Managerial accounting, 5th by jiambalvo test bank ch12

CHAPTER 12 Decentralization and Performance Evaluation Summary of Questions by Objectivses and Bloom’s Taxonomy Item SO BT Item True-False Statements 1 K K K K 10 K 11 K 12 Multiple Choice Questions 31 K 58 32 C 59 33 K 60 34 K 61 35 K 62 36 K 63 37 K 64 38 C 65 39 K 66 40 C 67 41 K 68 42 K 69 43 K 70 44 K 71 45 K 72 46 K 73 47 K 74 48 C 75 49 C 76 50 K 77 51 K 78 52 K 79 53 C 80 54 C 81 55 K 82 56 K 83 57 K 84 Matching 162 1-7 K Exercises 163 AP 167 164 AP 168 165 AN 169 166 AN 170 SO BT Item SO BT Item 3 3 K K K K K K 13 14 15 16 17 18 4 4 4 4 4 4 4 4,5 6 5 6 6 K C C C AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP K C C K C K K AP 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 *103 *104 *105 *106 *107 *108 *109 *110 *111 4 4,6 4,6 AN AP AP AP SO BT 4 4 K C K K C K 19 20 21 22 23 24 5 6 C K K C C C 6 6 6 6 6 7 7 A1 A1 A1 A1 A1 A1 A1 A1 A1 AP AP AP AP AP AP AP AP AP AP AP AP AP K K K K K K K K AP C C K K AP *112 *113 *114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 A1 A1 A1 4 4 4 4 4 4 4 4 4 4 171 4,6 172 4,5 173 4,5, 174 AP A N A N AP 175 176 177 *178 4,6 A1 Item SO BT 25 26 27 28 *29 *30 7 A1 A1 K K K K K K AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP AP 139 140 141 142 143 144 145 146 147 148 149 150 151 152 *153 *154 *155 *156 157 158 159 160 161 4 6 6 4 A1 A1 A1 A1 6 6 AP AP AP K K K AN AN AN =N AP AP AP AP AP AP AP AP AN AP AP AP AP AP AP AN AP AN 179 180 6 AN AP 12-2 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition Challenge Exercises 181 4,5 EV 182 Short-Answer Essays 186 C 188 187 C 189 AN 183 4,5 A 184 4 C C 190 191 C K *192 AN A1 C 185 4,6 EV 12-3 Chapter 12 Decentralization and Performance Evaluation True-False In decentralized organizations, upper level corporate managers provide substantial authority to subunits because they have the most expertise An advantage of decentralization is that subunit managers can respond more quickly to changing circumstances Lack of goal incongruence is a problem in decentralized organizations In a decentralized organization, performance evaluations encourage managers to behave as if their own personal goals are congruent with the goals of the company as a whole Increased motivation of managers is an advantage of decentralization Evaluating the performance of a subunit is the same as evaluating the performance of the subunit manager Responsibility accounting holds managers responsible for all direct and allocated costs charged to their operational unit Managers of cost centers are evaluated in order to decide if a division should be expanded, contracted, or changed A profit center is a subunit that has responsibility for controlling costs and revenues and generating a return on assets invested in the subunit 10 Most service departments, such as machine maintenance and computer services, are considered cost centers 11 An investment center manager is responsible for controllable revenues and costs, and controllable investments 12 Cost centers, profit centers, and investment centers are all responsible for controlling costs in the respective subunit 13 One of the primary tools for evaluating the performance of profit centers is residual income 14 A profit margin of 12 percent indicates that each dollar of assets invested generated 12 cents of profit 15 Return on investment can be improved by increasing net income or increasing the assets invested 16 One disadvantage of evaluating performance using return on investment is that assets are measured at their market value 17 If managers are evaluated using return on investment, they are often over aggressive of accepting new investments because the investment will provide an increase in net income 18 One of the primary tools for evaluating the performance of investment centers is residual income 12-4 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 19 Managers who are evaluated favorably when profit is used as the performance measure will most likely be evaluated favorably when return on investment is used as the performance measure 20 Managers tend to over invest when profit is used to evaluate them 21 Managers tend to under invest when return on investment is used to evaluate them 22 When residual income is calculated, an amount is subtracted to cover the profit that the company believes should be earned by the assets invested in the subunit 23 When performance evaluation is based on return on investment, managers will usually accept projects that yield less than the required rate of return 24 Using NOPAT as ‘income’ in the residual income model is appropriate because managers not control the choice of using debt versus equity financing for the assets invested in their division 25 Economic value added is calculated as the return on investment adjusted for accounting distortions 26 The four dimensions of performance that are considered in a balanced scorecard are financial, customer, internal processes, and strategy 27 A balanced scorecard is used to evaluate investment centers 28 A strategy map is a diagram of relationships across the four dimensions of a balanced scorecard *29 When an efficient market exists, the variable cost will generally be the best transfer price *30 Transfer prices should represent the opportunity costs of the transferred item Material from the appendix to the chapter is marked with an asterisk (*) Answers F T F T T 10 F F F F T 11 12 13 14 15 T T F F F 16 17 18 19 20 F F T F T 21 22 23 24 25 T T F T F 26 27 28 *29 *30 F T T F T 12-5 Chapter 12 Decentralization and Performance Evaluation MULTIPLE CHOICE 31 Firms that grant substantial decision-making authority to the managers of subunits are referred to as A residual organizations B profit centers C responsibility organizations D decentralized organizations 32 Which of the following determines the level of decentralization in a company? A The diversity of the company’s products B The number of levels of employees and management in the company C The extent of decision-making authority given to the subunit managers D The globalization of the company’s sales 33 Which of the following is not an advantage of decentralization of a company? A Subunit managers have better information B Subunit managers will act to benefit the organization as a whole C Subunit managers can respond quicker to changing circumstances D Subunit managers receive training helpful to future transition into top-level management positions 34 Which of the following is an advantage of a decentralized organization? A Allows for duplication of activities B Enables managers to enhance goal incongruence C Provides excellent training for potential top-level executives D Allows only top-level managers to make all decisions 35 Which of the following is a disadvantage of a decentralized organization? A Managers’ goals are congruent with the goals of the company as a whole B Some activities may be duplicated and incur unnecessary costs C Managers with the highest authority may take inappropriate decisions D Managers may take more time to respond to changing circumstances 36 Goal congruence refers to the match between A locations of manufacturing plants and customers B goals based on profits and those based on return on investment C number of units produced and number of units sold D goals of the individual managers and those of the company as a whole 37 Companies evaluate performance of subunits and subunit managers in order to A identify successful operations B influence the behavior of managers C determine areas that need improvement D All of these answer choices are correct 12-6 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 38 The evaluation of a subunit should be separated from the evaluation of the subunit’s manager because A a subunit always shows better performance B an excellent manager may be doing the best job possible in a poor subunit C poor performance by managers may cause subunits to perform poorly D GAAP requires separate evaluations of managers and the respective subunits 39 For what does responsibility accounting hold managers responsible? A All costs charged to a manager’s subunit B All costs charged to a manager’s subunit plus a share of company-wide fixed costs C Only the costs that a manager can control D Only the costs that a manager have personally approved 40 If a company uses responsibility accounting, a shift supervisor in the Austin production plant should be held responsible for A all costs associated with the Austin plant B direct costs incurred on the supervisor’s shift C a share of all of the company’s costs D direct material, direct labor, and all manufacturing overhead incurred on the supervisor’s shift 41 A cost center A is responsible for generating profit B should be evaluated using return on investment to best motivate managers C places its managers responsible for all costs under their control D requires a set of performance measures that are more complex than those for an investment center 42 A subunit that has responsibility for controlling costs, but does not have responsibility for generating revenue is a(n) A investment center B cost center C profit center D value added center 43 Which of the following units of Walmart will most likely be a cost center? A A Walmart store in Dallas, Texas B The corporate payroll department C The pharmacy department D The optical department 44 Most service departments, such as machine maintenance and janitorial services, are examples of A investment centers B profit centers C cost centers D transfer centers 12-7 Chapter 12 Decentralization and Performance Evaluation 45 If responsibility centers are ranked in order of increasing responsibility, the ranking is A investment centers, cost centers, profit centers B cost centers, investment centers, profit centers C cost centers, profit centers, investment centers D investment centers, profit centers, cost centers 46 Which of the following is a characteristic of a profit center? A The center’s manager has control over revenues and costs B The subunit has responsibility for generating revenues, controlling costs, and generating a return on assets C The subunit can be evaluated using residual income D The subunit can be evaluated by comparing it to other investment centers 47 A manager who has the ability to replace assets within his division, is in control of what type of center? A Business center B Profit center C Cost center D Investment center 48 The Cadillac division of General Motors is considered A a profit center B an investment center C a cost center D a center that will be evaluated on profit margin 49 Which of the following is a responsibility that distinguishes an investment center manager from a profit center manager? A Setting prices for products B Controlling costs C Generating revenues while controlling costs D Significantly influencing investment decisions 50 What does ROI measure? A The amount of profit generated out of each sales dollar B The amount of sales generated out of each dollar of assets invested C The amount of profit generated out of each dollar of assets invested D The amount of revenue generated out of each sales dollar 51 Return on investment is the ratio of A investment center income to invested capital B sales to net income C profit center revenues to assets invested D profit center revenues to profit center expenses 52 Return on investment is used to evaluate A profit centers B cost centers C investment centers D revenue centers 12-8 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 53 Why is return on investment better than income as a measure of performance for an investment center? A The calculation for income is determined by GAAP, while return on investment is adjusted to meet the needs of the company B Return on investment is easier to calculate than income C Return on investment considers the amount invested as well as the income D Return on investment is forward looking, while income is backward looking 54 Which of the following can improve a company’s return on investment? I Increase the profit margin II Decrease total assets III Decrease the contribution margin A I, II, and III B I and III C II and III D I and II 55 Profit margin is A the ratio of sales to income B multiplied by investment turnover to calculate return on investment C the amount of income earned on each dollar of assets invested D All of these answer choices are correct 56 The income amount that is used in the calculation of return on investment is usually A earnings before interest and taxes B net income as defined by GAAP C operating cash flows D net operating profit after taxes 57 NOPAT is A net income with costs removed that managers at the divisional level are unable to control B net income plus noncash flow amounts C net income less the cost of financing D net income minus noninterest-bearing current liabilities 58 NOPAT does not hold the investment center manager responsible for A interest expense B interest expense and noninterest-bearing current liabilities C noninterest-bearing current liabilities D assets invested in the division 59 NOPAT is used for ‘income’ in the return on investment formula because A investment center managers should not be evaluated based on long-term financing decisions since they not have responsibility for making those decisions B NOPAT represents the return to stockholders, and divisions are free to issue stock C NOPAT represents the return to debt capital, and division managers generally are free to issue debt needed to acquire new investments D All of these answer choices are correct 12-9 Chapter 12 Decentralization and Performance Evaluation 60 Which of the following consists of noninterest-bearing current liabilities? A Accrued income taxes and income taxes payable B Accounts receivable and accounts payable C Accounts payable and dividends declared D Wages payable and notes payable 61 It is difficult to compare investment centers using return on investment when there is a significant difference in the _ between the investment centers A age of the assets B net operating profit after taxes C amount of noninterest-bearing current liabilities D market share 62 The 2014 income statement for the East Division of Procter Wells Company is as follows: Sales $1,800,000 Operating expenses 1,380,000 Net operating income 420,000 Interest expense 120,000 Earnings before taxes 300,000 Income tax expense (40%) 120,000 Net income $ 180,000 This division’s invested capital is $4,000,000 How much is the East Division’s return on investment? A 6.3% B 5.7% C 10.5% D 7.5% 63 The income statement for the Commercial Construction Division of the Kenyon Company is as follows: Sales $272,000 Operating expenses 132,000 Net operating income 140,000 Interest expense 20,000 Earnings before taxes 120,000 Income tax expense (30%) 36,000 Net income $ 84,000 If this division’s invested capital is $500,000, how much is its return on investment? A 19.6% B 16.8% C 20.8% D 14.0% 64 South Division of Renato Enterprises reported net income of $480,000 in March on sales of $7,900,000 If this division has no interest expense, an income tax rate of 30 percent, and reported a return on investment of 12 percent, how much is invested capital? A $948,000 B $4,000,000 C $2,800,000 D More information is needed to determine the answer 12-10 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 65 West Division of PoolGuard has invested capital of $900,000 This division incurred $80,000 in interest expense and $20,000 in income tax expense related to interest in July If this division reported a return on investment of 15 percent, how much is NOPAT? A $60,000 B $75,000 C $135,000 D $195,000 66 Rail Star Company reported the following results for 2014: Sales Investment turnover Return on investment $6,000,000 2.4 10% Given this information, how much is the company’s invested capital? A $2,500,000 B $1,440,000 C $600,000 D $1,440,000 67 The Florida Division of Garner Furniture reported the following results for 2014: Invested capital Profit margin Return on investment $800,000 5% 8% Given this information, how much was sales? A $1,280,000 B $500,000 C $1,600,000 D $64,000 68 The 2014 income statement for the Clothing Division of Tom Ron Surf Company is as follows: Sales Operating expenses Net operating income Interest expense Earnings before taxes Income tax expense (30%) Net income $445,000 270,000 175,000 35,000 140,000 42,000 $ 98,000 How much is net operating profit after taxes? A $108,500 B $133,000 C $73,500 D $122,500 12-34 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition Answers 31 D 32 C 33 B 34 C 35 B 36 D 37 D 38 B 39 C 40 B 41 C 42 B 43 B 44 C 45 C 46 A 47 D 48 B 49 D 50 C 51 A 52 C 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 C D B D A A A A A A A B C A A D B C B A B A 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 C A C D A B B B D A C A A D C B D A A D C B 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 A A A C A B A D B C D B C D A B D A B C A C 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 139 140 B A D C D C A C B A A D A D C D C C A A C D 141 142 143 144 145 146 147 148 149 150 151 152 153 154 155 156 157 158 159 160 161 A D D A D D A C D A D A C A B D A B A B A 12-35 Chapter 12 Decentralization and Performance Evaluation MATCHING 162 Match each of the following terms with the phrase that most closely describes it Each answer may be used only once _ Balanced scorecard NOPAT _ Cost center Profit center _ Decentralized organization Profit margin _ Economic value added 10 Residual income _ Goal congruence 11 Return on investment _ Investment center 12 Investment turnover A B C D E F G H I J K L Answers Ratio of investment center income to invested capital Net income + interest expense – tax savings due to interest expense Firms that grant substantial decision-making authority to the managers of subunits Ratio of income to sales Compatibility between personal goals and the goals of the organization Residual income adjusted for accounting distortions Subunit that has responsibility for controlling costs but is not responsible for generating revenues Ratio of sales to invested capital Subunit that has responsibility for generating revenues as well as controlling costs Set of performance measures that consider factors other than financial results Subunit charged with earning income that is consistent with the amount of assets invested in the segment NOPAT minus profit required for the level of investment in the investment center J G C F E K 10 11 12 B I D L A H 12-36 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition EXERCISES 163 Smith Division produces soap and reported sales of $540,000, which generated a net income after tax deduction of $77,900 for 2014 The division did not incur any interest expenditure during the year Smith Division’s invested capital for the year amounted to $820,000 Smith’s parent corporation has a required rate of return equal to 10 percent and a cost of capital of percent How is the division performing if it is evaluated using return on investment? Answer Return on investment = $77,900 ÷ $820,000 = 9.5% Smith Division earned less than the required rate of return of 10 percent indicating is it not performing as well as the parent corporation expects it to perform 164 Floyd Productions’ West Division reported sales of $280,000 and net income totaling $58,800 The invested capital in West Division is $336,000 Calculate West Division’s profit margin, investment turnover, and return on investment Answer Profit margin = $58,800 ÷ $280,000 = 21% Investment turnover = $280,000 ÷ $336,000 = 0.83 Return on investment = $58,800 ÷ $336,000 = 17.5% 165 For fiscal year 2014, Regency Division of Florida Malls had income as follows: Sales revenue $43,000,000 Expenses: Cost of goods sold $28,400,000 Selling and administrative expense 5,600,000 Interest expense 1,100,000 35,100,000 Income before taxes 7,900,000 Income tax expense 2,765,000 Net income $ 5,135,000 The Regency Division’s total assets were $89,000,000 and its current liabilities totaled $3,200,000 with $700,000 of these being interest-bearing The company has a required rate of return of percent and a cost of capital of 7.2 percent Calculate NOPAT, invested capital, and return on investment for Regency Division and comment on the company’s performance Answer Income tax rate = $2,765,000 ÷$7,900,000 = 35% NOPAT = $5,135,000 + $1,100,000 (1 – 0.35) = $5,850,000 Invested capital = $89,000,000 – ($3,200,000 – $700,000) = $86,500,000 Return on investment = $5,850,000 ÷ $86,500,000 = 6.76% The division is not performing well given that the required rate of return on invested capital is percent, and the division has generated only 6.76 percent from the invested assets 166 The chief operating officer (COO) of the DeSoto Corporation is considering the effect of depreciation on the return on investment of one of its divisions In the most recent year, the division had net operating profit after taxes totaling $1,377,000 and the invested capital was 12-37 Chapter 12 Decentralization and Performance Evaluation $16,200,000 The COO has determined that total assets will decline each year by percent due to depreciation of plant and equipment, but NOPAT will remain relatively constant a b Calculate return on investment for each of the next three years considering the change in value of the assets Explain why evaluation in terms of return on investment may lead managers to delay purchases of equipment that, in the long-run, will be needed to remain competitive Answer a NOPAT Investment Return on investment b 167 Year $1,377,000 $16,200,000 8.50% Year $1,377,000 $15,228,000 9.04% Year $1,377,000 $14,314,320 9.62% If no new investment is made, return on investment automatically improves from 8.50 percent to 9.62 percent over the three-year period Managers have an incentive to avoid or delay investments that will increase the investment base to prevent a reduction of the return on investment Consider the following information for South Coast Division of the Lacy’s Department Stores for 2014 and 2013 2014 2013 Total assets $24,000,000 $21,600,000 Noninterest-bearing current liabilities 1,600,000 2,100,000 Interest-bearing current liabilities 800,000 500,000 Sales 44,800,000 42,900,000 Interest expense 1,100,000 1,400,000 Net income 3,596,000 3,707,400 Tax rate 40% 40% a b c Compute return on investment for both years Break the return on investment down into profit margin and investment turnover Comment on the change in financial performance between 2013 and 2014 Answer a 2014: [$3,596,000 + ($1,100,000 × (1 – 40%))] ÷ ($24,000,000 – $1,600,000) = 19.0% 2013: [$3,707,400 + ($1,400,000 ì (1 40%))] ữ ($21,600,000 $2,100,000) = 23.3% b Profit margin: 2014: [$3,596,000 + ($1,100,000 × (1 – 40%))] ÷ $44,800,000 = 9.5% 2013: [$3,707,400 + ($1,400,000 × (1 – 40%))] ÷ $42,900,000 = 10.6% Investment turnover: 2014: $44,800,000 ÷ ($24,000,000 – $1,600,000) = 2.00 2013: $42,900,000 ÷ ($21,600,000 – $2,100,000) = 2.20 c Between 2013 and 2014, return on investment declined from 23.3% to 19.0% This was due to the decrease in profit margin (10.6% to 9.5%) and the decrease in investment turnover (2.2 to 2.0) 12-38 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 168 Cowell Enterprises has two divisions Its Seaboard Division has $800,000 in invested capital Its sales totaled $1,440,000 in a year when NOPAT was $123,120 Calculate the division’s profit margin, investment turnover, and return on investment Answer Profit margin = $123,120 ÷ $1,440,000 = 8.55% Investment turnover = $1,440,000 ÷ $800,000 = 1.80 Return on investment = $123,120 ÷ $800,000 = 15.39% 169 Loyalty Company has net income of $150,000, $100,000 in interest expense, an income tax rate of 35 percent, and a cost of capital of 14 percent It has total assets of $1,525,000, with noninterest-bearing current liabilities of $275,000 Calculate NOPAT and residual income for Loyalty Answer NOPAT = $150,000 + [$100,000 × (1 – 0.35)] = $215,000 Residual income = $215,000 – [($1,525,000 – $275,000) × 0.14] = $40,000 170 Information for the Container Division of Advanced Disposal for a recent year is given below: Sales $30,000,000 Interest expense 4,000,000 Net income 2,000,000 Total assets 80,000,000 Noninterest-bearing current liabilities 20,000,000 Interest-bearing current liabilities 1,000,000 Cost of capital 11% Required rate of return 13% Income tax rate 30% Calculate the following amounts for Container Division: a NOPAT b Invested capital c Return on investment d Residual income Answer a NOPAT = $2,000,000 + [$4,000,000 × (1 – 0.3)] = $4,800,000 b Invested capital = $80,000,000 – $20,000,000 = $60,000,000 c Return on investment = $4,800,000 ÷ $60,000,000 = 8% d Residual income = $4,800,000 – ($60,000,000 × 0.11) = ($1,800,000) 12-39 171 Chapter 12 Decentralization and Performance Evaluation Sanford Division of Shoebox Enterprises compiled the following information concerning its performance in a recent year: Total assets Noninterest-bearing current liabilities Sales Interest expense Net income Cost of capital Required rate of return Income tax rate $5,200,000 240,000 4,100,000 90,000 480,000 8.5% 9.8% 30% How much wealth did Sanford Division add to Shoebox Enterprises’ shareholder value? Answer NOPAT = $480,000 + $90,000 × (1 – 30%) = $543,000 Invested capital = $5,200,000 – $240,000 = $4,960,000 Residual income = $543,000 – ($4,960,000 × 8.5%) = $121,400 172 Top management of the Luxor Corp is trying to construct a performance evaluation system to use to evaluate each of its three divisions Financial data are as follows: Granite Marble Porcelain Total assets $830,000 $3,700,000 $4,200,000 Noninterest-bearing current liabilities 40,000 650,000 200,000 NOPAT 102,700 259,250 500,000 Income tax rate 40% 40% 40% Cost of capital 7% 8% 9% Required rate of return 10% 12% 11% How will the divisions be ranked (from best to worst performance) if the evaluation is based on ‘profit’ compared to return on investment? Under which evaluation method is management more likely to overinvest? Under which method is more likely to underinvest? Answer Return on investment – Granite Division = $102,700 ÷ [$830,000 – $40,000] = 13.0% Return on investment – Marble Division= $259,250 ÷ [$3,700,000 – $650,000] = 8.50% Return on investment – Porcelain Division = $500,000 ÷ [$4,200,000 – $200,000] = 12.5% Based on profit: Porcelain Division, Marble Division, Granite Division Based on ROI: Granite Division, Porcelain Division, Marble Division Managers evaluated using profit tend to overinvest to generate a few extra dollars of profit even if the investment does not meet the minimum required rate of return Managers evaluated using return on investment tend to underinvest because they don’t want their divisional return on investment to decline 12-40 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 173 Consider the following data, which relate to the two divisions of Office Products Total assets Noninterest-bearing current liabilities NOPAT Cost of capital West Division $51,000,000 6,000,000 12,000,000 8% East Division $28,000,000 3,500,000 5,020,000 10% Compare the two divisions in terms of return on investment and residual income In the past year, which division has created the most wealth for Office Product’s shareholders? Answer West Division: Return on investment = $12,000,000 ÷ $45,000,000 = 26.7% Residual Income = $12,000,000 – (.08 × $45,000,000) = $8,400,000 East Division: Return on investment = $5,020,000 ÷ $24,500,000 = 20.5% Residual Income = $5,020,000 – (.10 × $24,500,000) = $2,570,000 West Division created more wealth, $8,400,000, as compared to $2,570,000 for East Division 174 The Pastry Division of Cinotti’s Bakery reported NOPAT totaling $512,000 in 2014 This included $330,000 in research and development costs for 2014 Additionally, research and development in 2013 and 2012 were, respectively, $280,000 and $240,000 Invested capital at the end of 2014 totaled $5,400,000 The company is subject to a 30% income tax rate Cinotti capitalizes and amortizes intangible assets over years The company’s cost of capital is percent and its required rate of return is percent How much is EVA? Answer Adjustment to NOPAT: For 2014 R&D expensed 2012 R&D: $240,000 ÷ 2013 R&D: $280,000 ÷ 2014 R&D: $330,000 ÷ Total adjustment before income taxes Income tax effect ($117,500 × 30%) Net adjustment to NOPAT Adjustment to invested capital: 2012 R&D: $240,000 × 1/4 2013 R&D: $280,000 × 2/4 2014 R&D: $330,000 × 3/4 Total adjustment to invested capital $330,000 (60,000) (70,000) (82,500) 117,500 35,250 $ 82,250 $ 60,000 140,000 247,500 $447,500 EVA = ($512,000 + $82,250) – 7% × ($5,400,000 + $447,500) = $184,925 12-41 175 Chapter 12 Decentralization and Performance Evaluation The Knob Division of Barnett Brass has NOPAT of $42,000 The company’s cost of capital is 5.5 percent, its required rate of return is 8.4 percent The division’s invested capital totals $560,000 How much is the division’s residual income? Answer Residual Income = $42,000 – ($560,000 × 5.5%) = $11,200 176 For fiscal year 2014, the Pharmacy Division of Halgreen RX reported net income totaling $6,000,000 Its interest expense was $1,000,000, and the income tax rate was 40 percent The total assets of the Pharmacy Division were $68,000,000, and total current liabilities were $7,000,000 with $3,200,000 being interest-bearing The company’s cost of capital is percent and its required rate of return is percent Calculate NOPAT, invested capital, and residual income for the Pharmacy Division and comment on the division’s contribution to the company’s performance Answer NOPAT Invested capital Residual income = = = $6,000,000 + [$1,000,000 × (1 – 40)] = $6,600,000 $68,000,000 – ($7,000,000 – $3,200,000) = $64,200,000 $6,600,000 – (.08 × $64,200,000) = $1,464,000 The Pharmacy Division contributed $1,464,000 to the wealth of Halgreen RX during 2014 This is the amount that exceeds the cost of financing the assets invested in the Pharmacy Division 177 Walk-In Care Center is a division of Shands Corporation and is organized as an investment center In the past year, the Care Center reported an after-tax income of $760,000 Total interest expense was $70,000, and the center’s income tax rate is 35 percent Its assets totaled $12,000,000, noninterest-bearing current liabilities were $900,000, and interest-bearing current liabilities totaled $600,000 Shands has established a required rate of return of percent, while its cost of capital is 6.4 percent Calculate the residual income generated by Walk-In Care Center Answer NOPAT Invested capital Residual income *178 = = = $760,000 + [$70,000 × (1 – 35)] = $805,500 $12,000,000 – $900,000 = $11,100,000 $805,500 – (6.4% × $11,100,000) = $95,100 Windsor Medical Services has two outpatient clinics and a pathology laboratory, which are organized as separate profit centers When the pathology laboratory conducts tests ordered by the clinics, the clinics are charged the basic market price of the tests The managers of the clinics object to this practice and argue that because they are all part of the same company, they should be charged for the cost of the procedures rather than market price Support the use of market prices or cost-based prices for charging clinics for tests performed by the pathology laboratory Answer The lab is organized as a profit center Therefore, it should be allowed to charge competitive market prices for tests Charging cost-based prices may lead to inefficient use of lab tests by the outpatient clinics (since they can use the lab at a charge less than the opportunity cost associated with the use) and lab managers may lose their incentive to perform effectively 12-42 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 179 Good Buy Electronics is considering a plan by which its managers will be evaluated and rewarded based on a measure of economic value added Before adopting the plan, management wants you to calculate the projected amount of EVA for 2014, based on financial forecasts and prior financial data, as follows: Total assets Noninterest-bearing current liabilities Sales Net income Interest expense Research and development Income tax rate Cost of capital Required rate of return $57,000,000 20,000,000 120,000,000 5,800,000 1,200,000 2,400,000 35% 7% 9% Research and development expenditures in 2012 and 2013 were $1,200,000 and $2,100,000, respectively Research and development is amortized over a three-year life a b Answer a b Explain why it is important to capitalize research and development if managers are rewarded based on EVA Calculate forecasted EVA for 2014 Under GAAP, research and development is treated as an expense even though it creates future value Managers may be tempted to cut back on research and development in order to increase reported earnings With EVA, research and development is capitalized and amortized over the future periods that are benefited Since it is not immediately expensed for purposes of calculating EVA and because managers are rewarded based on their EVA performance, managers will have less incentive to cut research and development Net income Plus interest, net of taxes ($1,200,000 × (1 – 35%)) Plus 2014 R&D Less amortization of 2014 R&D ($2,400,000 ÷ 3) Less amortization of 2013 R&D ($2,100,000 ÷ 3) Less amortization of 2012 R&D ($1,200,000 ÷ 3) Before taxes adjustment to NOPAT Income tax effect ($500,000 × 35%) Net adjusted to NOPAT NOPAT adjusted for R&D $5,800,000 780,000 $2,400,000 (800,000) (700,000) (400,000) 500,000 (175,000) Total assets $ 57,000,000 Less noninterest-bearing current liabilities (20,000,000) Plus unamortized R&D: 2014: $2,400,000 × 2/3 1,600,000 2013: $2,100,000 × 1/3 700,000 Investment 39,300,000 Less cost of capital investment (.07 × $39,300,000) Economic value added 325,000 6,905,000 2,751,000 $4,154,000 12-43 180 Chapter 12 Decentralization and Performance Evaluation Stand Up Comics operates comedy clubs in in several states The following financial information is available for 2014 and 2013 2014 2013 Income from operations $ 900,000 $ 850,000 Net income 537,420 507,000 Interest expense 6,000 5,000 Total assets 4,000,000 3,500,000 Noninterest-bearing current liabilities 290,000 280,000 Research & development costs 200,000 160,000 Income tax rate 40% 40% Required rate of return 7% 6.5% Cost of capital 5% 4% Intangibles are amortized over years Although net income has increased by percent, a shareholder evaluating the company’s financial performance asserts that, financial performance has decreased in 2014 Support this assertion with appropriate calculations of economic value added Answer Economic value added has decreased from 2013 to 2014 by $38,380 2014 Net income $537,420 Plus: Interest expense, net of tax 3,600 NOPAT 541,020 Adjustment for accounting distortions: ($200,000 – $40,000 – $50,000) × (1 – 40%) 66,000 ($160,000 – $40,000) × (1 – 40%) NOPAT adjusted $607,020 Total assets Less NIBCL Add adjustment for accounting distortions: 2014: ($200,000 ì ắ) + ($160,000 ì 2/4) 2013: ($160,000 ì ắ) Adjusted investment Cost of capital Required NOPAT Economic value added $4,000,000 (290,000) 2013 $507,000 3,000 510,000 72,000 $582,000 $3,500,000 (280,000) 230,000 3,940,000 5% 197,000 $ 410,020 120,000 3,340,000 4% 133,600 $ 448,400 12-44 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition CHALLENGE EXERCISES 181 CocaCola has divisions It uses a 10.9 percent required rate of return Its Dasani Division has an invested capital amounting to $998,000 and reported profits of $122,000 during the current year The division manager is considering whether expanding the shipping docks at an estimated cost of $182,000 will enhance the division The expansion is expected to increase annual income by an estimated $18,100 a b Answer a b 182 Calculate the Dasani Division’s ROI if the docks are expanded What will the Dasani Division’s manager most likely if he is evaluated using ROI? Briefly justify why the manager will take that action ROI = [$122,000 + $18,100] ÷ [$998,000 + $182,000] = 11.87% Original ROI = $122,000 ÷ $998,000 = 12.22% The expansion of the shipping docks will cause the division's ROI to decline, making the manager's performance look bad, so he is more likely to reject the project even though the project's ROI exceeds CocaCola’s required rate of return Outkast Division of Music, Inc has a 5.5 percent cost of capital and a 25 percent income tax rate The company compiled the following information for Outkast Division in 2014: Total assets $10,700,000 Net income 1,200,000 Sales 9,800,000 Current liabilities, interest bearing 540,000 Current liabilities, non-interest bearing 620,000 Interest expense 510,000 a b c Name and calculate the two components of ROI Show how the components in part A can be used together to calculate ROI Interpret your answer to part b Answer a Profit margin = [$1,200,000 + ($510,000 × (1 – 25%)] ÷ $9,800,000 = 16.15% Investment turnover = $9,800,000 ÷ [$10,700,000 – $620,000] = 0.9722 b Profit margin × Investment turnover = 16.15% × 0.9722 times = 15.70% c Outkast Division generated about 15.7 cents of profit for each dollar of assets invested in the division 12-45 183 Chapter 12 Decentralization and Performance Evaluation LB Division of BulbCo had net income totaling $56,700, sales totaling $650,000, no interest cost, and a 30 percent income tax rate for 2014 Invested capital totals $540,000 BulbCo’s required rate of return is percent and its cost of capital is percent The 2014 ROI of LB Division is 10.5 percent LB Division is considering an investment in a new machine on January 1, 2015 that will generate additional annual sales of $76,000 and additional annual operating expenses (other than depreciation) totaling $39,000 The cost of the new machine is $140,000 with an estimated salvage value of $15,000 at the end of its 5-year estimated life LB will pay cash for the machine a Calculate NOPAT for 2015 if LB Division acquires the new machine b Assuming no change in original operations, determine the 2015 return on investment if LB buys the machine If LB Division’s manager is evaluated on ROI, will he accept the project? Briefly justify your response c Answer a Incremental revenue Incremental operating costs Incremental depreciation ($140,000 – $15,000) ÷ Increase in income before taxes Income tax expense Incremental net income from new machine Net income from original operations Adjusted net income = NOPAT b ROI = $65,100 ÷ [$540,000 + $140,000 – $25,000] = 9.94% c LB Division had an ROI of 10.5 percent without the new machine ROI of the division decreases to 9.94 percent if the new machine is acquired The manager would most likely not acquire the new machine since it would decrease his division's ROI and make his performance appear poor compared to his current performance $76,000 (39,000) (25,000) 12,000 (3,600) 8,400 56,700 $65,100 12-46 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 184 Frigate Co compiled the following information concerning its West Division for 2014: Sales revenue Invested capital NOPAT $10,500,000 12,900,000 870,000 Research and development costs Current liabilities-interest bearing Current liabilities-non-interest bearing $940,000 210,000 320,000 R&D costs incurred by West Division during 2013 totaled $700,000 The company’s notes indicate its amortization policy is years Frigate has a 7.8 percent cost of capital, a 9.1 percent required rate of return, and a 32 percent income tax rate a How much is EVA for the West Division for 2014? b What information is provided by Frigate’s EVA for 2014? Answer 185 a EVA = NOPAT + Accounting adj., net of taxes − CC [Invested capital + Accounting adj.] = $870,000 + [$612,000 × (1 – 32%)] – 7.8% [$12,900,000 + $1,172,000] = $188,544 Before tax adjustment to NOPAT: $940,000 – ($700,000 ÷ 5) – ($940,000 ÷ 5) = $612,000 Adjustment to invested capital: ($700,000 × 3/5) + ($940,000 × 4/5) = $1,172,000 b Frigate's shareholders' equity increased by $188,544 as a result of the performance of West Division during 2014 The Florida Division is being evaluated by upper management of the parent company, Assistance Corporation The following amounts were determined for Florida Division for 2014: Residual income $333,600 Return on investment 10.6% Economic value added $464,760 Interpret each of the three amounts as it applies to Florida Division for 2014 Answer Residual income: The Florida Division contributed $333,600 to the shareholder wealth of Assistance Corporation during 2014 Return on investment: The Florida Division generated about 10.6 cents of profit for each dollar of assets invested in the division Economic value added: After adjusting for the accounting distortions, the Florida Division contributed $464,760 to the shareholder wealth of Assistance Corporation during 2014 12-47 Chapter 12 Decentralization and Performance Evaluation SHORT-ANSWER ESSAYS 186 List and briefly describe the advantages and disadvantages of decentralization for an organization Answer The advantages of decentralization are: Superior decisions, because decisions are made by the managers who are closest to the situation and should have the best information about the situation Faster response to changing circumstances, because decisions are not made by higherlevel managers who need to be advised of all the facts Increased motivation of managers, because they are responsible for their own decisions and the results of those decisions Excellent training for future top-level executives, because managers have decisionmaking experience The disadvantages of decentralization are Costly duplication of services, as each subunit acts independently A danger of a lack of goal congruence if managers build their own “empires” rather than doing what is best for the overall organization 187 What are the differences between cost centers, profit centers, and investment centers? Answer Cost centers are subunits that have responsibility for controlling costs, but are not expected to generate revenues Profit centers have responsibility for generating revenues as well as controlling costs; in other words, they are expected to earn a profit Investment centers are responsible for costs, revenues, and investments An investment center must earn a profit large enough to cover a charge for the assets that have been invested in the investment center 188 How is return on investment (ROI) calculated? List two actions that a manager could take to increase its return on investment Answer Return on investment is income divided by invested capital The income figure that is typically used is NOPAT (net operating income after taxes), is the income adjusted for interest expense and the tax implications of the interest expense A manager can increase the return on investment by increasing the profit margin or by increasing investment turnover by generating more sales for each dollar that is invested 12-48 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 189 Explain why net interest is added back to net income to get NOPAT Answer Interest results from the decision to use debt versus equity financing That decision is normally not made by division managers The adding back of interest, less the related tax effect, removes the impact of the financing decision that is not controllable by division management 190 What is economic value added and why is it superior to other performance measures? Answer Economic value added is residual income adjusted for accounting distortions Like residual income, it encourages managers to make appropriate levels of investment In addition, it treats items such as research and development costs as having a long-term benefit to the company 191 What are the four dimensions of the balanced scorecard? Answer The four dimensions of the balanced scorecard are financial perspective, customer perspective, internal processes perspective, and learning and growth *192 There are a number of alternative methods for determining a transfer price Which method typically motivates the best decisions? Why? Answer The transfer price that motivates the best decisions is the one that is closest to the opportunity cost of producing an item and transferring it to the buying division Usually, this is very close to the market price of the item Material from the appendix to the chapter is marked with an asterisk (*) ... years By how much is NOPAT adjusted as it relates to computing EVA for 2014? A $8,190,000 B $11,700,000 C $8,600,000 D $6,020,000 12-18 Test Bank to accompany Jiambalvo Managerial Accounting, 5th. .. Division generate on each revenue dollar earned by the division? A 92.3% B 16.0% C 33.3% D 30.8% 12-24 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 125 The Pastry Division of Dream... that need improvement D All of these answer choices are correct 12-6 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 38 The evaluation of a subunit should be separated from