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

When investments in facilities are shared by different subunits in a firm, allocation of the cost of these common facilities to sharing units should be determined by:

Because residual income (RI) is a dollar amount, in contrast to a percentage (like return on investment, ROI), RI:

Put simply, transfer pricing is a management tool for assigning a "price" to internally transferred goods (or services) in order to simulate the marketplace, thus encouraging managers to make decisions that are in the best interest of the:

A measure of the manager's ability to produce increased sales from a given level of investment is:

Division A, which is operating at capacity, produces a component that currently sells in a competitive market for $25 per unit. At the current level of production, the fixed cost of producing this component is $8 per unit and the variable cost is $10 per unit. Division B would like to purchase this component from Division A. The price that Division A should charge Division B for this component is:

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Which one of the following is not a limitation shared by residual income (RI) and return on investment (ROI) divisional performance measures?

Return on investment (ROI) is the result of multiplying:

If after-tax income of Grey Division, adjusted for economic value, is 15% of sales, capital employed is $5,000,000 (adjusted for equity-equivalents), the divisional cost of capital (discount rate) is 8%, and sales are $12,000,000, then Economic Value Added (EVA®) is:

Which one of the following transfer pricing alternatives is based on determining an appropriate markup, where the markup is based on gross profits of unrelated firms selling similar products?

Simmons Bedding Company manufactures an array of bedding-related products, including pillows. The Cover Division of Simmons makes covers, while the Assembly Division of the company produces finished pillows. The covers can be sold separately for $10.00 a piece, while the pillows sell for $12.00 per unit. For performance evaluation purposes, these two divisions are treated as investment centers. Financial results from the most recent accounting period are as follows: Cover Division Assembly Division Traceable manufacturing costs \ 6,000,000 \ 1,500,000 External sales \ 4,000,000 \ 7,200,000 Market value of output transferred from Cover Division to the Assembly Division \6 ,000,000 Required: 1. What is the operating income for each of the two divisions and for the company as a whole? (Use market value as the transfer price.) 2. Do you think each of the two divisional managers is happy with this transfer pricing method? Explain.

The estimated price that could be received for the sale of divisional assets is referred to as:

Ellie Jackson is upset by the new transfer pricing system recently implemented at Monson Company. As manager of the first of three sequential production departments, she can't see the value of a transfer pricing system for her department. "We can't sell what we produce to any outside buyer. And we're never pushed for capacity, so I don't think transfer pricing will do anything but make my life more complicated." You are Ellie's boss. Required: Explain how transfer pricing can help Ellie evaluate her department's operations and allow you to more effectively evaluate her management abilities.

An investment center's return on investment (ROI) is affected by a change in: Asset Turnover Return on Sales (A) Yes Yes (B) Yes No (C) No No (D) No Yes (E) Yes Not likely

Parkside Inc. has three divisions (Entertainment, Plastics, and Video Card), each of which is considered an investment center for performance evaluation purposes. The Entertainment Division manufactures video arcade equipment using products produced by the other two divisions, as follows: 1. The Entertainment Division purchases plastic components from the Plastics Division that are considered unique (i.e., they are made exclusively for the Entertainment Division). In addition, the Plastics Division makes less-complex plastic components that it sells externally, to other producers. 2. The Entertainment Division purchases, for each unit it produces, a video card from Parkside's Video Card Division, which also sells this video card externally (to other producers). The per-unit manufacturing costs associated with each of the above two items, as incurred by the Plastic Components Division and the Video Card Division, respectively, are: Plastic Components Video Cards Direct material \ 1.25 \ 2.40 Direct labor 2.35 3.00 Variable overhead 1.00 1.50 Fixed overhead 0.40 2.25 Total cost \5 .00 \9 .15 Assume that the Entertainment Division is able to purchase a large quantity of video cards from an outside source at $8.70/unit. The Video Cards Division, having excess capacity, agrees to lower its transfer price to $8.70/unit. This action would likely:

Parkside Inc. has three divisions (Entertainment, Plastics, and Video Card), each of which is considered an investment center for performance evaluation purposes. The Entertainment Division manufactures video arcade equipment using products produced by the other two divisions, as follows: 1. The Entertainment Division purchases plastic components from the Plastics Division that are considered unique (i.e., they are made exclusively for the Entertainment Division). In addition, the Plastics Division makes less-complex plastic components that it sells externally, to other producers. 2. The Entertainment Division purchases, for each unit it produces, a video card from Parkside's Video Card Division, which also sells this video card externally (to other producers). The per-unit manufacturing costs associated with each of the above two items, as incurred by the Plastic Components Division and the Video Card Division, respectively, are: Plastic Components Video Cards Direct material \ 1.25 \ 2.40 Direct labor 2.35 3.00 Variable overhead 1.00 1.50 Fixed overhead 0.40 2.25 Total cost \5 .00 \9 .15 Assume that the Plastics Division has excess capacity and has negotiated a transfer price of $5.60 per plastic component with the Entertainment Division. This price will likely:

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 the minimum rate of return is 11%, what is Division P's residual income (RI)?

Which of the following items would most likely not be incorporated into the calculation of a division's investment base when using the residual income (RI) or the return on investment (ROI) approach for performance measurement and evaluation?

The text presents what it calls a general transfer pricing rule that can be used to help set an appropriate transfer price. The following questions pertain to this general rule. Required: 1. Present, in equation form, the general transfer pricing rule presented in the chapter. Briefly describe the elements of the model. 2. In what sense is the model presented in the chapter a general transfer pricing rule? 3. Evaluate the general transfer pricing rule in light of the objectives for transfer pricing that are presented in the chapter. 4. What are some of the major implementation issues associated with applying the general transfer pricing rule in practice?

Each of the following represents a way of calculating ROI (return on investment) for a division except: