Question 1

The primary limitation of a full-cost based transfer pricing system is that:

Accepted Answer

Full-cost based transfer pricing can lead to the suboptimal decision-making by the supplying and purchasing divisions as they may focus solely on reducing their own costs rather than maximizing overall profitability for the organization. This can lead to conflicts between different divisions and may not align with the goals of the organization as a whole.

Question 2

A fully-owned subsidiary of a multinational company reports its return on investment (ROI) periodically during the year. This unit of the company, for performance evaluation purposes, is likely considered a(n):

Accepted Answer

A fully-owned subsidiary of a multinational company that reports its ROI periodically during the year is likely considered an investment center. An investment center is responsible for generating a return on the assets allocated to it, and its performance is measured primarily by its ROI. This center has control over both the expenses that it incurs and the revenue that it generates, making it a good choice for performance evaluation purposes. The other options, such as profit center, revenue center, cost center, or operating center, all have limited control over their expenses and/or revenue, making them less suitable for evaluating overall performance in terms of ROI.

Question 3

Selected data from Division A of Green Company are as follows:
$\begin{array}{lcc}
\text { Sales } & \$ & 500,000 \
\text { Average investment } & \$ & 300,000 \
\text { Operating income } & \$ & 60,000 \
\text { Minimum rate of return } & & 15 \%
\end{array}$Division A's residual income (RI) is:

Accepted Answer

Residual income is calculated as Operating Income minus the product of Average Investment and Minimum Rate of Return. RI = $60,000 - ($300,000 * 15%) = $60,000 - $45,000 = $15,000.

Question 4

Selected data from Division A of Green Company are as follows:
$\begin{array}{lcc}
\text { Sales } & \$ & 500,000 \
\text { Average investment } & \$ & 300,000 \
\text { Operating income } & \$ & 60,000 \
\text { Minimum rate of return } & & 15 \%
\end{array}$
Division A's return on investment (ROI) is:

Accepted Answer

Return on Investment (ROI) is calculated as Operating Income divided by Average Investment. For Division A, ROI = $60,000 / $300,000 = 0.20 or 20%.

Question 5

The two approaches for estimating Economic Value Added (EVA®) are:

Accepted Answer

The answer of The two approaches for estimating Economic Value...

Question 6

Expropriation occurs when the government in which a foreign company's investment assets are located:

Accepted Answer

Expropriation refers to the act of a government taking ownership and control of foreign company's assets located within their jurisdiction, without the consent of the company.

Question 7

The following results pertain to an investment center.
$\begin{array}{lc}
\text { Sales } & \$ 1,500,000 \
\text { Variable costs } & 800,000 \
\text { Traceable fixed costs } & 100,000 \
\text { Average investment } & 1,000,000 \
\text { Divisional cost of capital (discount rate) } & 10 \%
\end{array}$How much is the return on investment (ROI) for this investment center?

Accepted Answer

The ROI is calculated as (Net Operating Income / Average Investment). Net Operating Income = Sales - Variable Costs - Traceable Fixed Costs = $1,500,000 - $800,000 - $100,000 = $600,000. ROI = $600,000 / $1,000,000 = 60%.

Question 8

Residual income (RI) may be a better measure for performance evaluation of an investment center than return on investment (ROI) because:

Accepted Answer

Residual income encourages managers to make investments that earn more than the minimum required rate of return, thus not discouraging potentially profitable investments due to already high rates of return in their divisions, unlike ROI which might lead to rejecting profitable projects to maintain high ROI percentages.

Question 9

Selected data from Division A of Green Company are as follows:
$\begin{array}{lcc}
\text { Sales } & \$ & 500,000 \
\text { Average investment } & \$ & 300,000 \
\text { Operating income } & \$ & 60,000 \
\text { Minimum rate of return } & & 15 \%
\end{array}$Division A's return on sales (ROS) is:

Accepted Answer

Return on Sales (ROS) is calculated as Operating Income divided by Sales. For Division A, ROS = $60,000 / $500,000 = 0.12 or 12%.

Question 10

Selected data from Division A of Green Company are as follows:
$\begin{array}{lcc}
\text { Sales } & \$ & 500,000 \
\text { Average investment } & \$ & 300,000 \
\text { Operating income } & \$ & 60,000 \
\text { Minimum rate of return } & & 15 \%
\end{array}$If the minimum rate of return was 10%, Division A's residual income (RI) would be:

Accepted Answer

The answer of Selected data from Division A of Green...

Question 11

The following results pertain to an investment center.
$\begin{array}{lc}
\text { Sales } & \$ 1,500,000 \
\text { Variable costs } & 800,000 \
\text { Traceable fixed costs } & 100,000 \
\text { Average investment } & 1,000,000 \
\text { Divisional cost of capital (discount rate) } & 10 \%
\end{array}$
How much is the residual income (RI) for this investment center?

Accepted Answer

The answer of The following results pertain to an investment...

Question 12

In the context of transfer pricing, dual pricing is:

Accepted Answer

Dual pricing refers to the use of two or more transfer pricing methods simultaneously. It helps to eliminate the conflict between different units by providing a fair and reasonable pricing mechanism. The use of multiple pricing methods enables the organization to address the unique characteristics and challenges of each transaction, resulting in a more accurate allocation of profits and costs. Dual pricing is a commonly used transfer pricing technique in multinational corporations, especially those with complex structures and diverse operations.

Question 13

Selected data from Division A of Green Company are as follows:
$\begin{array}{lcc}
\text { Sales } & \$ & 500,000 \
\text { Average investment } & \$ & 300,000 \
\text { Operating income } & \$ & 60,000 \
\text { Minimum rate of return } & & 15 \%
\end{array}$Division A's asset turnover (AT) is (rounded):

Accepted Answer

Asset Turnover (AT) is calculated as Sales divided by Average Investment. Here, AT = $500,000 / $300,000 = 1.67.

Question 14

Given a competitive outside market for identical intermediate goods, what is generally considered the best transfer price, assuming all relevant information is readily available?

Accepted Answer

The best transfer price would be the market price of the intermediate goods, as it ensures that the selling division receives a fair price for their product and incentivizes them to continue producing at a competitive level. Since there is a competitive outside market for the goods, the market price should reflect the true value of the product. Using average cost or full cost may not accurately reflect the true value or demand for the product, and adding a mark-up for profit may lead to a transfer price that is not competitive in the outside market.

Question 15

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:

Accepted Answer

Since Division A is operating at capacity and sells the component in a competitive market for $25 per unit, it would not make sense to sell it internally for less than the market price. Selling to Division B at the market price of $25 ensures Division A does not lose potential revenue from external sales.

Question 16

One approach to measuring the short-term financial performance of a business unit considered an investment center is return on investment (ROI). ROI is expressed as operating income of the investment center:

Accepted Answer

Return on Investment (ROI) is calculated by dividing the operating income of the investment center by the assets used by the investment center. This approach provides a measure of how efficiently the investment center is using its assets to generate profits.

Question 17

One advantage of the return on investment (ROI) metric is that it:

Accepted Answer

One advantage of using return on investment (ROI) as a metric is that it can be compared to interest rates and rates of return on alternative investments, allowing for better decision-making in terms of investment opportunities.

Question 18

Transfer prices based on actual costs of the selling division as opposed to standard costs incurred by that division:

Accepted Answer

Transfer prices based on actual costs of the selling division may fail to provide an incentive for the selling division to control costs since they will be reimbursed for the actual costs incurred. This can lead to inefficiencies and higher costs for the overall organization.

Question 19

A company has two divisions, X and Y, each operated as an investment center.X charges Y $55 per unit for each unit transferred to Y.Other data are: $$\begin{array} { | l | r | l | } 
\hline \text { X's variable cost per unit } & \$ 40 & \
\hline \text { X's fixed costs } & \$ 100,000 & \
\hline \text { X's annual sales to Y } & 5,000 & \text { units } \
\hline \text { X's sales to outsiders } & 10,000 & \text { units } \
\hline
\end{array}$$ X is planning to raise its transfer price to $65 per unit. Division Y can purchase units at $50 each from outsiders, but doing so would idle X's facilities now committed to producing units for Y. Division X cannot increase its sales to outsiders. From the perspective of the short-term profit position of the company as a whole, from which source should Division Y acquire the units?

Accepted Answer

Purchasing from Division X, even at the increased transfer price, keeps the production within the company, ensuring that the internal resources are utilized and the company's overall profit margin is maintained or improved. Buying from outside at $50 per unit might seem cheaper, but it would idle X's facilities, potentially increasing the overall costs when considering the fixed costs and the lost contribution margin from internal transfers.

Question 20

A company established a branch to sell automobile seat covers. The company purchases these covers and stores them in a warehouse. The covers are then shipped from the warehouse to both the home office and the new branch, FOB (Free On Board) destination. Home office management is responsible for setting the transfer price of the covers charged to the branch. Per-unit costs of the covers are:$$\begin{array} { | r | l | } 
\hline \$ 60.00 & \text { purchase price } \
\hline \$ 2.50 & \text { shipping cost to warehouse } \
\hline \$ 3.00 & \text { handling cost, including } \$ 1 \text { allocated administrative overhead } \
\hline \$ 3.50 & \text { shipping cost to branch, paid by home office } \
\hline
\end{array}$$ According to the general transfer-pricing formula given in the text, the minimum transfer price that home office should charge the branch is:

Accepted Answer

The answer of A company established a branch to sell...

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

The primary limitation of a full-cost based transfer pricing system is that:

A fully-owned subsidiary of a multinational company reports its return on investment (ROI) periodically during the year. This unit of the company, for performance evaluation purposes, is likely considered a(n) :

Selected data from Division A of Green Company are as follows: $\begin{array}{lcc}\text { Sales } & \$ & 500,000 \\\text { Average investment } & \$ & 300,000 \\\text { Operating income } & \$ & 60,000 \\\text { Minimum rate of return } & & 15 \%\end{array}$ Division A's residual income (RI) is: