Question 1

Use of net book value (NBV) in valuing investment in operating plant assets, in contrast to using current value, will:

Accepted Answer

E

Question 2

The conventional return on investment (ROI) performance measure calculates "profit" and "investment" based on:

Accepted Answer

The conventional ROI performance measure is based on Generally Accepted Accounting Principles (GAAP), which are accounting standards and guidelines used by companies to prepare and present financial statements. These principles ensure consistency and fairness in financial reporting and allow for useful comparisons between companies. Therefore, B is the best choice.

Question 3

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:

Accepted Answer

The use of gross book value (GBV) reflects the historical cost of the asset, which is an objective and verifiable figure. This measure is not affected by changes in the value of the currency or the impact of inflation. Therefore, those who value objectivity prefer this approach.

Question 4

Which of the following is the most appropriate and comprehensive short-term financial-performance indicator for an investment center that is a division of a larger business entity?

Accepted Answer

Residual income (RI) is the most appropriate and comprehensive short-term financial-performance indicator for an investment center because it measures the absolute amount of profit that exceeds the minimum required return on a company's operating assets, taking into account both the operating income and the cost of capital for the investment center. This provides a more complete picture of the investment center's performance in contributing to the overall company's value.

Question 5

Under the notion of controllability, it is most appropriate for top management to evaluate the profitability of an investment center in terms of:

Accepted Answer

Controllability refers to the extent to which an investment center manager can influence the center's results. Evaluating profitability of an investment center in terms of profits in relation to the amount of capital invested in the unit is most appropriate for controllability because it takes into account the level of investment made in the center and reflects the manager's ability to generate profits with the resources allocated to them. This approach is also known as return on investment (ROI).

Question 6

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

Accepted Answer

The choice of valuation method for inventories would not affect the valuation of fixed assets used by the investment center, as these assets are typically valued using separate methods. However, it could impact the investment base and level of operating income reported by the investment center, as well as potentially impacting current assets and return on sales.

Question 7

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

Accepted Answer

C) Return on sales (ROS) by asset turnover (AT) is a correct formula for calculating ROI, as ROI can be broken down into these two components to analyze profitability and efficiency separately.

Question 8

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

Accepted Answer

The most appropriate method for allocating the cost of shared facilities to the different subunits is to use the relative amount of use or demand for the facilities by each subunit. This method ensures that each subunit is charged for their fair share of the facility usage, which reflects their actual benefit from the shared facility. This method is widely accepted and recommended by management accounting textbooks and practices. Other methods suggested in the answer choices are not as appropriate or commonly used. GAAP and replacement cost are not relevant to the allocation of shared facilities cost, and the amount of capacity alone does not reflect the actual usage of the facilities. The AICPA may provide guidance on cost allocation but does not prescribe specific techniques.

Question 9

As a general rule, leased assets should be included as part of the calculation of "investment" (for calculating ROI and residual income) since they represent assets used:

Accepted Answer

Leased assets are used to generate operating income, so they should be included in the calculation of investment for metrics like ROI and residual income. Option A is incorrect because leased assets are not typically used as collateral for borrowing funds. Option C is incorrect because leased assets do not directly offset current operating expenses. Option D is incorrect because leasing does not directly reduce taxes. Option E is also incorrect because leased assets are not relevant to estimating earnings per share.

Question 10

Return on investment (ROI) encourages business units-such as investment centers- to invest only in projects that earn:

Accepted Answer

ROI measures the profitability of an investment and is calculated as net income divided by the cost of investment. Therefore, in order for a business unit to increase its overall ROI, it must invest only in projects that generate a higher rate of return than its current ROI. Option E is the only choice that aligns with this requirement.

Question 11

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

Accepted Answer

Since RI is an absolute measure of profitability and not a percentage, it cannot be used to compare or evaluate the financial performance of business units of significantly different sizes. A more appropriate measure in such cases would be return on investment (ROI), which is a percentage-based measure.

Question 12

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

Accepted Answer

RI is a dollar amount that represents the income earned above the minimum required rate of return. It can be adjusted for differing levels of risk across investment centers within an organization by using different discount rates. This makes it more useful than ROI, which is a percentage and cannot be easily adjusted for risk.

Question 13

A primary limitation of ROI as a performance-evaluation metric for investment centers is that ROI:

Accepted Answer

ROI measures the return on a financial investment, but it does not capture the value of intangible assets such as intellectual property or human capital which are increasingly important in the knowledge-based economy. Therefore, it may understate the level of investment required for these types of organizations to generate a return.

Question 14

The difference between the historical cost and the net book value (NBV) of a plant asset is the:

Accepted Answer

The difference between historical cost (original cost) and net book value (NBV) is the amount of accumulated depreciation expense on the asset. NBV is the costs of the asset minus accumulated depreciation on the asset. Residual value, depreciation expense for the current period, estimate of remaining useful life, and estimated replacement cost all factor into the calculation of NBV.

Question 15

Firms with high operating leverage tend to have:

Accepted Answer

Firms with high operating leverage have a higher proportion of fixed costs in their cost structure. When sales increase, the contribution margin increases, resulting in a higher return on sales. However, a decrease in sales can result in a significant decline in profits due to the high fixed costs. Therefore, firms with high operating leverage tend to have a low asset turnover (due to the high fixed costs) but a high return on sales.

Question 16

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 mangers to make decisions that are in the best interest of the:

Accepted Answer

Transfer pricing is designed to encourage managers to make decisions that are in the best interest of the firm as a whole, rather than just their individual operating unit or department. By setting transfer prices that reflect the external market, internal managers are motivated to operate efficiently and maximize overall profits for the company. This helps ensure that the firm operates cohesively and achieves its overall goals and objectives.

Question 17

Determination of the useful life of an asset and choice of a depreciation method will affect all of the following except:

Accepted Answer

The determination of useful life and depreciation method affect financial statements and performance measures, such as operating income, ROI, depreciation expense, and NBV. However, they do not directly impact the opportunity cost of lost sales on alternative projects, which is an external factor.

Question 18

In contrast to residual income (RI), economic value added (EVA) uses:

Accepted Answer

The answer of In contrast to residual income (RI), economic...

Question 19

Which one of the following is an advantage of both ROI and Residual Income (RI)?

Accepted Answer

Both ROI and RI take into account all three elements that are important for measuring short-term financial performance of investment centers: revenues, costs, and investments. This makes them advantageous as they provide a comprehensive view of the financial performance of an investment center.

Question 20

The use of replacement cost of assets for purposes of calculating ROI has the advantage(s) of:

Accepted Answer

The use of replacement cost of assets provides a relevant measure of the level of investment in a continuing business, which is a key factor in determining ROI. This method takes into account the current value of assets, rather than historical costs, and is therefore more accurate in reflecting the true value of a company's investment.

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