Exam 19: Strategic Performance Measurement: Investment Centers and Transfer Pricing

Selected data from Chering Division's accounting records revealed the following: Sales \ 825,000 Average investment \ 440,000 Net operating income \ 66,000 Minimum rate of return (divisional cost of capital) 14\% Chering Division's asset turnover (AT) is calculated to be:

Domi Products, a multi-divisional manufacturing company, measures performance and awards bonuses to division managers based upon divisional operating income. Under the current bonus plan, common company-wide operating expenses are allocated evenly to all five of its divisions. For example, if rent were $50,000, each division would be charged $10,000. In planning next year's budget, corporate management has requested that the division managers recommend how common expenses should be distributed to the divisions. The division managers met and jointly developed an incentive plan that would more equitably distribute common expenses on the basis of resources used and that would measure each division manager's performance based on return on assets (ROI), with divisional bonuses based on a target ROI. They jointly presented their recommendation to corporate management. Required: 1. Describe at least three problems that Domi Products could encounter when using return on investment (ROI) as the basis of performance measurement. 2a. Define the residual income (RI) approach to segment performance measurement. 2b. Determine if Domi Products should implement this approach instead of the ROI approach. 3. Discuss the behavioral implications of the division managers' involvement in the corporate budgeting process, and the decision to more equitably allocate common costs.

The choice of valuation method for inventories would normally not affect which item(s) used in calculating Return on Investment (ROI)?

Selected data from Chering Division's accounting records revealed the following: Sales \ 825,000 Average investment \ 440,000 Net operating income \ 66,000 Minimum rate of return (divisional cost of capital) 14\% Chering Division's return on investment (ROI) is:

A company currently earning a profit can increase its return on investment (ROI) by:

Pacific Mill consists of two operating divisions, a Cutting division and the Assembly division. The Cutting division prepares cords of timber at its sawmills, while the Assembly division prepares the cut cords of lumber into board-feet of finished wood (which is sold to various furniture manufacturers). During the most recent year the Cutting division prepared 60,000 cords of wood at a cost of $1,320,000. All of this lumber was transferred to the Assembly division, where incremental costs of $12 per cord were added. Pacific Mill sold the 600,000 board-feet of finished wood for $5,000,000. Required: 1. What would the operating income for each of the two divisions be if the transfer price from Cutting to Assembly was set at the cord cost of $22 per cord? (Show calculations.) 2. What would the operating income for each of the two divisions be if the transfer price is set at $18 per cord? (Show calculations.) 3. Since Cutting transfers all of its output internally (to Assembly), does the manager of Cutting care what price is selected? Why? Should Cutting be treated as a cost center under the circumstances (rather than a profit center or investment center)? Explain.

Managerial performance can be measured in various ways, including return on investment (ROI) and residual income (RI). A good reason for using RI rather than ROI is:

Consider the following data for three divisions of a company, X, Y, and Z: Divisional: X Y Z Sales \ 1,800,000 \ 900,000 \ 4,800,000 Operating Income 252,000 108,000 240,000 Investment in assets 630,000 540,000 3,000,000 The return on sales (ROS) for Division Z is:

Consider the following data for three divisions of a company, X, Y, and Z: Divisional: X Y Z Sales \ 1,800,000 \ 900,000 \ 4,800,000 Operating Income 252,000 108,000 240,000 Investment in assets 630,000 540,000 3,000,000 The asset turnover (AT) for Division Y is calculated to be (rounded):

What are the principal advantages and disadvantages of using cost-based transfer prices? (Give a short explanation of each item you list.)

Consider the following data for three divisions of a company, X, Y, and Z: Divisional: X Y Z Sales \ 1,800,000 \ 900,000 \ 4,800,000 Operating Income 252,000 108,000 240,000 Investment in assets 630,000 540,000 3,000,000 The return on investment (ROI) for Division Z is:

Consider the following data from two divisions of a company, P and Q: Divisional Sales \ 1,500,000 \ 1,000,000 Operating Income \ 600,000 \ 450,000 Investment \ 4,000,000 \ 2,750,000 If both divisions were presented with an opportunity to invest in a project that is estimated to achieve an ROI of 15%, what will the units likely decide?

One advantage of the return on investment (ROI) metric is that it:

Return on investment (ROI) can be directly increased by:

The use of gross book value (GBV) for measuring the level of investment in depreciable assets (for purposes of calculating return on investment, ROI) is preferred by those who value the objectivity of:

Since residual income (RI) is not a percentage, it is not very useful for:

Consider the following data for three divisions of a company, X, Y, and Z: Divisional: X Y Z Sales \ 1,800,000 \ 900,000 \ 4,800,000 Operating Income 252,000 108,000 240,000 Investment in assets 630,000 540,000 3,000,000 The return on sales (ROS) for Division Y is:

A primary goal of transfer pricing is to:

Compared to return on investment (ROI), residual income (RI) may be a better measure of the financial performance of an investment center because:

In the context of transfer pricing, dual pricing is: