Deck 15: Performance Evaluation and Compensation

Question 1

If manufacturing departments are only responsible for production decisions, they are considered cost centers.

Answer 1

True

Question 2

Return on investment is typically calculated as net income divided by total sales.

Answer 2

False

Question 3

Compensation contracts can be based on accounting and / or non-accounting measurements.

Answer 3

True

Question 4

In a profit center, managers' primary goal is to maximize revenues.

Question 5

Agency theory is an analytical framework that tells managers how to solve potential conflicts with shareholders.

Question 6

Agency theory is related to accounting because organizations incur costs, including the costs to produce accounting information, to solve conflicts that might arise between managers and owners.

Question 7

A transfer price is required only when goods or services are transferred between cost centers in the same organization.

Question 8

Responsibility accounting is the process of using financial information to justify pay increases and promotions for managers.

Question 9

An ideal transfer price would be the opportunity cost of internal transfers.

Question 10

Investment center managers are held responsible only for their costs.

Question 11

Economic value added can be measured so that it reduces most of the problems that arise under residual income.

Question 12

Executive compensation is typically set by the shareholders at the annual meeting.

Question 13

Return on investment cannot be used effectively to evaluate profit centers because it motivates managers to make suboptimal decisions from the viewpoint of the organizations' owners.

Question 14

Residual income measures a company's profits given a required rate of return.

Question 15

Decentralization typically eliminates agency costs from for-profit organizations.

Question 16

An organization's chief executive officer can be both a principal and an agent.

Question 17

Technical details about complex manufacturing processes are examples of specific knowledge.

Question 18

Return on investment can be decomposed into two ratios: investment turnover and return on sales.

Question 19

Managers can reduce agency costs through the use of compensation contracts.

Question 20

Choices about decision-making authority and about organizational structure are often related.

Question 21

Which of the following responsibility centers can be evaluated using residual income?

A) Cost centers
B) Profit centers
C) Revenue centers
D) Investment centers

Question 22

KNY Corporation reported operating income of $80,000 and average operating assets of $120,000 in a recent accounting period. Which of the following transactions would definitely increase KNY's return on investment?

A) Increasing product prices
B) Switching suppliers for raw materials
C) Collecting accounts receivable
D) Decreasing research and development expense

Question 23

A segment with an ROI of 30% has an income of $84,000. The company's required rate of return on segment investments is 18%. The segment's residual income is

A) $50,400
B) $25,200
C) $26,712
D) $33,600

Question 24

Use the following information for the next 2 questions.
Division A of Sibley, Inc. has operating data as follows: Division B wants to purchase units from Division A. If Division A agrees to sell units to Division B, A's variable costs will be $5 less per unit.
If Division A is operating at capacity, what is the minimum price it should charge?

A) $40
B) $75
C) $20
D) $60

Question 25

THN Corporation reported operating income of $30,000, revenue of $50,000, and average operating assets of $40,000 for a recent year. Which of the following is true?

A) THN has an adequate return on investment
B) THN's return on sales was 1.67
C) THN's return on investment was 75%
D) THN's return on sales was 80%

Question 26

Division A of a firm produces a single product, which is sold only to Division B. Division A has a total investment of $1,000,000, while Division B has a total investment of $2,000,000. Division A annually sells 100,000 units of its product to Division B for $5 per unit and earns $150,000 in operating income. Division B currently earns $250,000. If Division A raises its selling price to $6 per unit and nothing else changes,

A) Division A's ROI will increase to 20%
B) The firm's overall ROI will rise
C) The firm's overall ROI will fall
D) The firm's overall ROI will remain unchanged

Question 27

Use the following information for the next 2 questions.
Division A of Sibley, Inc. has operating data as follows: Division B wants to purchase units from Division A. If Division A agrees to sell units to Division B, A's variable costs will be $5 less per unit.
If Division A has capacity available to meet B's requirements, what is the minimum price it should charge?

A) $40
B) $75
C) $20
D) $60

Question 28

Transfer pricing policies can affect a company's tax liability, particularly if it does business internationally.

