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CHAPTER 12

FINANCIAL CONTROL
TRUE/FALSE
1.

Financial control involves the use of financial measures to assess organizational and
management performance.
a.
True
b.
False

2.

Financial measures identify what is wrong, not simply provide a signal that something needs
attention.
a.
True
b.
False

3.

Financial measures can highlight falling sales and profits, but only nonfinancial measures can
identify why this is occurring.
a.
True
b.
False

4.

Properly chosen nonfinancial measures anticipate and help to explain financial results.
a.
True
b.
False

5.

In a centralized organization, front-line employees are trained to respond to changes in the


business environment.
a.
True
b.
False

6.

The amount of decentralization reflects the organizations trust in its employees.


a.
True
b.
False

7.

When an organization moves to decentralized decision making, control moves from results
control to task control.
a.
True
b.
False

8.

For an organization to be successful, activities within sales, manufacturing, and customer


service need to be coordinated.
a.
True
b.
False

9.

Organizations use nonfinancial control to provide a summary measure of how well their
systems of operations control are working.
a.
True
b.
False

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10.

Properly chosen nonfinancial measures anticipate and explain financial results.


a.
True
b.
False

11.

A cost center should be evaluated solely on its ability to control and reduce costs.
a.
True
b.
False

12.

A major problem faced by profit centers is assigning jointly earned revenues.


a.
True
b.
False

13.

A cost center is like an independent business.


a.
True
b.
False

14.

Performance measures should influence decision-making behavior.


a.
True
b.
False

15.

For the segment manager to be properly evaluated, common costs should be allocated to the
various segments, even if an arbitrary allocation is required.
a.
True
b.
False

16.

Contribution margin is the best measure of the controllable contribution of a profit center
toward organizational profit.
a.
True
b.
False

17.

If a product line were eliminated, forecasted annual corporate profits would decrease by the
amount of that product lines segment margin.
a.
True
b.
False

18.

In general, managers are motivated to influence generated revenues when those revenues are
included in their performance measures.
a.
True
b.
False

19.

Conventional segment margin income statements clearly capture the interactive effects
among responsibility centers.
a.
True
b.
False

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20.

A major goal of transfer pricing is to motivate the decision maker to act in the organizations
best interests.
a.
True
b.
False

21.

Transfer prices based on actual costs provide no incentive to the supplying division to
control costs.
a.
True
b.
False

22.

If external markets exist, then cost-based transfer prices are the most appropriate.
a.
True
b.
False

23.

Negotiated transfer prices, and therefore production decisions, may reflect the negotiating
skills of the parties rather than economic considerations.
a.
True
b.
False

24.

Return on investment (ROI) encourages segment managers to accept all capital projects
with returns greater than the companys cost of capital.
a.
True
b.
False

25.

The most widely accepted definition of productivity is the ratio of output over input.
a.
True
b.
False

26.

Economic value added evaluates income relative to the level of investment required.
a.
True
b.
False

27.

A sole ratio value can be extremely meaningful.


a.
True
b.
False

28.

The net profit margin ratio for Wal-Mart, a discount store, is approximately 3%. This is low
compared to Microsofts 20% net profit margin ratio, and therefore, indicates Wal-Mart is a
poor investment.
a.
True
b.
False

29.

In general, a grocery store would be expected to have a greater inventory turnover ratio
than a retailer such as Sears.
a.
True
b.
False

30.

In general, a debt ratio of 90% indicates lower financial risk than a debt ratio of 60%.
a.
True
b.
False

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MULTIPLE CHOICE
31.

Financial control highlights:


a.
falling profits
b.
poor quality
c.
high prices
d.
unsatisfactory service

32.

All of the following are reasons that financial control may be an ineffective scorecard
EXCEPT that:
a.
it fails to identify the causes or drivers of performance
b.
it focuses on financial measures while ignoring other important attributes of
performance
c.
it focuses on long-term rather than short-term performance measures
d.
it is an aggregate, rather than a detailed measure of performance

33.

Performance measures for financial control include all of the following EXCEPT:
a.
reduced cycle times
b.
ROI ( return on investment) and economic value added
c.
profit
d.
cost

34.

Which of the following statements is FALSE regarding financial and nonfinancial measures
of performance?
a.
Nonfinancial measures may help to anticipate and explain financial results.
b.
Financial results include aggregate measures.
c.
Nonfinancial results may help to identify the causes of financial results.
d.
Financial results are lead indicators of future success.

35.

In a centralized organization:
a.
local-division managers have greater control over their business segments
b.
there are few deviations from the standardized way of doing things
c.
front-line employees are trained to respond to changes in the business environment
d.
decisions are made by the managers most familiar with the problems and opportunities

36.

In a decentralized organization:
a.
local-division managers must receive higher approval for most business decisions
b.
company-wide standard operating procedures are common
c.
local-division managers have an opportunity to gain decision-making experience
d.
decisions are made by senior executives

37.

A decentralized organization does all the following EXCEPT it:


a.
encourages local success rather than organizational success
b.
trains employees in skills needed for decision making
c.
assigns responsibility to front-line employees
d.
adapts to the local business environment

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38.

All of the following are true of responsibility centers EXCEPT that they:
a.
operate like a small business
b.
promote the interests of the larger organization
c.
coordinate activities with other responsibility centers
d.
are best used in a centralized organization

39.

The MOST likely result of decentralization is to give local-division managers the


responsibility for:
a.
evaluating strategic goals
b.
allocating joint costs
c.
operating decisions
d.
financial control

40.

According to the text, performance measures for responsibility centers should:


a.
be broad enough to motivate desired performance
b.
evaluate performance under a managers control
c.
evaluate performance that a manager can influence
d.
All of the above are correct.

41.

A local unit is evaluated as a profit center but the corporate office controls many facets of
the operation. If local-unit performance is poor, it may reflect:
a.
poor corporate decisions
b.
poor local decisions
c.
conditions that no one can control
d.
All of the above are correct.

42.

Measuring performance based on cost per unit will motivate performance that includes
keeping __________ under control.
a.
only costs
b.
costs and on-time delivery
c.
costs and the amount of defects
d.
only quality

43.

A cost center is a business segment:


a.
that usually evaluates employee performance by comparing the work performed to a
standard
b.
in which intraperiod cost comparisons can be misleading if the output mix and
product-mix level are constant
c.
that usually includes individual stores within a department-store chain
d.
that should be evaluated solely on its ability to control and reduce costs

44.

All of the following are true of a revenue center EXCEPT that it:
a.
controls service quality and units sold
b.
controls the acquisition cost of the product or service sold
c.
may control price, product mix, and promotional activities
d.
may incur sales and marketing costs

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45.

When responsibility centers are treated as profit centers:


a.
the segment manager has responsibility for pricing and product selection, but not for
purchasing and promotion
b.
the corporate office makes most of the operating and pricing decisions
c.
the information technology group of a manufacturing firm would typically be treated
as a profit center
d.
there are usually problems associated with assigning jointly earned revenues

46.

A fully-owned subsidiary of a multinational firm reports return on investment four times a


year. This is an example of:
a.
a revenue center
b.
a cost center
c.
an investment center
d.
a profit center

47.

Segment margin includes:


a.
all costs traceable to the segment
b.
the segments share of allocated corporate costs
c.
the segments share of allocated unavoidable costs
d.
All of the above are correct.

48.

For a profit center, the __________ is the best measure of the controllable contribution of
the center towards organizational profit and other organizational costs.
a.
contribution margin
b.
segment margin
c.
segment income
d.
net income

49.

All of the following are true regarding a units segment margin EXCEPT that:
a.
it is an estimate of the units short-term effect on organizational income
b.
if that unit had been eliminated, corporate profits would have decreased by this
amount
c.
it results from netting revenues and costs that are proportional to volume
d.
it is the best measure of financial performance for segment management

50.

Caution should be taken when interpreting a segment margin income statement because:
a.
revenues may be based on transfer prices
b.
the interactive effects among responsibility centers are generally not clearly captured
c.
expenses may be a result of subjective allocation of jointly incurred costs
d.
All of the above are correct.

51.

Building depreciation should be allocated to individual cost centers:


a.
based on the square footage each cost center uses
b.
based on the number of employees utilized by each individual center
c.
only if the allocation serves some decision-making purpose
d.
never, because it is a non-cash cost that should not be allocated

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 52 THROUGH 55.


The management accountant for the Casey & Grant Book Store has prepared the following
segmented income statement for the most current year.
Cookbook
Travel Book
Classics
Total
Sales
$60,000
$100,000
$40,000
$200,000
Variable expenses
36,000
65,000
20,000
121,000
Contribution margin
24,000
35,000
20,000
79,000
Other costs
18,000
21,000
8,000
47,000
Segment margin
6,000
14,000
12,000
32,000
Allocated avoidable costs
2,000
1,000
3,000
6,000
Segment income
4,000
13,000
9,000
26,000
Allocated corporate costs
7,000
7,000
7,000
21,000
Corporate profit
$(3,000)
$ 6,000
$ 2,000
$ 5,000
52.

If the cookbook product line had been eliminated prior to this year, the company would
have reported:
a.
greater corporate profits
b.
the same amount of corporate profits
c.
less corporate profits
d.
resulting profits cannot be determined

53.

If the travel book line had been discontinued, the short-term effect on corporate profits
would be a decrease of:
a.
$35,000
b.
$14,000
c.
$13,000
d.
$6,000

54.

Assume that the classics product line has been discontinued and long-term capacity has had
time to adjust. The projected long-term effect of this action on annual corporate profits
would be a decrease of:
a.
$20,000
b.
$12,000
c.
$9,000
d.
$2,000

55.

Assume an advertising campaign could increase revenues for any of the products by
$15,000. To maximize corporate profits, the __________ product line should receive the
advertising dollars.
a.
classics
b.
travel book
c.
cookbook
d.
From the information given, the correct product line cannot be determined.

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56.

If a company subscribes to the controllability principle, then it would be best to evaluate


product line management on:
a.
contribution margin
b.
corporate profit
c.
segment income
d.
segment margin

57.

The primary goal of transfer pricing is to:


a.
motivate the decision maker to act in the organizations best interests
b.
obtain a high transfer price for the supplying unit
c.
obtain a high transfer price for the receiving unit
d.
agree on a price for external sales

58.

All of the following are true of market-based transfer prices EXCEPT that they:
a.
may lead to goods/services being purchased externally
b.
provide an independent valuation
c.
exist for all transferred products and services
d.
provide the proper economic incentives

59.

All of the following are true of cost-based transfer prices EXCEPT that they:
a.
provide no incentive to the supplying division to control costs when actual costs are
used
b.
may use standard costs to help maintain operating efficiency
c.
promote the optimal level of transactions for the overall organization
d.
dont give proper guidance when operating capacity is constrained

60.

The MOST likely result of a negotiated transfer price is that it:


a.
takes away the ultimate responsibility of the resulting transfer price from the two
parties
b.
may reflect the relative negotiating skills of the two parties
c.
generally results in transferring more than the optimum number of units
d.
reflects purely economic considerations

61.

An administered transfer price:


a.
is most often used for infrequent transactions
b.
retains the accountability of both parties
c.
reflects pure economic considerations
d.
provides an arbitrary distribution of revenues and costs between the parties

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 62 THROUGH 65.


The Jordan Company manufacturers only one type of shoe and has two divisions, the Sole
Division and the Assembly Division. The Sole Division manufactures soles and then "sells" them
to the Assembly Division, which completes the shoes and sells them to retailers. The market price
for the Assembly Division to purchase a pair of soles is $20. Fixed costs are per pair at 100,000
units.
Sole's costs per pair of soles are:
Direct materials
Direct labor
Variable overhead
Division fixed costs

$4
$3
$2
$1

Assembly's costs per completed pair of shoes are:


Direct materials
$5
Direct labor
$1
Variable overhead
$1
Division fixed costs
$9
62.

If the cost-based transfer price is 180% of variable costs , what is the transfer price per pair
of soles from the Sole Division to the Assembly Division?
a.
$14.40
b.
$12.60
c.
$16.20
d.
$28.80

63.

Calculate and compare the difference in overall corporate net income between Scenario A
and Scenario B if the Assembly Division sells 100,000 pairs of shoes for $60 per pair to
customers.
Scenario A: Negotiated transfer price of $15 per pair of soles
Scenario B: Market-based transfer price
a.
$500,000 more net income under Scenario A
b.
$500,000 of net income using Scenario B
c.
$100,000 of net income using Scenario A
d.
None of the above is correct.

64.

Assume the transfer price for a pair of soles is 180% of full costs of the Sole Division and
100,000 of soles are produced and transferred to the Assembly Division. The Sole Division's
operating income is:
a.
$800,000
b.
$900,000
c.
$1,280,000
d.
$1,800,000

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65.

If the Assembly Division sells 100,000 pairs of shoes at a price of $60 a pair to customers,
what is the operating income of both divisions together?
a.
$4,400,000
b.
$3,400,000
c.
$3,000,000
d.
indeterminable

66.

Problems of using investment centers include all of the problems associated with profit
centers plus all of the following EXCEPT:
a.
how to identify the assets used by each investment center
b.
how to assign jointly-used assets such as buildings
c.
how to determine the value of the assets
d.
what method to use to depreciate the assets

67.

All of the following equations represent return on investment (ROI) EXCEPT:


a.
efficiency x productivity
b.
operating income / investment
c.
return on sales x inventory turnover
d.
(operating income / sales) x (sales / investment)

68.

To discover where to make improvements in productivity, managers might do all of the


following EXCEPT:
a.
calculate the ratio of output over input
b.
compare return on sales to a competitors return on sales
c.
use trend analysis
d.
compare the asset turnover ratio for this accounting period to an industry norm

69.

Return on investment (ROI) can be increased by:


a.
increasing sales
b.
decreasing operating assets
c.
decreasing operating income
d.
decreasing asset turnover

70.

The MAJOR criticism of using return on investment (ROI) for financial control is that it:
a.
gives managers an incentive to reject projects with an ROI greater than the companys
required rate of return but less than the departments current ROI
b.
usually uses the blended rate of capital as the required rate of return
c.
encourages competition among segment managers
d.
is a measure of overall performance

71.

Assume an organizations cost of capital is 10% and Department X currently has a 15%
return on investment (ROI). The manager of Department X, who is evaluated on ROI,
would MOST likely accept an investment that is expected to return:
a.
more than 10%
b.
more than 15%
c.
more than 10% but less than 15%
d.
less than 15%

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 72 THROUGH 74.


Randall Company makes and distributes outdoor play equipment. Last year sales were
$12,000,000, operating income was $3,000,000, and the assets used were $15,000,000.
72.

Return on sales, the efficiency component of return on investment (ROI), is:


a.
20%
b.
80%
c.
25%
d.
125%

73.

Asset turnover, the productivity component of return on investment (ROI), is:


a.
20%
b.
80%
c.
25%
d.
125%

74.

The return on investment (ROI) is:


a.
20%
b.
80%
c.
25%
d.
125%

75.

Economic value added:


a.
encourages segment managers to accept only new capital projects with a return on
investment (ROI) that exceed the current ROI
b.
of $50,000 indicates the segment earned $50,000 for the company
c.
of $10,000 indicates the segments actual earnings exceeded the companys cost of
capital by $10,000
d.
is considered an inferior method of evaluating investment center performance

76.

The text discusses how Quaker Oats used economic value added to evaluate the practice of
trade loading, which is a practice of loading up the supply line with product to last several
months. This application of economic value added would focus on:
a.
comparing the profit changes caused by trade loading with changes in customer
satisfaction
b.
the effect on partners in the distribution channel caused by abandoning trade loading
c.
the difference in prices caused by trade loading
d.
comparing the benefits and costs of trade loading with the required investment in
inventory

77.

A measure of operations efficiency generally divides:


a.
output by input
b.
standard revenues by standard costs
c.
sales by cost of goods sold
d.
sales by investment

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78.

All of the following are true regarding productivity EXCEPT:


a.
that an example of raw material productivity is weight of the final product to the
weight of the raw materials
b.
that the most widely accepted definition of productivity is the ratio of operating
income over sales
c.
that an example of machine productivity is a machine's output per hour
d.
machine productivity is an effective method of relating process results with financial
results

79.

Assume an organizations cost of capital is 10% and Division X has operating income of
$1.5 million and uses $10 million of capital. The economic value added for Division X is:
a.
$100,000
b.
$150,000
c.
$500,000
d.
$850,000

80.

All of the following are true regarding common size statements EXCEPT that they:
a.
help to identify trends over time
b.
allow comparison of financial components of similar organizations
c.
express balance sheet amounts as a percent of total assets
d.
express income statement amounts as a percent of net income

81.

The text showed that Nortels sales fell over 40% between 2000 and 2001, but the cost of
sales as a common-size percentage increased dramatically because:
a.
revenues were falling at a faster rate than Nortel could shed fixed costs
b.
assets acquired were purchased for more than book value
c.
intangible assets decreased due to the write-down or write-off of many bad
investments
d.
common stockholders equity increased to reflect the financing of investments

82.

Ratios:
a.
need to be compared to other information, such as company ratios from prior years, to
be useful
b.
on their own, provide enough information for decision makers to make well-informed
decisions
c.
must use amounts from the same financial statement
d.
have a set formula so there is consistency in calculations and they can be easily
compared to ratios of competitors

83.

Which of the following statements is true regarding profitability ratios?


a.
The current ratio measures a companys ability to meet short-term obligations a
profitability ratio.
b.
A return on assets of 15% indicates that for every dollar invested in assets, the
company is generating 15 cents in net income.
c.
If the industry average for the net profit margin ratio were 10%, then a company ratio
of 5% would be considered favorable.
d.
A decreasing trend for the return on common equity ratio is considered favorable.

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84.

Which of the following statements is true regarding asset use (productivity) ratios?
a.
The dividend payout ratio indicates the proportion of net income paid out in dividends
a productivity ratio.
b.
A total asset turnover of 2.0 indicates that for every dollar invested in assets, the
company is generating $2 in net income.
c.
If the industry average for the inventory turnover ratio is 4 times, then a company ratio
of 6 times indicates a company is turning over inventory faster than the industry
average. This would be considered favorable.
d.
A decreasing trend for accounts receivable turnover indicates receivables are being
collected in fewer days and is considered favorable.

85.

Which of the following statements is true regarding liquidity ratios?


a.
The debt ratio measures the proportion of assets financed by debt a liquidity ratio.
b.
The current ratio measures the ability to meet all debt obligations both short term
and long term.
c.
A decreasing trend for free cash flow indicates a strong cash position and a better
ability to meet current obligations.
d.
The times-interest-earned ratio may not be a good indicator of the organizations
ability to pay interest since interest is paid with cash and not income.

86.

Which of the following statements is true regarding financial leverage ratios?


a.
Return on common equity is a solvency ratio.
b.
A 1.5 debt-to-equity ratio indicates a greater proportion of company assets are being
financed with equity rather than with debt.
c.
If the industry average for the debt ratio is 60%, then a company ratio of 90%
indicates the proportion of total assets financed by debt is greater than average for the
industry.
d.
A decreasing trend for the debt-to-equity ratio indicates greater financial risk.

87.

Using the information below, return on common equity equals:


BALANCE SHEET
Accounts payable
Bonds payable
Common stock
Retained earnings
INCOME STATEMENT
Net income
a.
b.
c.
d.

December 31, 2005


$20,000
$100,000
$30,000
$50,000
2005
$20,000

10%
25%
11%
67%

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88.

Use the information below to select the correct response:


Cash
Accounts receivable
Inventory
Equipment, net
Accounts payable
Bonds payable
Common stock
Retained earnings
a.
b.
c.
d.

$ 10,000
$ 15,000
$ 25,000
$150,000
$ 20,000
$ 80,000
$ 30,000
$ 70,000

The quick ratio equals 0.25.


The current ratio equals 0.10.
The debt ratio equals 20%.
The debt-to-equity ratio equals 100%.

89.

Two companies are identical except for the fact that Company D uses the double-decliningbalance method of depreciation and Company S uses the straight-line method of
depreciation. Assume this is the first year of business for both companies. For Company D,
the ratio that will be greater is:
a.
the current ratio
b.
the net profit margin ratio
c.
the total asset turnover ratio
d.
the dividend yield ratio

90.

Lucy Company and Fred Company are identical except that Lucy Company uses the LIFO
inventory costing method and Fred Company uses the FIFO inventory costing method. In a
period of rising prices, the ratio that will be greater for Lucy Company is:
a.
the current ratio
b.
the inventory turnover ratio
c.
the net profit margin ratio
d.
the accounts receivable turnover ratio

91.

All of the following are limitations to ratio analysis EXCEPT that:


a.
information to calculate the ratios may come from two different financial statements
b.
ratios are based on historical results
c.
companies choose different accounting methods for depreciation and inventory costing
d.
interpretation may be difficult due to the effect of unknown economic or competitive
forces

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EXERCISE/PROBLEM
92.

93.

For each of the following activities, characteristics, and applications, identify whether they
are found in a (C)entralized organization, a (D)ecentralized organization, or (Both) types of
organizations.
(C / D / Both)
(C / D / Both)
(C / D / Both)
(C / D / Both)
(C / D / Both)

a.
b.
c.
d.
e.

(C / D / Both)
(C / D / Both)
(C / D / Both)
(C / D / Both)
(C / D / Both)

f.
g.
h.
i.
j.

Freedom for managers at lower organizational levels to make decisions


Best suited to organizations within stable environments
Greater responsiveness to user needs
Use the most efficient technologies
Maximum constraints and minimum freedom for managers at lowest
levels
Maximization of benefits over costs
Minimization of duplicate functions
Standard operating procedures
Requires trust in employees at all levels
Primarily task control rather than results control

The management accountant for the Chocolate Smore Company has prepared the following
segmented income statement.
Chocolate
Other Candy
Fudge
Total
Sales
$40,000
$25,000
$35,000
$100,000
Variable expenses
26,000
15,000
19,000
60,000
Contribution margin
14,000
10,000
16,000
40,000
Other costs
2,000
3,000
2,000
7,000
Segment margin
12,000
7,000
14,000
33,000
Allocated avoidable costs
3,000
3,000
2,000
8,000
Segment income
9,000
4,000
12,000
25,000
Allocated corporate costs
5,000
5,000
5,000
15,000
Corporate profit
$4,000
$(1,000)
$7,000
$10,000
Required:
a.
Do you recommend dropping the Other Candy product line? Why or why not?
b.
If the Chocolate product line had been discontinued, the short-term effect on corporate
profits would be a decrease of what amount?
c.
Assume that the Fudge product line has been discontinued and long-term capacity has
had time to adjust. The projected long-term effect of this action on annual corporate
profits would be a decrease of what amount?
d.
Assume that an advertising campaign could increase revenues for any of the products
by $15,000. To maximize corporate profits, which product line should receive the
advertising dollars? Why?
e.
How would you change the format of the segment margin statement above to make it
more understandable?

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94.

95.

For each of the following, identify whether it BEST relates to (M)arket-based, (C)ost-based,
(N)egotiated, (A)dministered, or (All) types of transfer pricing.
(M / C / N / A / All)
(M / C / N / A / All)
(M / C / N / A / All)
(M / C / N / A / All)

a.
b.
c.
d.

(M / C / N / A / All)
(M / C / N / A / All)
(M / C / N / A / All)

e.
f.
g.

(M / C / N / A / All)

h.

(M / C / N / A / All)
(M / C / N / A / All)

i.
j.

Bargaining between selling and buying units


Objective and provides the proper economic incentives
145% of full costs
Avoids confrontation and generally used when a transaction
occurs frequently
Internal product transfers are required
Prices listed in a trade journal
Prices do not reflect pure economic considerations nor
accountability considerations
Goal is to motivate decision makers to act in the organizations
best interest
Provide no incentive to the supplying division
Reflects support of the controllability principle

The Crandon Mill has two divisions. The Cutting Division prepares timber at its sawmills.
The Assembly Division prepares the cut lumber into finished wood for the furniture industry.
During the year, the Cutting Division prepared 60,000 cords of wood at a cost of $660,000.
All the lumber was transferred to the Assembly Division where additional operating costs of
$6 per cord were incurred. The 600,000 boardfeet of finished wood were sold for
$2,500,000.
Required:
a.

Determine the operating income for each division if the transfer price from Cutting to
Assembly is at cost, $11 a cord.

b.

Determine the operating income for each division if the transfer price is $9 per cord.

c.

Since the Cutting Division sells all of its wood internally to the Assembly Division,
does the manager care what price is selected? Why? Should the Cutting Division be a
cost center or a profit center under the circumstances?

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96.

Bedtime Bedding Company manufactures pillows. The Cover Division makes covers and the
Assembly Division makes the finished pillows. The covers can be sold separately for $5.00.
The pillows sell for $6.00. The information related to manufacturing for the most recent
year is as follows:

Manufacturing costs of division


Sales to external parties
Market value of covers transferred from
the Cover Division to the Assembly
Division

Cover
Division
$6,000,000
$4,000,000

Assembly
Division
$1,500,000
$7,200,000
$6,000,000

Required:
a.
Compute the operating income for each division and the company as a whole. Use
market value as the transfer price.
b.
Are all managers happy with this concept? Explain.
97.

Department income totals $10,000, investment in the department is $100,000, and the
companys cost of capital is 8%.
Required:
a.
Calculate the return on investment (ROI).
b.
Calculate economic value added.
c.
Assume there is a capital project that requires a $10,000 investment for a $900 return.
Would the department manager be more likely to accept the project if department
performance was evaluated using ROI or economic value added? Why?

98.
Cash
Accounts receivable
Inventory
Equipment, net
Accounts payable
Bonds payable
Common stock
Retained earnings

$ 25,000
$ 15,000
$ 60,000
$300,000
$ 50,000
$180,000
$ 40,000
$ 130,000

Required:
Use the information above to calculate the following ratios:
a.
the quick ratio;
b.
the current ratio;
c.
the debt ratio; and
d.
the debt-to-equity ratio.

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CRITICAL THINKING/ESSAY
99.

What is financial control and how does it relate to nonfinancial measures?

100. Discuss at least two inefficiencies of financial control.


101. Describe a profit center. What are some of the problems faced by profit centers?
102. What types of revenues and costs are used to calculate segment margin?
103. Is segment margin an appropriate measure of financial performance for segment
management? Why?
104. Why are transfer prices used? What is a market-based transfer price?
105. A division reports a 20% ROI, an 8% return on sales, and a 2.50 asset turnover ratio. How
can the manager of this division determine whether these results are favorable or not?
106 Ratio values standing by themselves have little to no meaning. Describe at least two different
ways to make ratios more useful.

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CHAPTER 12
FINANCIAL CONTROL
TRUE/FALSE

MULTIPLE CHOICE

LO1
LO1
LO1
LO1
LO2

1.
2.
3.
4.
5.

a
b
a
a
b

LO1
LO1
LO1
LO1
LO2

31.
32.
33.
34.
35.

a
c
a
d
b

LO5
LO6
LO6
LO6
LO6

61.
62.
63.
64.
65.

d
c
d
a
b

LO2
LO2
LO3
LO3
LO3

6.
7.
8.
9.
10.

a
b
a
b
a

LO2
LO2
LO2
LO2
LO3

36.
37.
38.
39.
40.

c
a
d
c
d

LO7
LO7
LO7
LO7
LO7

66.
67.
68.
69.
70.

d
c
b
b
a

LO3
LO3
LO3
LO3
LO4

11.
12.
13.
14.
15.

b
a
b
a
b

LO3
LO3
LO3
LO3
LO3

41.
42.
43.
44.
45.

d
a
a
b
d

LO7
LO7
LO7
LO7
LO7

71.
72.
73.
74.
75.

b
c
b
a
c

LO4
LO4
LO4
LO4
LO5

16.
17.
18.
19.
20.

b
a
a
b
a

LO3
LO4
LO4
LO4
LO4

46.
47.
48.
49.
50.

c
a
b
c
d

LO7
LO7
LO7
LO7
LO8

76.
77.
78.
79.
80.

d
a
b
c
d

LO5
LO5
LO5
LO7
LO7

21.
22.
23.
24.
25.

a
b
a
b
a

LO4
LO4
LO4
LO4
LO4

51.
52.
53.
54.
55.

c
c
b
c
a

LO8
LO8
LO8
LO8
LO8

81.
82.
83.
84.
85.

a
a
b
c
d

LO7
LO8
LO8
LO8
LO8

26.
27.
28.
29.
30.

a
b
b
a
b

LO4
LO5
LO5
LO5
LO5

56.
57.
58.
59.
60.

d
a
c
c
b

LO8
LO8
LO8
LO8
LO8

86.
87.
88.
89.
90.

c
b
d
c
b

LO8

91.

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MULTIPLE CHOICE
56.
62.
63.
64.
65.
72.
73.
74.
87.
88.

89.
90.

The Classics product line has a 50% contribution margin, which is greater than the 40% CM
of the Cookbook product line and the 35% CM of the Travel Book product line.
$9 x 1.8 = $16.20
The net income would be the same under both scenarios.
Revenue [($10 x 1.80) x 100,000)] - Costs ($10 x 100,000) = $800,000 Operating income
Revenues ($60 x 100,000) - Cost ($26 x 100,000) = $3,400,000 Operating income
$3,000,000 / $12,000,000 = 25%
$12,000,000 / $15,000,000 = 80%
$3,000,000 / $15,000,000 = 20% OR 25% x 80% = 20%
$20,000 net income / ($30,000 + $50,000) common equity = 25%
Debt to equity ratio = total liabilities ($20,000 + $80,000) / total equity ($30,000 +
$70,000) = 100%. Quick ratio = ($10,000 + $15,000) / current liabilities $20,000 = 1.25.
Current ratio = ($10,000 + $15,000 + $25,000) / current liabilities $20,000 = 2.50. Debt
ratio = total liabilities ($20,000 + $80,000) / total assets $200,000 = 50%.
Accumulated depreciation will be greater for Company D, resulting in lower total assets.
Sales divided by a lower total assets results in a greater asset turnover ratio for Company D.
Asset turnover ratio = sales / total assets.
Cost of sales is greater when using LIFO and ending inventory is less when using LIFO.
Therefore, cost of sales / inventory will be greater for Lucy Company.

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EXERCISE/PROBLEM
LO2
92. (C / D / Both)
(C / D / Both)
(C / D / Both)
(C / D / Both)
(C / D / Both)

a.
b.
c.
d.
e.

(C / D / Both)
(C / D / Both)
(C / D / Both)
(C / D / Both)
(C / D / Both)

f.
g.
h.
i.
j.

LO4
93. a.

Freedom for managers at lower organizational levels to make decisions


Best suited to organizations within stable environments
Greater responsiveness to user needs
Use the most efficient technologies
Maximum constraints and minimum freedom for managers at lowest
levels
Maximization of benefits over costs
Minimization of duplicate functions
Standard operating procedures
Requires trust in employees at all levels
Primarily task control rather than results control

No, I would not recommend dropping the Other Candy product line because the
$7,000 segment margin indicates that this product line contributes $7,000 toward
corporate costs and profits.

b.

If the Chocolate product line were discontinued, corporate profits would immediately
decrease by $12,000, the amount reported for the segment margin.

c.

If the Fudge product line were discontinued and long-term capacity has had time to
adjust, corporate profits would decrease by $12,000, the amount reported for the
segment income.

d.

To maximize corporate profits, the Fudge product line should receive the advertising
dollars because it has a contribution margin of approximately 46%, the highest
contribution margin of the three product lines.

e.

The current segment margin statement could be made more understandable if the
allocated corporate costs were only listed under the company total column, and they
were not part of the computation for each product line segment. It is obvious that the
corporate costs are arbitrarily allocated equally to each product line and arbitrary
allocations do not aid in decision making.

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LO5
94. (M / C / N / A / All)
(M / C / N / A / All)
(M / C / N / A / All)
(M / C / N / A / All)

a.
b.
c.
d.

(M / C / N / A / All)
(M / C / N / A / All)
(M / C / N / A / All)

e.
f.
g.

(M / C / N / A / All)

h.

(M / C / N / A / All)
(M / C / N / A / All)

i.
j.

Bargaining between selling and buying units


Objective and provides the proper economic incentives
145% of full costs
Avoids confrontation and generally used when a transaction
occurs frequently
Internal product transfers are required
Prices listed in a trade journal
Prices do not reflect pure economic considerations nor
accountability considerations
Goal is to motivate decision makers to act in the organizations
best interest
Provides no incentive to the supplying division
Reflects support of the controllability principle

LO3,6
95. a.
Cutting
$660,000*

Assembly
$2,500,000

$ 660,000
0
$ 660,000

$ 360,000
660,000
$1,020,000

$1,480,000

Revenue
Cost of service
Incurred
Transferred-in
Total

Cutting
$540,000*

Assembly
$2,500,000

$ 660,000
0
$ 660,000

$ 360,000
540,000
$ 900,000

Operating income

$(120,000)

$1,600,000

Revenue
Cost of services:
Incurred
Transferred-in
Total
Operating income
* 60,000 cords x $11 = $660,000
b.

* 60,000 cords x $9 = $540,000


c.

The manager of Cutting cares about the transfer price if the division is a profit center
but not if it is a cost center. Under the circumstances, the division probably should be
a cost center and it should not worry about the profit it pretends to make by selling to
another division.

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LO6
96. a.
Cover Division
Revenue:
External
Internal
Total
Cost of goods:
Incurred
Transferred-in
Total
Operating income
b.

LO7
97. a.

Assembly Division

Company

$ 4,000,000
6,000,000
$10,000,000

$7,200,000
0
$7,200,000

$11,200,000
0
$11,200,000

$ 6,000,000
0
$ 6,000,000

$1,500,000
6,000,000
$7,500,000

$ 7,500,000
0
$ 7,500,000

$ 4,000,000

$ (300,000)

$ 3,700,000

The Assembly manager is probably not happy because the division is showing a loss.
The manager would probably argue for a transfer price at something less than market
price. However, since the market is open and competitive, the market price can be
justified. The division needs to either increase its price or reduce its costs if it expects
to show a profit.

ROI is 10% ($10,000 department income / $100,000 investment in the department).

b.

Economic value added is $2,000 [$10,000 income - $8,000 ($100,000 x 8%)].

c.

By accepting the proposed project, the departments ROI will be reduced by 0.1% to
9.9%. The department manager being evaluated on ROI will probably reject the
$10,000 investment proposal even though the investment exceeds the companys 8%
cost of capital. New ROI of 9.9% = $10,900 segment income / $110,000 investment in
the segment.
By accepting the proposed project, the economic value added will be increased to
$2,100, an increase of $100. The department manager being evaluated on economic
value added will probably choose to accept the investment since it increases economic
value added for the department. New economic value added is $2,100 [$10,900 actual
income - $8,800 ($110,000 x 8%) cost of capital].

LO8
98. a.

Quick ratio = ($25,000 + $15,000) / current liabilities $50,000 = 0.80

b.

Current ratio = ($25,000 + $15,000 + $60,000) / current liabilities $50,000 = 2.00.

c.

Debt ratio = total liabilities ($50,000 + $180,000) / total assets $400,000 = 57.5%.

d.

Debt-to-equity ratio = total liabilities ($50,000 + $180,000) / total equity ($40,000 +


$130,000) = 135.3%.

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CRITICAL THINKING/ESSAY
LO1
99. What is financial control and how does it relate to nonfinancial measures?
Solution: Financial control involves the use of financial measures to assess organization and
management performance.
Financial measures provide a signal that something is wrong, while nonfinancial measures
identify what is wrong. For example, falling sales, a financial measure, indicates that
something is wrong. However, the falling sales may result from poor quality, poor service,
or high prices, which would be identified by the nonfinancial measures of the organization.
LO1
100. Discuss at least two inefficiencies of financial control.
Solution: First, financial control focuses on financial measures that do not measure other
important attributes such as product quality, employee satisfaction, and customer service.
Because these elements and others are important to the organizations long-term success,
they also should be measured and monitored.
Financial control measures the effect of the overall level of performance and ignores the
performance achieved on a more detailed level. For this reason, financial control does not
suggest how to improve performance, but only serves as a signal of potential problems and
opportunities.
Financial control is oriented to short-term performance and it only considers how well the
organization has performed this quarter or this year. This preoccupation with short-term
success is debilitating because little attention gets focused on long-term improvement.
LO3
101. Describe a profit center. What are some of the problems faced by profit centers?
Solution: Profit centers are responsibility centers in which managers and other employees
control both the revenues and the costs of the product or service provided. A profit center is
like an independent business, except that senior management controls the level of investment
in the responsibility center.
Problems faced by profit centers include deciding how to assign jointly-earned revenues and
jointly-incurred costs, and deciding how to record the interactions such as transfers of goods
and services between the various profit centers within the organization.

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LO4
102. What types of revenues and costs are used to calculate segment margin?
Solution: The revenues used to compute segment margin include those directly traceable to
the segment. Also included is the segments allocation of jointly-earned revenues and
revenues earned from other responsibility centers that may be based on transfer prices.
The costs used to compute segment margin include those directly traceable to the segment.
Also included is the segments allocation of jointly-incurred costs and costs of items
supplied internally to other responsibility centers that may be based on transfer prices.
Only those costs that are considered under the control of the segment manager should be
included.
LO4
103. Is segment margin an appropriate measure of financial performance for segment
management? Why?
Solution: Yes, it is an appropriate measure because all of the revenues and costs used to
compute segment margin are directly traceable to the segment and are essentially under the
control of the segment manager.
LO5
104. Why are transfer prices used? What is a market-based transfer price?
Solution: Transfer prices are used internally to value goods and services provided
(transferred) by one division to another. A market-based transfer price transfers those goods
from one division to another at their current market value.
LO7
105. A division reports a 20% ROI, an 8% return on sales, and a 2.50 asset turnover ratio. How
can the manager of this division determine whether these results are favorable or not?
Solution: Meaning is added when ratios are compared to past performance and trends are
revealed. Also, ratios can be compared to industry averages and ratios of comparable
organizations. To keep ratios in proper perspective, a background check into a companys
external environment should include information about general economic conditions,
political events and political climate, and industry outlook. The trends or comparative
differences help to determine if the division is doing well and they also provide signals of
where to look for potential problems and opportunities.
LO8
106. Ratio values standing by themselves have little to no meaning. Describe at least two different
ways to make ratios more useful.
Solution: (1) Meaning is added when ratios are compared to past performance and trends
are revealed. (2) To add meaning, compare ratios to other relevant information such as
industry averages and ratios of peer companies. (3) To keep ratios in proper perspective, a
background check into a companys external environment should include information about
general economic conditions, political events and political climate, and industry outlook.

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