Exam 14: Strategy and Control

A profit center is responsible for generating revenue, but it is not responsible for controlling costs

The divisional managers of West plc have requested that the method for calculating bonuses at the year be reviewed. Senior managers at the head office have proposed that a bonus of £40,000 will be paid to the divisional manager who has the best return on investment (ROI) of the 3 divisions and this policy is consistent with previous years. Divisional managers want the senior managers to take into account controllable costs and profits and residual income (RI) when deciding bonuses and also to include non-financial measures of performance. The main reason given by the head office for using ROI is that it is understood by all managers and that it is used by external analysts. Summary of Management Accounts to 31 December 1997 Southern (£) Eastern (£) Western (£) Sales 5,400,000 5,000,000 5,590,000 Controllable costs 3,700,000 3,502,000 3,660,000 Head Office Charges 998,000 1,282,000 1,170,000 Net Profit 702,000 716,000 760,000 Capital Employed Southern (£) Eastern (£) Western (£) Total Investment 4,700,000 5,100,000 5,200,000 Controllable Investment 4,000,000 4,100,000 4,274,000 Cost of Capital The head office has estimated that the group cost of capital is 10% Financial and non-financial measures of performance The divisional managers normally report on a wide range of financial measures each month to the head office but only use non-financial measures internally and each divisional manager is allowed to use their discretion when deciding on the range and number of measures to use. - Calculate the Return on Investment for the Western Division

All other things equal, which of the following would increase the residual income of a division

The Gasson Company sells three products, Product A, Product B and Product C, and had sales of £1,000,000 during the month of June. The company's overall contribution margin ratio was 37% and fixed expenses totaled £350,000. Sales were: Product A, £500,000; Product B, £300,000; and Product C, £200,000. Traceable fixed costs were: Product A, £120,000; Product B, £100,000; and Product C, £60,000. The variable expenses of Product A were £300,000 and the variable expenses of Product B were £180,000. -The common fixed expense for Gasson Company for the month of June was

Explain the differences between cost centres, profit centres and investment centres and the resulting differences as to how they should be assessed.

Sturr Market has 3 stores: P, Q, and R. During October, Store P had a contribution margin of £24,000 and a contribution margin ratio of 30%. Store Q had variable expenses of £48,000 and a contribution margin ratio of 40%. Store R had variable expenses of £84,000 and a variable expense ratio of 70% of sales. Sturr Market's total sales were

The managers of Herwhno want to introduce a new product line. The financial performance of the company for the most recent year is given below: Sales £63,300,000 Less variable costs £36,720,000 Contribution £26,580,000 Less fued expenses £22,720,000 Net profit £3,860,000 Divisional capital employed \ 23,200,000 The company estimates that the required return on investment should be a minimum of 12%. Details of new product line The sales manager estimates that sales for the new product will be 420,000 units per annum if the selling price is £5.20 per unit. Variable costs are estimated to be £2.86 per unit. Fixed costs will increase by £900,000. A budget of £2,000,000 has been agreed for investment in new machinery. - Calculate the Residual Income for the new investment of £2,000,000

Return on investment (ROI) would experience the greatest decrease under which of the following situations Turnover Margin A. Increase Increase B. Increase Decrease C. Decrease lncrease D. Decrease Decrease

Compare and contrast Return on Investment and Residual Income.

An advantage of the ROI formula is that it forces the manager to control the investment in operating assets as well as net operating income

ROI and residual income are tools used to evaluate managerial performance in profit centers

Residual income is the

Evaluate the part that can be played by EVA and other metrics in measuring performance.

Ring Incorporated's income statement for the most recent month is given below. Total Store P Store Q Sales £600,000 £200,000 £400,000 Variable expenses Contribution margin 216,000 56,000 160,000 Traceable fixed expenses Segment margin Common fixed expenses Net operating income - For each of the following questions, refer back to the original data. Currently the sales clerks receive a salary of £17,000 per month in Store Q. A proposal has been made to change from a fixed salary to a sales commission of 5%. Assume that this proposal is adopted, and that as a result sales in Store Q increase by £40,000. The new segment margin for Store Q should be

The divisional managers of West plc have requested that the method for calculating bonuses at the year be reviewed. Senior managers at the head office have proposed that a bonus of £40,000 will be paid to the divisional manager who has the best return on investment (ROI) of the 3 divisions and this policy is consistent with previous years. Divisional managers want the senior managers to take into account controllable costs and profits and residual income (RI) when deciding bonuses and also to include non-financial measures of performance. The main reason given by the head office for using ROI is that it is understood by all managers and that it is used by external analysts. Summary of Management Accounts to 31 December 1997 Southern (£) Eastern (£) Western (£) Sales 5,400,000 5,000,000 5,590,000 Controllable costs 3,700,000 3,502,000 3,660,000 Head Office Charges 998,000 1,282,000 1,170,000 Net Profit 702,000 716,000 760,000 Capital Employed Southern (£) Eastern (£) Western (£) Total Investment 4,700,000 5,100,000 5,200,000 Controllable Investment 4,000,000 4,100,000 4,274,000 Cost of Capital The head office has estimated that the group cost of capital is 10% Financial and non-financial measures of performance The divisional managers normally report on a wide range of financial measures each month to the head office but only use non-financial measures internally and each divisional manager is allowed to use their discretion when deciding on the range and number of measures to use. -Calculate the Controllable Residual Income for the Western Division

All other things equal, if a division's traceable fixed expenses decrease

A contribution income statement is probably the most effective tool for measuring performance in a cost center

Segmented income statements are most meaningful to managers when they are prepared

Chavez Company has two product lines-M and P. Line M had sales of £200,000 during October, a segment margin of 20%, and traceable fixed expenses of £30,000. The company as a whole had a contribution margin ratio of 30% and £135,000 in total contribution margin. Based on this information, total variable expenses for product P must have been

Soft Solutions problems of how to evaluate its Consumer Products Division, particularly with regard to shared costs, are outlined on page 579 of Ch 14. Explain possible solutions to this dilemma.