Question 29

The Jupiter Division of Space, Inc. produces dilithium crystals. One-third of its output is sold to the Antari Division, and the remainder is sold externally. Jupiter's estimated sales and cost data for the coming year are: Assume that Jupiter cannot sell any additional crystals externally. If the Antari Division has an opportunity to buy from an outside supplier at $1.40 per crystal and Jupiter refuses to meet this price, the company as a whole will be

A) $1,250 better off
B) $3,750 worse off
C) $6,250 better off
D) $5,000 worse off

Question 30

Use the following information for the next 2 questions.
Division A produces a component for Hielkema Company's main product - automobiles. The division operates as a profit center. It also sells to outsiders. The present selling price is $75 per component. The company buys 600,000 units of a similar component per year from outside sources. The external purchase price is $73 as a result of a quantity discount. Division A has adequate capacity to supply the needs of the Assembly division. The following data are for Division A:
The price range within which A would sell components to the Assembly Division is

A) $71 to $73
B) $65 to $73
C) $71 to $75
D) $65 to $75

Question 31

Use the following information for the next 2 questions.
The National Division of Roboto Company is buying 10,000 widgets from an outside supplier at $30 per unit. Roboto's Overseas Division, which is producing and selling at full capacity (12,000 units), has the following sales and cost structure:
If the Overseas Division meets the outside supplier's price and sells the 10,000 widgets to National, the effect on overall company profits will be

A) $ 75,000 higher
B) $150,000 lower
C) $300,000 higher
D) $225.000 lower

Question 32

In a dual-rate transfer pricing system, the selling department is credited for the market price and the buying department is charged the product's variable cost.

Question 33

If a product has an external market and divisions are treated as profit centers, cost-based transfer prices can often lead to suboptimal decisions.

Question 34

Use the following information for the next 2 questions.
The Mukilteo Division of Snohomish Corp. produces and sells a product to outside and internal customers. Per-unit data collected from its operations include:
If Mukilteo has excess capacity available to meet an internal order, what transfer price should be set?

A) $625
B) $355
C) $430
D) $285

Question 35

If a supplying division has excess capacity, the best transfer price is the product's variable cost.

Question 36

Hitek, Inc has 2 divisions, Diodes and Boards. The diode can be sold internally or externally. If sold externally, the sales price is $15 per diode. The Boards division needs 3 diodes for each electronic board it produces. The external sales prices and costs are: If Diodes can sell all of its production externally, what is the minimum price at which it would be willing to sell internally, and what is the maximum price the Board Division would be willing to pay?

Question 37

Use the following information for the next 2 questions.
The National Division of Roboto Company is buying 10,000 widgets from an outside supplier at $30 per unit. Roboto's Overseas Division, which is producing and selling at full capacity (12,000 units), has the following sales and cost structure:
If the National Division buys its 10,000 widgets from the Overseas Division, the transfer price should be

A) $45.00
B) $30.00
C) $22.50
D) $37.50

Question 38

Use the following information for the next 2 questions.
The Mukilteo Division of Snohomish Corp. produces and sells a product to outside and internal customers. Per-unit data collected from its operations include:
If Mukilteo is operating at full capacity and selling solely to outside customers, what price should another division pay for Mukilteo's product?

A) $285
B) $625
C) $640
D) $480

Question 39

Residual income is calculated as

A) Operating income - (required rate of return × average operating assets)
B) Net income - (required rate of return × average operating assets)
C) Operating income - (required rate of return × average equity)
D) Net income - (required rate of return × average equity)

Question 40

Use the following information for the next 2 questions.
Division A produces a component for Hielkema Company's main product - automobiles. The division operates as a profit center. It also sells to outsiders. The present selling price is $75 per component. The company buys 600,000 units of a similar component per year from outside sources. The external purchase price is $73 as a result of a quantity discount. Division A has adequate capacity to supply the needs of the Assembly division. The following data are for Division A:
The minimum price at which A would sell components internally is

A) $71
B) $73
C) $75
D) $65

Question 41

The Southern Division of WDY Corporation reported net income of $2,500, operating income of $4,000, average equity of $24,000, and average operating assets of $30,000 in a recent accounting period. If Southern's required rate of return is 12%, its residual income was

A) $380
B) $(380)
C) $400
D) $1,100

Question 42

Which type of knowledge is most costly to transfer within an organization?

A) Centralized
B) Decentralized
C) Financial
D) Specific

Question 43

Which of the following best describes "general knowledge" in a decision-making context?

A) Detailed information about manufacturing processes
B) Customer lists and preferences kept by individual departments in retail sales
C) Knowledge that is easily transferred between employees
D) Knowledge that can be obtained only outside the organization

Question 44

Decision-making based on general knowledge is more likely to occur in this type of organization

A) Centralized
B) Decentralized
C) Effective
D) Ineffective

Question 45

Under what circumstances could organizations eliminate agency costs, according to agency theory?

A) If they are not publicly traded
B) If bonuses are based on financial performance
C) If they publish audited financial statements
D) Organizations cannot eliminate agency costs

Question 46

Economic value added uses "adjusted after-tax operating income" as one of its inputs. One purpose of using after-tax income, rather than operating income, is to

A) Encourage managers to file tax reports
B) Encourage managers to minimize taxes
C) Improve information reported to the SEC
D) Remove bias from the EVA calculation

Question 47

Agency theory recognizes two kinds of information consumers. Which of the following describes the relationship between them?

A) Principals hire agents to make decisions for them.
B) Agents hire principals to hold them accountable for decisions.
C) Principals and agents work together in the best interest of the organization.
D) Principals are government employees, while agents work in the private sector.

Question 48

Responsibility accounting includes I. Monitoring primarily for mistakes
II) Assigning authority to subunit managers
III) Measuring the performance of subunit managers

A) I and II only
B) I and III only
C) II and III only
D) I, II, and III

Question 49

When decision making is decentralized

A) Upper management does not make decisions
B) Decision-making authority is delegated throughout the organization
C) The important information in an organization is very general
D) Organizations are less likely to experience agency costs concerning goal congruence

Question 50

What type of theory provides an analytical framework for the conflicts that arise between owners and managers?

A) Decision making theory
B) Conflict resolution theory
C) Agency theory
D) Evaluation theory

Question 51

Which of the following is an agency cost from a business owner's perspective?

A) Losses from poor economic conditions
B) Costs to provide appropriate incentive contracts for top management
C) General supplier price increases
D) Insufficient executive pay

Question 52

Specific knowledge is I. More detailed than general knowledge
II) More costly to transfer than general knowledge
III) An example of an agency cost

A) I and II only
B) I and III only
C) II and III only
D) I, II, and III

Question 53

An advantages of centralized decision making is

A) More motivated employees
B) More rapid decision making in all contexts
C) Greater effectiveness in volatile environments
D) Less monitoring of decisions

Question 54

Costs for producing and analyzing internal performance reports are examples of

A) Goal alignment costs
B) Losses from poor decisions
C) Monitoring costs
D) Contracting costs

Question 55

Because agents may not set the same goals and objectives as principals, organizations may experience which of the following general agency costs? I. Goal alignment costs
II) Losses from a downturn in economic conditions
III) Monitoring costs

A) I and III only
B) II and III only
C) III only
D) I, II, and III

Question 56

To reduce agency costs, organizations implement various systems and controls to monitor behavior, including I. Publishing audited financial statements
II) Filing income tax returns
III) Tying financial rewards to reported results

A) I and III only
B) I and II only
C) II and III only
D) I, II, and III

Question 57

Managers can reduce agency costs by

A) Giving agents less decision-making authority.
B) Holding agents responsible for the results of their decisions and rewarding them for good performance.
C) Constantly monitoring agents' actions to ensure goal congruence.
D) Reporting residual income in their SEC reports.

Question 58

How are research and development costs treated for financial reporting and for economic value added (EVA) calculations?

Question 59

Among the responsibility centers listed, which type of responsibility center is most likely to use growth in sales as a performance measure?

A) Cost
B) Profit
C) Revenue
D) Investment

Question 60

Budgets can be used to evaluate managerial performance in I. Cost centers
II) Profit centers
III) Investment centers

A) II only
B) I and II only
C) II and III only
D) I, II, and III

Question 61

Basing executive compensation on accounting earnings I. Is a popular practice in the United States
II) Is sharply criticized because of potential negative long-term effects
III) Leads to unbiased accounting practices

A) I and II only
B) I and III only
C) II and III only
D) I, II, and III

Question 62

Use the following information for the next 3 questions.
Chicago Division has a required rate of return of 15%. The weighted average cost of capital is 10%. Information for Chicago Divisions operations over the past 2 years follows.
What was the Chicago Division residual income for 20x5?

