Deck 14: Business Unit Performance Measurement

Question 1

Residual income is the difference between the divisional income and the cost of invested capital required to operate the division.This is the definition of residual income.

Answer 1

True

Question 2

One problem associated with using accounting measures to evaluate divisional performance is the measures are based on historical information.Historical costs may not reflect current conditions.

Answer 2

True

Question 3

Managerial myopia is the distortion in incentives that result from using accounting measures to evaluate performance.This is one definition of managerial myopia.

Answer 3

True

Question 4

Treating research and development costs as an expense rather than a long-term asset may reduce a manager's inclination to participate in research and development activities.There would be a large impact on income in a single year rather than spreading it over many years.

Question 5

It is not possible for a manager to accept an unacceptable project when his/her performance is evaluated using ROI.Since ROI is a ratio,a division with a lower than average ROI may choose a project that does not meet the corporate benchmarks.

Question 6

One advantage of using after-tax income as a performance measure of divisional results is it's a financial accounting measure that is also used to compute the organizational income.This makes it easier to understand and compare.

Question 7

Most organizations use residual income instead of return on investment (ROI)as a performance measure.ROI is much more common than residual income.

Question 8

The use of residual income reduces,but does not eliminate,the suboptimization problem.Suboptimization may still exist since accounting income does not necessarily reflect economic performance.

Question 9

A problem with ratio-based measures is that managers can make decisions that improve divisional income but lower total organizational income.This is the problem of suboptimization.

Question 10

Historical costs are based on the original costs to acquire a long-term asset,while current costs represent the costs to replace the long-term asset.These are the definitions of historical and current cost.

Question 11

One disadvantage of using after-tax income as a performance measure of divisional results is it's an absolute measure which makes it difficult to compare divisions of significantly different sizes.Larger divisions will naturally show larger income than a smaller division would.

Question 12

Economic value added (EVA)adjustments are made to both the after-tax income and the capital employed.Both income and capital are adjusted to eliminate accounting distortions.

Question 13

In general,a division's investment base includes an allocated share of the corporate headquarters' assets.The goal is controllable investment,so corporate costs should not be allocated.

Question 14

One problem with economic value added (EVA)adjustments is determining the appropriate life for expenditures that benefit multiple periods.There is uncertainty in how many years an expenditure will yield benefits.

Question 15

Using net book values instead of gross book values to compute return on investment (ROI)might encourage an investment center manager to delay replacing inefficient assets until they are fully depreciated.Book value decreases as the asset ages.Replacing an asset replaces a lower net investment with a larger one.

Question 16

In general,it is better to have a higher return on investment (ROI)than a lower one.This implies that either income is higher or the assets are being used more efficiently.

Question 17

Divisional income statements do not have to follow generally accepted accounting principles (GAAP)because they are internal reports.GAAP is only required for external reports.

Question 18

Like return on investment (ROI),economic value added (EVA)adjustments fail to sufficiently address the sub-optimization problem.Both ROI and EVA are ratio-based measures,which gives rise to suboptimization.

Question 19

Current costs should not be used to compute either return on investment (ROI)or residual income because current costs are not generally accepted accounting principles (GAAP).GAAP is not a relevant concern for either ROI or residual income.

Question 20

The profit margin ratio is computed by dividing after-tax operating income by sales.This is the definition of the profit margin ratio.

Question 21

How will increases in the following items affect residual income?

A)Option A
B)Option B
C)Option C
D)Option D

Question 22

A division earning a profit will increase its return on investment (ROI)if it increases operating expenses and:

A)sales by the same dollar amount.
B)sales by the same percentage.
C)investment by the same dollar amount.
D)investment by the same percentage.

Question 23

Residual income is similar to the _________ notion of profit as being the amount left over after all costs,including the cost of the capital employed in the division,are subtracted.

A)accountant's
B)manager's
C)shareholder's
D)economist's

Question 24

Which of the following statements is (are)true? (A)Divisional income statements do not include allocated common costs.(B)The gross margin ratio is computed by dividing operating income by sales.

A)Only A is true.
B)Only B is true.
C)Both A and B are true.
D)Neither A nor B is true.

Question 25

Which of the following should not be used for the cost of capital to compute residual income?

A)Historical weighted average cost of capital.
B)Marginal after-tax cost of new equity capital.
C)Cost of debt and equity used to finance a project.
D)Return on investment (ROI).

Question 26

Which of the following items would not be an example of an economic value added (EVA)adjustment to eliminate accounting distortions?

A)Research & development costs.
B)Advertising expenditures.
C)Patent amortization.
D)Common stock.

Question 27

Which one of the following items would most likely not be incorporated into the calculation of a division's investment base when using the residual income approach for performance measurement and evaluation?

A)Land being held by the division as a potential site for a new plant and parking lot.
B)Division inventories when division management exercises control over the inventory levels.
C)Division accounts payable when division management exercises control over the amount of short-term credit utilized.
D)Division accounts receivable when division management exercises control over credit policy and credit terms.

Question 28

Which of the following statements does not represent a limitation of using return on investment (ROI)for measuring and evaluating performance?

A)ROI uses accounting income which is based on historical costs.
B)ROI cannot be used to compare divisions of different sizes.
C)ROI has the potential to create goal congruence problems.
D)ROI fails to align some costs incurred in one period with the benefits received in another perioD.ROI can be used to compare different sized divisions-this is an advantage of ROI.

Question 29

Which of the following statement(s)is/are true? (A)If a division's return on investment (ROI)exceeds its cost of capital,then its residual income is positive.(B)If a division's cost of capital equals its return on investment (ROI),then its residual income is zero.

A)Only (A)is true.
B)Only (B)is true.
C)Both (A)and (B)are true.
D)Neither (A)and (B)is true.

Question 30

The asset turnover is a measure (ratio)of an investment center's ability to:

A)earn profits.
B)generate sales.
C)control costs.
D)remain solvent.

Question 31

A manager can always increase his/her return on investment (ROI)by:

A)reducing the asset turnover.
B)decreasing residual income.
C)increasing the operating profit margin.
D)expanding operating assets while holding sales and expenses constant.

Question 32

Return on investment (ROI)can be decomposed into the asset turnover and the:

A)gross margin ratio.
B)profit margin ratio.
C)operating margin ratio.
D)contribution margin ratio.

Question 33

Managerial performance can be measured in many different ways including return on investment (ROI)and residual income.A good reason for using residual income instead of ROI is that:

A)residual income can be computed without regard to identifying an investment base.
B)appropriate goal congruence behavior is more likely to occur when using residual income.
C)residual income is well accepted in many organizations and often used in the financial press.
D)ROI does not take into consideration both the investment turnover ratio and return-on-sales percentage.

Question 34

The measure (ratio)that reflects the performance of a manager regarding sales and cost of goods sold,but not other operating costs and income taxes,is called the:

A)gross margin ratio.
B)profit margin ratio.
C)operating margin ratio.
D)contribution margin ratio.

Question 35

If a division is evaluated using return on investment (ROI)without regard to how assets are financed,the denominator in the ROI calculation will be:

A)current assets.
B)working capital.
C)total assets available.
D)total assets employeD.

Question 36

How will decreases in the following items affect return on investment (ROI)?

A)Option A
B)Option B
C)Option C
D)Option D

Question 37

How will decreases in the following items affect residual income?

A)Option A
B)Option B
C)Option C
D)Option D

Question 38

Which of the following statement(s)is/are false? (A)Residual income can be used to compare divisions of different sizes.(B)Residual income can be used to compare divisions that are profit centers.

A)Only (A)is false.
B)Only (B)is false.
C)Both (A)and (B)are false.
D)Neither (A)and (B)is false.

Question 39

After-tax income divided by sales is called the:

A)gross margin ratio.
B)profit margin ratio.
C)operating margin ratio.
D)contribution margin ratio.

Question 40

How will increases in the following items affect return on investment (ROI)?

A)Option A
B)Option B
C)Option C
D)Option D

Question 41

Which of the following statements regarding the use of historical costs and current costs to compute return on investment (ROI)is (are)true? (A)Historical costs are based on the original costs to acquire a long-term asset,while current costs represent the costs to replace the long-term asset.(B)For a specific multiple-period project,the return on investment (ROI)computed using current costs will generally be less than the ROI computed using historical costs.

A)Only (A)is true.
B)Only (B)is true.
C)Both (A)and (B)are true.
D)Neither (A)and (B)is true.

Question 42

Using ending balances for the investment base in computing return on investment (ROI)might encourage managers to acquire assets:

A)early in the year and dispose of assets late in the year.
B)early in the year and dispose of assets early in the year.
C)late in the year and dispose of assets late in the year.
D)late in the year and dispose of assets early in the year.

Question 43

Which of the following items would not require an adjustment to capital employed when using economic value added (EVA)?

A)Research & development costs.
B)Advertising expenditures.
C)Preferred stock.
D)Patents developeD.Stock does not require an adjustment to capital employed;the other three do because they are expensed under GAAP.

Question 44

Welsh Corporation's return on investment (ROI)on some new equipment was 20% using beginning-of-year net book value.The gross book value of the equipment is $250,000.Accumulated depreciation at the beginning of the year was $10,000.This represents one-half year's straight-line depreciation.What is the annual before-tax cash flow from the new equipment?

A)$68,000.
B)$60,000.
C)$48,000.
D)$20,000.

Question 45

Using beginning balances for the investment base in computing return on investment (ROI)might encourage managers to acquire assets:

A)early in the year and dispose of assets late in the year.
B)early in the year and dispose of assets early in the year.
C)late in the year and dispose of assets late in the year.
D)late in the year and dispose of assets early in the year.

Question 46

Rayburn Corporation purchased a new machine for $120,000.The machine has an estimated useful life of 10-years with no salvage value and a return on investment (ROI)of 15%.ROI is computed using annual cash flows and straight-line depreciation.What is the annual cash flow using the gross book value method?

A)$12,200.
B)$18,000.
C)$28,200.
D)$30,000.

Question 47

The following information is available for Company X: What is Company X's return on investment (ROI)?

A)6.0%.
B)10.0%.
C)15.0%.
D)24.0%.

Question 48

The following information has been gathered for the Green Division: Compute the Green Division's residual income.

A)$1,800.
B)$2,700.
C)$3,600.
D)$5,400.

Question 49

Use the following information to compute residual income:

A)$12,000.
B)$22,500.
C)$30,000.
D)$48,000.

Question 50

The FGH Company has an asset turnover of 3.0 times,using assets of $45,000.The company also has a return on investment (ROI)of 20%.What was the company's operating profit margin?

A)5.0%.
B)6.0%.
C)6.7%.
D)8.3%.

Question 51

The FGH Company has an asset turnover of 3.0 times,using assets of $45,000.The company also has a return on investment (ROI)of 20%.If the residual income was $2,250,what was the company's cost of capital?

A)6.0%.
B)10.0%.
C)15.0%.
D)20.0%.

Question 52

In 2012,Wishbone Corporation had an operating profit of $750,000 and a residual income of $300,000.If Wishbone's cost of capital is 15%,what is the amount of the invested capital?

A)$5,000,000.
B)$3,000,000.
C)$2,000,000.
D)$1,250,000.

Question 53

The Najacht Division of the Rassbach Company has a return on investment (ROI)of 12%,sales of $200,000,and an asset turnover of 2.0.What was Najacht's operating income?

A)$6,000.
B)$12,000.
C)$24,000.
D)$48,000.

Question 54

The ABC Company has three divisions: A Division,B Division,and C Division. What was C Division's cost of capital last year?

A)8%.
B)12%.
C)18%.
D)20%.

Question 55

Level return on investments (ROI)over the life of a long-term project is more likely when ROI is computed using:

A)historical costs and net book values.
B)historical costs and gross book values.
C)current costs and net book values.
D)current costs and gross book values.

Question 56

Economic value added (EVA)assumes that which of the following GAAP expenses would not result in an adjustment to either the income or the capital employed?

A)Research & development costs.
B)Use of process costing rather than job costing.
C)Advertising expenses.
D)Writeoff of goodwill.

Question 57

The ABC Company has three divisions: A Division,B Division,and C Division. What was B Division's return on investment (ROI)last year?

A)16.00%.
B)20.00%.
C)24.00%.
D)33.75%.

Question 58

The ABC Company has three divisions: A Division,B Division,and C Division. What was A Division's residual income last year?

A)$12,000.
B)$22,500.
C)$30,000.
D)$48,000.

Question 59

The following information is available for Company X: What is Company X's residual income?

A)$2,000.
B)$2,500.
C)$3,500.
D)$4,000.

Question 60

Economic value added (EVA)is a concept that is closely related to residual income.EVA is computed by:

A)subtracting the adjusted total cost of capital from the adjusted after-tax income.
B)subtracting adjusted after-tax income from total divisional investment.
C)dividing adjusted after-tax income by adjusted divisional investment.
D)dividing adjusted after-tax income by adjusted total cost of capital.

Question 61

The following information pertains to Quest Co.'s Gold Division for the current year: (CPA adapted) Quest's return on investment was:

A)10.00%.
B)13.33%.
C)27.50%.
D)30.00%.

Question 62

Which of the following will not result in an increase in the residual income,assuming other factors remain constant?

A)An increase in sales.
B)An increase in the minimum required rate of return.
C)A decrease in expenses.
D)A decrease in operating assets.

Question 63

Residual income is a better measure for performance evaluation of an investment center manager than return on investment (ROI)because: (CMA adapted)

A)the problems associated with measuring the asset base are eliminated.
B)desirable investment decisions will not be neglected by high return divisions.
C)only the gross book value of assets needs to be calculated.
D)returns do not increase as assets are depreciateD.

Question 64

All other things the same,which of the following would increase residual income?

A)Increase in average operating assets.
B)Decrease in average operating assets.
C)Increase in minimum required return.
D)Decrease in net operating income.

Question 65

Residual income is a performance evaluation that is used in conjunction with,or instead of,return on investment (ROI).In many cases,residual income is preferred to ROI because: (CIA adapted)

A)residual income is a measure over time,while ROI represents the results for one period.
B)residual income concentrates on maximizing absolute dollars of income rather than a percentage return,as with ROI.
C)the imputed interest rate used in calculating residual income is more easily derived than the target rate that is compared to the calculated ROI.
D)average investment is employed with residual income while year-end investment is employed with ROI.

Question 66

The following information pertains to Bala Co.for the year ended December 31: (CPA adapted) Which of the following equations should be used to compute Bala's return on investment (ROI)?

A)(4/6)× (6/1)= ROI
B)(6/4)× (1/6)= ROI
C)(4/6)× (1/6)= ROI
D)(6/4)× (6/1)= ROI

Question 67

REB Service Co.is a computer service center.For the month of May,REB had the following operating statistics: (CMA adapted) Based on the above information,which one of the following statements is correct? REB has a:

A)return on investment of 4%.
B)residual income of $(2,000).
C)return on investment of 5.6%.
D)residual income of $(22,000).

Question 68

A firm earning a profit can increase its return on investment by: (CMA adapted)

A)increasing sales revenue and operating expenses by the same dollar amount.
B)decreasing sales revenues and operating expenses by the same percentage.
C)increasing investment and operating expenses by the same dollar amount.
D)increasing sales revenues and operating expenses by the same percentage.

Question 69

James Webb is the general manager of the Industrial Product Division,and his performance is measured using the residual income method.Webb is reviewing the following forecasted information for his division for next year: (CMA adapted) If the cost of capital is 15% and Webb wants to achieve a residual income target of $2,000,000,what will costs have to be in order to achieve the target?

A)$9,000,000.
B)$10,800,000.
C)$25,150,000.
D)$25,690,000.

Question 70

A company purchased assets costing $200,000 which will be depreciated over 5-years using straight-line depreciation and no salvage value.The company also purchased land and other assets,which are not depreciable at a cost of $200,000.It is estimated that in 5-years,the value of these assets will be unchanged.Assume that annual cash profits are $80,000 and,for return on investment (ROI)calculations,the company uses end-of-year asset values.If sales each year average $840,000,what will be the asset turnover using gross book value?

A)3.0.
B)2.6.
C)2.1.
D)1.9.

Question 71

In computing the margin in a ROI analysis,which of the following is used?

A)Sales in the denominator.
B)Net operating income in the denominator.
C)Average operating assets in the denominator.
D)Residual income in the denominator.

Question 72

Residual income is a better measure for performance evaluation of an investment center manager than return on investment because: (CMA adapted)

A)the problems associated with measuring the asset base are eliminated.
B)desirable investment decisions will not be neglected by high-return divisions.
C)only the gross book value of assets needs to be calculated.
D)the arguments about the implicit cost of interest are eliminateD.Problems in measuring the asset base,gross versus net book values,and implicit cost of interest are present in both residual income and ROI.Residual income avoids the suboptimization problem with high return divisions.

Question 73

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

A)Fixed assets employed in division operations.
B)Land being held by the division as a site for a new plant.
C)Division inventories when division management exercises control over the amount of short-term credit used.
D)Division accounts payable when division management exercises control over the amount of short-term credit useD.Land would be a strategic asset that is not controlled by the division manager.

Question 74

Residual income is a better measure for performance evaluation of an investment center manager than return on investment because: (CMA adapted)

A)the problems associated with measuring the asset base are eliminated.
B)desirable investment decisions will not be rejected by divisions that already have a high ROI.
C)only the gross book value of assets needs to be calculated.
D)returns do not increase as assets are depreciateD.Residual income indicates those situations with more than a threshold return that should be accepteD.

Question 75

In determining the dollar amount to use for operating assets in the return on investment (ROI)calculation,companies will generally use either net book value or gross cost of the assets.Which of the following is an argument for the use of net book value rather than gross cost?

A)It is consistent with how assets are reported on the balance sheet.
B)It eliminates the depreciation method as a factor in ROI calculations.
C)It encourages the replacement of old,worn-out equipment.
D)All of the above.

Question 76

Return on investment (ROI)is a very popular measure employed to evaluate the performance of corporate segments because it incorporates all of the major ingredients of profitability (revenue,cost,investment)into a single measure.Under which one of the following combinations of actions regarding a segment's revenues,costs,and investment would a segment's ROI always increase? (CIA adapted)

A)Option A
B)Option B
C)Option C
D)Option D