Decentralized Performance Evaluation: True / False Questions

Chapter 10
Decentralized Performance Evaluation

True / False Questions

1. In a decentralized organization, lower-level managers are given a great deal of autonomy in decision-
making.

True False

2. One disadvantage of decentralization is that it fosters competition among divisions.

True False

3. The controllability principle holds that managers should not be held responsible only for what they can
control but are also responsible for allocated costs.

True False

4. The part of the organization for which managers are responsible is called a related-party center.

True False

5. A legal services department would be an example of a cost center.

True False

6. A revenue center manager is responsible for more functions than is a profit center manager.

True False

7. A profit center manager often also supervises revenue and cost center managers.

True False

8. The most common method of evaluating a profit center manager is the segmented income statement.

True False

9. Investment center managers have control over the investment of assets.

True False

10-1
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10. Segment margin and profit margin are identical terms.

True False

11. The balanced scorecard attempts to focus managers' attention on more than just financial measures.

True False

12. Return on investment is calculated as the return on the segment's assets divided by the value of those
assets.

True False

13. The DuPont method breaks residual income into profit margin and investment turnover.

True False

14. Investment turnover is defined as the ratio of sales revenue to average invested assets.

True False

15. Profit margin is defined as the ratio of sales revenue to operating income.

True False

16. Residual income is the difference between operating profit and the minimum profit the organization must
earn to cover the ROI.

True False

17. The hurdle rate is also called economic value added.

True False

18. Residual income can avoid the problems of goal incongruence.

True False

19. Residual income is a leading indicator of financial performance.

True False

20. In transfer pricing, the manager of the buying division is motivated to pay the highest price possible.

True False

Multiple Choice Questions

10-2
21. In what type of organization is decision-making authority spread throughout the organization?

A. Centralized organization
B. Decentralized organization
C. Participative organization
D. Top-down organization

22. Which of the following is not an advantage of decentralization?

A. Allows top managers to focus on strategic issues

B. Potential duplication of resources
C. Allows for development of managerial expertise
D. Managers can react quickly to local information

23. Which of the following is a disadvantage of decentralization?

A. Fosters competition among divisions

B. Managers have specialized knowledge
C. Potential duplication of resources
D. Allows top managers to focus on strategic issues

24. One of the most important concepts in responsibility accounting is the

A. balanced scorecard.
B. controllability principle.
C. related-party transactions.
D. transfer price.

25. Which of the following is the primary tool used by cost centers to manage costs?

A. Return on investment
B. Budgetary control system
C. Balanced scorecard
D. Transfer pricing

26. The responsibility center in which the manager does not have responsibility and authority over revenues is

A. a cost center.

B. an investment center.
C. a profit center.
D. a revenue center.

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27. The responsibility center in which the manager has responsibility and authority over revenues, costs and
assets is

A. a cost center.

C. a profit center.

28. The responsibility center in which the manager does not have responsibility and authority over costs is

A. a cost center.

C. a profit center.

29. The responsibility center in which the manager has responsibility and authority over only revenues and
costs is

A. a cost center.

C. a profit center.

30. Which of the following responsibility centers will use a segmented income statement as an evaluation
tool?

A. cost center
B. revenue center
C. profit center
D. balanced center

31. Which of the following statements follows from the controllability principle?

A. A profit center manager should be evaluated based on residual income, not return on investment.
B. An investment center manager should be evaluated based on return on investment, not residual income.
C. A profit center manager should be evaluated based on segment margin, not profit margin.
D. A cost center manager should be evaluated on costs and revenues, not just costs.

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32. Which of the following is not a perspective used by the balanced scorecard?

A. Financial
B. Short-term
C. Customer
D. Learning and growth

33. Which of the following balanced scorecard perspectives measures an organization's ability to change?

A. Customer
B. Internal business processes
C. Learning and growth
D. Financial

34. Which of the following balanced scorecard perspectives measures how an organization satisfies its
stakeholders?

A. Customer
D. Financial

35. Which of the following is not something that should be compiled for each dimension of the balanced
scorecard?

A. Performance measures
B. Targets
C. Strategic vision
D. Specific objectives

36. Almond, Inc. uses a balanced scorecard. One of the measures on the scorecard is the percentage of revenue
from repeat sales. Which balanced scorecard perspective would this measure most likely fit into?

A. Customer perspective
B. Learning and growth perspective
C. Internal business perspective
D. Financial perspective

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37. Almond, Inc. uses a balanced scorecard. One of the measures on the scorecard is the average education
level of the firm's managers. Which balanced scorecard perspective would this measure most likely fit
into?


38. Almond, Inc. uses a balanced scorecard. One of the measures on the scorecard is the average age of raw
materials inventory. Which balanced scorecard perspective would this measure most likely fit into?


39. Almond, Inc. uses a balanced scorecard. One of the measures on the scorecard is the change in stock price.
Which balanced scorecard perspective would this measure most likely fit into?


40. Return on investment can be calculated as

A. ROI = sales revenue/average invested assets

B. ROI = operating income/sales revenue
C. ROI = operating income/average invested assets
D. ROI = average invested assets/sales revenue

41. Profit margin can be calculated as

A. Sales revenue/average invested assets

B. Operating income/sales revenue
C. Operating income/average invested assets
D. Average invested assets/sales revenue

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42. Investment turnover can be calculated as



43. Avocado Company has an operating income of $80,000 on revenues of $1,000,000. Average invested
assets are $500,000, and Avocado Company has an 8% cost of capital. What is the return on investment?

A. 8%
B. 10%
C. 16%
D. 20%

assets are $500,000 and Avocado Company has an 8% cost of capital. What is the profit margin?

A. 8%
B. 10%
C. 16%
D. 20%

assets are $500,000 and Avocado Company has an 8% cost of capital. What is the investment turnover?

A. 10
B. 5
C. 2
D. 16%

46. Florida Inc. has revenues of $1,500,000 resulting in an operating income of $105,000. Average invested
assets total $750,000; the cost of capital is 10%. Return on investment is

A. 7%
B. 14%
C. $75,000
D. $30,000

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assets total $750,000; the cost of capital is 10%. The profit margin is

A. 7%
B. 14%
C. 2.00
D. 0.50

assets total $750,000; the cost of capital is 10%. The investment turnover is

A. 7%
B. 14%
C. 2.00
D. 0.50

49. Crawford Corp. has an ROI of 15% and a residual income of $10,000. If operating income equals $30,000,
what is the amount of average invested assets?

A. $200,000
B. $66,667
C. $450,000
D. $150,000

50. Devon Inc. has a profit margin of 12% and an investment turnover of 2.5. Sales revenue is $600,000. What
is the operating income?

A. $180,000
B. $28,800
C. $72,000
D. $240,000

51. Devon Inc. has a profit margin of 12% and an investment turnover of 2.5. Sales revenue is $600,000. What
is the amount of average invested assets?

A. $240,000
B. $1,500,000
C. $50,000
D. $72,000

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52. Palm Inc. has a profit margin of 15% and an investment turnover of 2. Sales revenue is $800,000. What is
the operating income?

A. $240,000
B. $60,000
C. $120,000
D. $400,000

53. Palm Inc. has a profit margin of 15% and an investment turnover of 2. Sales revenue is $800,000. What is
the amount of average invested assets?

A. $240,000
B. $400,000
C. $120,000
D. $60,000

54. Grove Corp. has revenues of $1,500,000 resulting in an operating income of $105,000. Average invested
assets total $750,000. Calculate the ROI if sales increase by 10% and the profit margin and investment
level remain constant.

A. 7.7%
B. 14%
C. 15.4%
D. 7.0%

55. Grove Corp. has revenues of $1,500,000 resulting in an operating income of $105,000. Average invested
assets total $750,000. If sales increase by 10% and the investment level remains constant, what is the
investment turnover?

A. 2.00
B. 2.20
C. 7.0%
D. 7.7%

56. Tropic Corp. has sales revenue of $500,000 resulting in operating income of $54,000. Average invested
assets total $600,000, and the cost of capital is 6%. Calculate the return on investment if sales increase by
10% and the profit margin and invested assets remain the same.

A. 9.0%
B. 9.9%
C. 10.8%
D. 6.0%

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57. Residual income can be calculated as

A. Operating income - (hurdle rate × average invested assets)

B. Segment margin - (hurdle rate × average invested assets)
C. Operating income - (ROI × average invested assets)
D. Operating income - investment turnover

58. If the ROI of a project is greater than the hurdle rate, the residual income will be

A. equal to operating income.

B. greater than zero.
C. greater than operating income.
D. greater than average invested assets.

assets are $500,000 and Avocado Company has an 8% cost of capital. What is the residual income?

A. $100,000
B. $20,000
C. $120,000
D. $40,000

60. Miami Corp. has an operating income of $120,000, average invested assets of $600,000, and a cost of
capital of 7%. What is the residual income?

A. $100,000
B. $166,667
C. $78,000
D. $42,000

61. Dade Corp. has residual income of $10,000. If operating income equals $30,000 and the minimum required
rate of return is 8%, what are average invested assets?

A. $125,000
B. $375,000
C. $250,000
D. $500,000

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62. Killian Corp. has a residual income of $30,000 on invested assets of $450,000. If the hurdle rate is 10%,
what is the operating income?

A. $30,000
B. $45,000
C. $3,000
D. $75,000

63. Pine Corp. has revenues of $500,000 resulting in an operating income of $54,000. Invested assets total
$600,000. Residual income is $18,000. Calculate the new residual income if sales increase by 10% and the
profit margin and invested assets remain the same.

A. $23,400
B. $0
C. $3,240
D. $36,000

64. Which of the following is not a limitation of return on investment?

A. Use of ROI may lead to goal incongruence.

B. ROI is a lagging indicator of financial performance.
C. ROI evaluates the short-term.
D. ROI is a commonly used measure for financial performance.

65. Which of the following statements contrasting residual income with return on investment is correct?

A. ROI may lead to goal incongruence while residual income does not.
B. ROI is a lagging indicator while residual income is a leading indicator.
C. Residual income is a financial measure while return on investment emphasizes the customer
perspective.
D. Residual income is a long-term measure while ROI is a short-term measure.

66. Howard has an ROI of 16% based on revenues of $400,000. The investment turnover is 2. What is the
residual income if the cost of capital is 9%?

A. $64,000
B. $36,000
C. $4,000 negative
D. $14,000

10-11
67. Coral has a profit margin of 16% based on revenues of $400,000 and an investment turnover is 2. What is
the residual income when the cost of capital is 10%?

A. $44,000
B. $20,000
C. $40,000
D. $64,000

68. Reef Corp. has revenues of $500,000 resulting in an operating income of $54,000. Invested assets total
$600,000, the cost of capital is 6%. Calculate the increase in residual income if sales increase by 10% and
the profit margin and invested assets remain the same.

A. $5,400
B. $24,000
C. $0
D. $7,500

69. King Corp. has revenues of $1,500,000 resulting in an operating income of $105,000. Average invested
assets total $750,000, and the hurdle rate is 6%. Calculate the residual income if sales increase by 10% and
the profit margin and invested assets remain constant.

A. $115,500
B. $45,000
C. $0
D. $70,500

70. Colonial has an ROI of 18% based on revenues of $300,000. The investment turnover is 1.5 and residual
income is $20,000. What is the hurdle rate?

A. 18%
B. 12%
C. 8%
D. 15%

71. Estate has an ROI of 16% based on revenues of $400,000. The residual income is $14,000 and the
investment turnover is 2. What is the hurdle rate?

A. 16%
B. 8%
C. 9%
D. 18%

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72. Indigo Corp. has an ROI of 15% and a residual income of $10,000. If operating income equals $30,000,
what is the hurdle rate?

A. 15%
B. 10%
C. 33.3%
D. 18.3%

73. A ________________ is the amount that one division charges when it sells goods or services to another
division in the same company

A. residual income
B. negotiated price
C. related price
D. transfer price

74. Which of the following is not a method used to determine transfer prices?

A. market price method

B. cost-based method
C. negotiation
D. balanced scorecard method

75. The transfer pricing method that uses the price the company would charge external customers is the

A. market price method.

B. cost-based method.
C. negotiation.
D. balanced scorecard method.

76. The transfer pricing method that uses either the variable cost or the full cost as the basis for setting the
transfer price is the


C. negotiation.

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77. When negotiating a transfer price, the highest price the buyer will be willing to pay is the _____________,
while the lowest price the seller will be willing to accept is the _______________.

A. market price…full cost

B. full cost…variable cost
C. market price…variable cost
D. variable cost…market price

78. Evergreen Corp. has two divisions, Fern and Bark. Fern produces a widget that Bark could use in the
production of units that cost $175 in variable costs, plus the cost of the widget, to manufacture. Fern's
variable costs are $60 per widget, and fixed manufacturing costs are applied at a rate of $36 per widget.
Widgets sell on the open market for $105 each. Evergreen's policy is that internal transfers will be made at
variable cost. If Bark purchases the widgets from Fern, what will be the transfer price?

A. $60
B. $96
C. $100
D. $175

full cost. If Bark purchases the widgets from Fern, what will be the transfer price?

A. $60
B. $96
C. $105
D. $175

variable cost plus 20%. If Bark purchases the widgets from Fern, what will be the transfer price?

A. $72.00
B. $115.20
C. $126.00
D. $210.00

10-14
full cost plus 20%. If Bark purchases the widgets from Fern, what will be the transfer price?

A. $72.00
B. $115.20
C. $126.00
D. $210.00

82. Holiday Corp. has two divisions, Quail and Marlin. Quail produces a widget that Marlin could use in its
production. Quail's variable costs are $4 per widget while the full cost is $7. Widgets sell on the open
market for $12 each. If Quail has excess capacity, what would be the minimum transfer price if Marlin
currently is purchasing 100,000 units on the open market?

A. $4.00
B. $5.00
C. $7.00
D. $12.00

market for $12 each. If Quail has excess capacity, what would be the maximum transfer price if Marlin

A. $4.00
B. $5.00
C. $7.00
D. $12.00

market for $12 each. If Quail has excess capacity, what would be the cost savings if the transfer was made
and Marlin currently is purchasing 100,000 units on the open market?

A. $0
B. $700,000
C. $800,000
D. $1,200,000

10-15
market for $12 each. If Quail is operating at capacity, what would be the minimum transfer price if Marlin

A. $4.00
B. $5.00
C. $7.00
D. $12.00

market for $12 each. If Quail is operating at capacity, what would be the maximum transfer price if Marlin

A. $4.00
B. $5.00
C. $7.00
D. $12.00

market for $12 each. If Quail is operating at capacity, what would be the cost savings if the transfer was
made and Marlin currently is purchasing 100,000 units on the open market?

A. $0
B. $700,000
C. $800,000
D. $1,200,000

88. Spring Corp. has two divisions, Daffodil and Tulip. Daffodil produces a gadget that Tulip could use in its
production. Tulip currently purchases 100,000 gadgets for $12.50 on the open market. Daffodil's variable
costs are $6 per widget while the full cost is $9.35. Daffodil sells gadgets for $13 each. If Daffodil is
operating at capacity, what would be the maximum transfer price Tulip would pay internally?

A. $6.00
B. $9.35
C. $12.50
D. $13.00

10-16
operating at less than full capacity, what would be the maximum transfer price Tulip would pay internally?

A. $6.00
B. $9.35
C. $12.50
D. $13.00

operating at capacity, what would be the minimum transfer price Daffodil would accept for an internal
transfer?

A. $6.00
B. $9.35
C. $12.50
D. $13.00

operating at less than full capacity, what would be the minimum transfer price Daffodil would accept for an
internal transfer?

A. $6.00
B. $9.35
C. $12.50
D. $13.00

92. Spice Company has two divisions, Parsley and Sage. Parsley produces a unit that Sage could use in its
production. Sage currently is purchasing 50,000 units from an outside supplier for $50. Parsley is operating
at less than its full capacity of 550,000 and has variable costs of $27 per unit. The full cost to manufacture
the unit is $38. Parsley currently sells 450,000 units at a selling price of $54. If an internal transfer is made,
variable shipping and administrative costs of $2 per unit could be avoided. What would be the impact on
Spice Company's overall profits if the internal transfer were made?

A. no change in overall profits

B. $1,250,000 increase in profits
C. $200,000 decrease in profits
D. $700,000 increase in profits

10-17
at less than full capacity and has variable costs of $27 per unit. The full cost to manufacture the unit is $38.
Parsley currently sells 450,000 units at a selling price of $54. If an internal transfer is made, variable
shipping and administrative costs of $2 per unit could be avoided. What would be the minimum transfer
price?

A. $25
B. $27
C. $36
D. $52

at less than full capacity and has variable costs of $27 per unit. The full cost to manufacture the unit is $38.
Parsley currently sells 450,000 units at a selling price of $54. If an internal transfer is made, variable
shipping and administrative costs of $2 per unit could be avoided. What would be the maximum transfer
price?

A. $25
B. $27
C. $38
D. $50

95. Tiffany Company has two divisions, Gold and Silver. Gold produces a unit that Silver could use in its
production. Silver currently is purchasing 50,000 units from an outside supplier for $25. Gold is operating
at less than full capacity and has variable costs of $13.50 per unit. The full cost to manufacture the unit is
$20. Gold currently sells 450,000 units at a selling price of $27. If an internal transfer is made, variable
shipping and administrative costs of $1 per unit could be avoided. If the internal transfer is made, what
would be the impact on Tiffany Company's overall profits?

A. $625,000 increase
B. $1,125,000 increase
C. $225,000 decrease
D. No change in profits

10-18
shipping and administrative costs of $1 per unit could be avoided. How much profit will Gold receive from
the transfer if a transfer price of $22.50 is agreed upon?

A. $225,000
B. $275,000
C. $500,000
D. $725,000

shipping and administrative costs of $1 per unit could be avoided. How much will Silver save by not
purchasing from outside if a transfer price of $22.50 is agreed upon?

A. $225,000
B. $250,000
C. $175,000
D. $125,000

98. Swan Company has two divisions, Hill and Paradise. Hill produces a unit that Paradise could use in its
production. Paradise currently is purchasing 5,000 units from an outside supplier for $56. Hill is operating
$43.40. Hill currently sells 450,000 units at a selling price of $61.60. What would be the impact on Swan
Company's overall profits if the internal transfer is made?

A. $28,000 increase
B. $126,000 increase
C. $7,000 decrease

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$43.40. Hill currently sells 450,000 units at a selling price of $61.60. How much profit will Hill receive
from the transfer if a transfer price of $42 is agreed upon?

A. $7,000 loss
B. $98,000 loss
C. $35,000 profit
D. $56,000 profit

$43.40. Hill currently sells 450,000 units at a selling price of $61.60. How much will Paradise save by not
purchasing from outside if a transfer price of $42 is agreed upon?