A) $(12,540)
B) $3,300
C) $15,300
D) $19,800

Question 63

To protect shareholders from excessive compensation practices, executive compensation packages are best set by

A) The board of directors
B) A committee of primarily outside members of the board of directors
C) A committee of top management employees
D) The external auditors

Question 64

Setting transfer prices can be especially problematic when

A) Managers are evaluated based on non-financial factors
B) Compensation is tied to the financial performance of responsibility centers
C) Centralized decision making is the organizational norm
D) Compensation is tied to the financial performance of the organization as a whole

Question 65

"Reduce costs by 5%" is an example of a(n)

A) Measurement
B) Agency cost
C) Benchmark
D) Reward

Question 66

Efficiency measures, such as number of new products developed, may be more useful than financial measures in

A) Profit centers.
B) Discretionary cost centers.
C) Revenue centers.
D) Investment centers.

Question 67

Use the following information for the next 3 questions.
Chicago Division has a required rate of return of 15%. The weighted average cost of capital is 10%. Information for Chicago Divisions operations over the past 2 years follows.
What was the Chicago Division ROI for 20x5 (rounded to nearest 0.1%)?

A) 11.2%
B) 13.2%
C) 15.5%
D) 16.0%

Question 68

A transfer pricing policy based on market price

A) Maximizes total organizational profit.
B) Is best because the market price is always objective and easily obtainable.
C) May result in suboptimal decision making for the company as a whole.
D) Is the only alternative accepted by the Internal Revenue Service.

Question 69

Which of the following transfer pricing systems potentially takes the most time to establish?

A) Market-based
B) Dual-rate
C) Negotiated
D) Full-cost

Question 70

Managers are held responsible for revenues in I. Revenue centers
II) Profit centers
III) Investment centers

A) I and III only
B) II and III only
C) I only
D) I, II, and III

Question 71

Use the following information for the next 3 questions.
Chicago Division has a required rate of return of 15%. The weighted average cost of capital is 10%. Information for Chicago Divisions operations over the past 2 years follows.
What was the Chicago Division EVA for 20x5?

A) $3,960
B) $11,960
C) $20,460
D) $27,800

Question 72

Which of the following is an advantage of cost-based transfer prices? I. Managers do not have much incentive to reduce fixed costs
II) Managers may be motivated to purchase goods and services from outside the company
III) Contribution margins may be split between buying and selling divisions

A) I only
B) II only
C) III only
D) None of the above (I, II, and III are all disadvantages)

Question 73

Dual-rate transfer pricing systems are appropriate when the

A) Market price is unknown
B) Selling department has excess capacity
C) Market price is higher than the variable cost
D) Market price is higher than the full cost

Question 74

Stock-based compensation has been used to encourage

A) Focus on long-range results
B) Focus on short-term results
C) Higher compensation for executives
D) Lower compensation for executives

Question 75

A corporate accounting department would most often be considered a

A) Cost center, because it is typically a high cost operation
B) Cost center, because its costs can be controlled by upper management
C) Revenue center, if accountants have input in pricing decisions
D) Cost center, because it is a support service

Question 76

Compensation contracts that provide incentives for agents to increase organizational value might include I. Cash-based bonuses
II) Stock options
III) Cash bonuses based on stock price increases or targets

A) I and II only
B) II and III only
C) I and III only
D) I, II, and III

Question 77

Which prices are recorded by departments under a dual-rate transfer pricing system?

Question 78

Problems with market-based transfer prices include

A) Lack of knowledge about underlying costs
B) Lack of objectivity
C) Their impact on corporate profitability
D) Their lack of reliance on supply-and-demand relationships

Question 79

When a company uses activity-based transfer prices

A) The internal buyer is motivated to overstate the number of units to buy internally
B) The internal buyer is motivated to understate the number of units to buy internally
C) Capacity is usually reserved for products or services that are transferred internally
D) Batch-level costs are excluded from the computation

Question 80

The price used to record exchanges of goods and services inside an organization is called a

A) Transfer price
B) Exchange price
C) Full price
D) Suboptimal price