True b. False ANSWER: True RATIONALE: EVA is after-tax operating income minus the dollar cost of capital employed. The dollar cost of capital employed is the actual percentage cost of capital multiplied by the total capital employed.

22. In terms of operating income for the company as a whole, the transfer price set by the buying and selling divisions nets out. a. True b. False ANSWER: True 23. If there is a competitive outside market for the transferred product, then the best transfer price is the cost-based transfer price. a. True b. False ANSWER:

False

RATIONALE:

If there is a competitive outside market for the transferred product, then the best transfer price is the market price.

24. In negotiated transfer pricing, the buying division sets the ceiling (maximum possible transfer price) for the bargaining range. a. True b. False ANSWER: True 25. In negotiated transfer pricing, the selling division sets the ceiling (maximum possible transfer price) for the bargaining range. a. True b. False ANSWER: False 26. The selling division would never agree to a transfer price below its full manufacturing cost. a. True b. False ANSWER: False

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Chapter 12 - Performance Evaluation and Decentralization 27. A transfer price is the price charged for a component by the selling division to the buying division of the same company. a. True b. False ANSWER: True 28. The price charged for the transferred good affects the costs of the buying division and the revenues of the selling division. a. True b. False ANSWER: True 29. Transfer pricing is a complex issue. a. True b. False ANSWER: True 30. When the selling division can sell and the buying division can buy externally at the market price, the company as a whole will be in the same position whether or not a market price transfer takes place internally. a. True b. False ANSWER:

True

RATIONALE: This is true with regard to revenue, cost and gross profit but perhaps not for all aspects such as production, inventory, etc. 31. Several transfer pricing policies are used in practice. These transfer pricing policies include market price, costbased transfer prices, and negotiated transfer prices. a. True b. False ANSWER: True 32. The selling division is forced to transfer a product internally when a cost-based transfer pricing policy is set by top management. a. True b. False ANSWER: False RATIONALE: Neither division is forced to transfer the product internally. The transfer pricing policy only requires that if the product is transferred, it must be at cost.

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Chapter 12 - Performance Evaluation and Decentralization 33. When a product is transferred at market price, the transfer will optimize both divisional and company-wide profits. a. True b. False ANSWER:

True

RATIONALE:

If there is a competitive outside market for the transferred product, then the best transfer price is the market price. In such a case, divisional managers' actions will simultaneously optimize divisional profits and firmwide profits.

34. In _______________ decision making, decisions are made at the very top level, and lower-level managers are charged with implementing these decisions. ANSWER: centralized 35. ________________ decision making allows managers at lower levels to make and implement key decisions pertaining to their areas of responsibility. ANSWER: Decentralized 36. Decentralization usually is achieved by creating units called ___________. ANSWER: divisions 37. A ____________________ is a segment of the business whose manager is accountable for specific sets of activities. ANSWER: responsibility center 38. When a manager is responsible for only costs it is known as a(n) _______________. ANSWER: cost center 39. A(n) ________________ is when a manager is responsible only for sales. ANSWER: revenue center 40. An ______________________ is when a manager is responsible for revenues, costs and investments. ANSWER: investment center 41. Typically, investment centers are evaluated on the basis of __________________. ANSWER: return on investment 42. _____________________ refers to earnings before non-operating revenue, expenses, interest and taxes. ANSWER: Operating income 43. _____________ is the ratio of operating income to sales. ANSWER: Margin 44. _________________ is found by dividing sales by average operating assets. ANSWER: Turnover Cengage Learning Testing, Powered by Cognero

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Chapter 12 - Performance Evaluation and Decentralization 45. _______________ indicate the minimum ROI necessary to accept an investment. ANSWER: Hurdle rate 46. Thedifferencebetweenoperatingincomeandtheminimumdollarreturnrequiredonacompany’soperatingassets is the _______________. ANSWER: residual income 47. ___________________ is after-tax operating income minus the dollar cost of capital employed. ANSWER: Economic value added 48. A _________________ is the price charged for a component by the selling division to the buying division of the same company. ANSWER: transfer price 49. If there is a competitive outside market for the transferred product, then the best transfer price is the _____________. ANSWER: market price 50. The ________________ is a strategic management system that defines a strategic-based responsibility accounting system. ANSWER: Balanced Scorecard 51. ______________________ occurs whenever managers receive information about the effectiveness of strategy implementation as well as the validity of the assumptions underlying the strategy. ANSWER: Double-loop feedback 52. _________________ emphasizes only effectiveness of implementation. ANSWER: Single-loop feedback 53. ________________ is the difference between realization and sacrifice, where realization is what the customer receives and sacrifice is what is given up in return. ANSWER: Customer value 54. The practice of delegating decision-making authority to the lower levels of management in a company is a. centralization. b. decentralization. c. performance evaluation. d. authorization. e. hierarchy flattening. ANSWER: b

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Chapter 12 - Performance Evaluation and Decentralization 55. Which of the following is a reason for decentralization? a. Ease of gathering and using local information. b. Focusing of central management. c. Training and motivating segment managers. d. Exposing segments to market forces. e. All of these. ANSWER: e 56. Divisions in a decentralized company can be created along which of the following lines? a. geographical b. types of goods or services produced c. type of responsibility given to divisional manager d. All of these answers are correct. e. None of these answers are correct. ANSWER: d 57. A responsibility center in which a manager is responsible only for costs is a(n) a. investment center. b. revenue center. c. profit center. d. cost center. e. center not presented here. ANSWER: d 58. A responsibility center in which a manager is responsible only for sales is a(n) a. cost center. b. revenue center. c. profit center. d. investment center. e. None of these. ANSWER: b 59. A responsibility center in which a manager is responsible for both revenues and costs is a(n) a. cost center. b. revenue center. c. profit center. d. investment center e. None of these. ANSWER: c

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Chapter 12 - Performance Evaluation and Decentralization 60. A responsibility center in which a manager is responsible for revenues, cost, and investment is a(n) a. cost center. b. revenue center. c. profit center. d. investment center. e. None of these. ANSWER: d 61. The decision-making approach that allows managers at lower levels to make and implement key decisions pertaining to their areas of responsibility is a. responsibility accounting. b. controllable accounting. c. decentralization. d. optimal strategic accounting. e. None of these. ANSWER: c 62. Decentralization is frequently chosen by companies because it a. allows higher management to make all decisions. b. allows higher management to gather local information to make better decisions. c. protects segments of the company from competitive pressures. d. allows for training and motivation of local managers. e. allows the CEO to make all important decisions. ANSWER: d 63. A segment of Mega Inc., manufactures and sells blankets. The various models of blankets are produced in a single factory using stable technology. They are sold by the sales department, also located in the factory. The segment is most probably accounted for as a(n) a. cost center. b. revenue center. c. profit center. d. investment center. e. None of these. ANSWER: c

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Chapter 12 - Performance Evaluation and Decentralization 64. JetSky Airways has three divisions, the Western Division, the Eastern Division, and the Northern Division. The manager of the Western Division had wanted to purchase replacement airplanes for the division. However, he decided against it because, although revenues would increase and the new planes would be less expensive to operate, the initial cost of the planes was quite large. The Western Division is most probably accounted for as a(n) a. cost center. b. investment center. c. profit center. d. revenue center. e. None of these. ANSWER: b 65. Return on investment (ROI) is calculated as a. operating income / average operating assets. b. average operating assets / operating income. c. (beginning operating assets + ending operating assets) / 2. d. sales / average operating assets. e. operating income / sales. ANSWER: a 66. Margin is calculated as a. operating income / sales. b. average operating assets / operating income. c. (beginning operating assets + ending operating assets) / 2. d. sales / average operating assets. e. operating income / average operating assets operating income / sales. ANSWER: a 67. Turnover is calculated as a. operating income / average operating assets. b. average operating assets / operating income. c. (beginning operating assets + ending operating assets) / 2. d. sales / average operating assets. e. operating income / sales. ANSWER: d

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Chapter 12 - Performance Evaluation and Decentralization 68. A positive result that stems from the use of return on investment (ROI) is that it encourages managers to focus on a. the relationship among sales, expenses, and investment. b. cost efficiency. c. operating asset efficiency. d. the efficient use of resources in generating income. e. All of these. ANSWER: e 69. Division A had ROI of 15% last year. The manager of Division A is considering an additional investment for the coming year. What step will the manager likely choose to take? a. Accept the investment as long as it provides positive operating income. b. Accept the investment as long as its ROI is positive. c. Reject the investment if it returns more than 15% ROI. d. Reject the investment if it returns less than 15% ROI. e. Reject the investment if it returns an ROI equal to 15%. ANSWER: d 70. The manager of a division is displeased with the ROI of the division. One step that would increase ROI (holding everything else constant) is a. increasing investment. b. increasing sales. c. increasing costs. d. decreasing operating income. e. None of these. ANSWER: b 71. Which of the following is a disadvantage of a focus on return on investment? a. It can encourage managers to focus on cost cutting efforts. b. It can produce a narrow focus on divisional profitability at the expense of profitability for the overall firm. c. It can encourage managers to cut inventories and reduce overall investment. d. It can encourage managers to focus on the long run at the expense of the short run. e. It can accomplish all of these disadvantages. ANSWER: b

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Chapter 12 - Performance Evaluation and Decentralization 72. Castor Company had income of $10,000, average assets of $100,000 and sales of $40,000. What is Castor's ROI? a. 10% b. 20% c. 25% d. 0.4% e. 40% ANSWER: a RATIONALE: ROI = $10,000 / $100,000 = 0.10 or 10% 73. Shandling Company had operating income of $70,000, sales of $218,750, and turnover of 0.5. What is Shandling's ROI? a. 32% b. 50% c. 16% d. 64% e. Cannot be determined from this information. ANSWER:

c

RATIONALE: ROI = margin × turnover = ($70,000 / $218,750) × 0.5 = 0.16 or 16% 74. Beta Division had the following information: Asset base in Beta Division $400,000 Operating income in Beta Division $50,000 Cost of capital 12% Target ROI 15% Margin for Beta Division 20% If the asset base is decreased by $100,000, with no other changes, the return on investment of Beta Division will be a. 100.0%. b. 16.7%. c. 600.0%. d. 62.5%. ANSWER: b RATIONALE: SUPPORTING CALCULATIONS: $50,000 / ($400,000 − $100,000) = 16.7%

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Chapter 12 - Performance Evaluation and Decentralization 75. If the National Division of American Products Company had a turnover ratio of 4.2 and a margin of 0.10, the return on investment would be a. 23.8%. b. 420.0%. c. 42.0%. d. 238.0%. ANSWER: c RATIONALE: SUPPORTING CALCULATIONS: 4.2 × 0.10 = .42 or 42% 76. If the margin of 0.30 stayed the same and the turnover ratio of 5.0 increased by 10%, the ROI would a. increase by 10%. b. decrease by 10%. c. increase by 15%. d. remain the same. ANSWER: a RATIONALE: SUPPORTING CALCULATIONS: [(0.30 × 5.5*) − 1.5**] / 1.5 = 10% increase *5.00×1.1 **0.30 ×5.00 77. If the operating asset turnover ratio increased by 30% and the margin increased by 20%, the divisional ROI a. would increase by 56%. b. would decrease by 60%. c. would increase by 20%. d. cannot be determined. ANSWER: a RATIONALE: SUPPORTING CALCULATIONS: 1.30 × 1.20 = 1.56 or a 56% increase 78. If the operating asset turnover increased by 50% and the margin increased by 50%, the ROI would increase by a. 50%. b. 25%. c. 100%. d. 125%. ANSWER: d RATIONALE: SUPPORTING CALCULATIONS: 1.50 × 1.50 = 2.25 or 125% increase

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Chapter 12 - Performance Evaluation and Decentralization 79. Which of the following is not an advantage of ROI? a. It encourages managers of departments with high ROIs to invest in average ROI projects. b. It encourages managers to pay careful attention to the relationships among sales, expenses, and investment. c. It encourages cost efficiency. d. It discourages excessive investment in operating assets. ANSWER: a 80. Which of the following is not a disadvantage of the ROI performance measure? a. It encourages managers to focus on the long run rather than the short run. b. It discourages managers from investing in projects that would decrease divisional ROI but increase the profitability of the company as a whole. c. It encourages myopic behavior. d. All of these are disadvantages of the ROI measure. ANSWER: a Figure 12-1. Dempsey Company provided the following information for last year: Operating income $86,000 Sales $225,000 Beginning operating assets $390,000 Ending operating assets $420,000 81. Refer to Figure 12-1. Calculate Dempsey's margin for last year, rounding to two decimal places. a. 2.0 b. 0.26 c. 0.38 d. 0.50 e. 0.35 ANSWER:

c

RATIONALE: Margin = $86,000 / $225,000 = 0.38 82. Refer to ...