A. $70,000
B. $56,000
C. $7,000 more cost
D. $28,000

Essay Questions

10-20
101. Calculate the missing values:


10-21
103. Eureka Corp has a hurdle rate of 8%. Calculate the missing values:

104. The Marine Division of Pacific Corp has average invested assets of $110,000,000. Sales revenue of
$50,250,000 results in an operating income of $9,967,000. The hurdle rate is 7%.
a. Calculate the return on investment.

b. Calculate the profit margin.
c. Calculate the investment turnover.
d. Calculate the residual income.

10-22
105. Hubbard Division of the Market Company has an opportunity to invest in a new project. The project will
yield an incremental operating income of $36,750 on average invested assets of $460,000. Hubbard
currently has operating income of $210,000 on average invested assets of $2,050,000. Market Company
requires a 6% rate of return on new projects.
a. What is Hubbard's ROI before making an investment in the project?

b. What is Hubbard's residual income before making an investment in the project?
c. What is Hubbard's ROI after making the investment in the project?
d. What is Hubbard's residual income after making the investment in the project?

106. Ontario Company has two divisions with the following results:

Ontario Company has a hurdle rate of 10%.
a. Calculate the return on investment for each division.

b. Break each division's return on investment down into its component parts using the DuPont method.
c. Calculate the residual income for each division

10-23
107. Madison Corp has a hurdle rate of 9%. Calculate the missing values:

108. The Walnut Division of Benton Corp has average invested assets of $22,500,000. Sales revenue of


10-24
109. Superior Division of the Monroe Company has an opportunity to invest in a new project. The project will
yield an incremental operating income of $73,350 on average invested assets of $900,000. Superior
Division currently has operating income of $425,000 on average invested assets of $4,325,000. Monroe
Company has a 7% hurdle rate for new projects.
a. What is Superior Division's ROI before making an investment in the project?

b. What is Superior Division's residual income before making an investment in the project?
c. What is Superior Division's ROI after making the investment in the project?
d. What is Superior Division's residual income after making the investment in the project?

110. Warren Company has two divisions with the following results:

Warren Company has a hurdle rate of 12%.


10-25
111. The following information is available about the status and operations of the Manufacturing Division of
Taylor Company, which has a hurdle rate of 6%.

a. Compute the ROI for the Manufacturing Division.

b. Break the Manufacturing Division ROI down using the DuPont formula.
c. Compute the residual income for the Manufacturing Division.

112. Avery Company has two divisions, Polk and Bishop. Polk produces an item that Bishop could use in its
production. Bishop currently is purchasing 25,000 units from an outside supplier for $24 per unit. Polk is
currently operating at less than its full capacity of 600,000 units and has variable costs of $12 per unit. The
full cost to manufacture the unit is $18. Polk currently sells 450,000 units at a selling price of $25.50 per
unit.
a. What will be the effect on Avery Company's operating profit if the transfer is made internally?
b. What is the minimum transfer price from Polk's perspective?
c. What is the maximum transfer price from Bishop's perspective?

10-26
113. Sandy Company has two divisions, Huron and Cortez. Huron produces an item that Cortez could use in its
production. Cortez currently is purchasing 50,000 units from an outside supplier for $24 per unit. Huron is
currently operating at full capacity of 600,000 units and has variable costs of $13.50 per unit. The full cost
to manufacture the unit is $19.50. Huron currently sells 600,000 units at a selling price of $25.50 per unit.
a. What will be the effect on Sandy Company's operating profit if the transfer is made internally?
b. What is the minimum transfer price from Huron's perspective?
c. What is the maximum transfer price from Cortez' perspective?

114. National Company has two divisions, Walton and Iowa. Walton produces an item that Iowa could use in its
production. Iowa currently is purchasing 50,000 units from an outside supplier for $9.10 per unit. Walton
has sufficient capacity and has variable costs of $5.25 per unit. The full cost to manufacture the unit is
$7.70. Walton currently sells 450,000 units at a selling price of $9.80 per unit.
a. What will be the effect on National Company's operating profit if the transfer is made internally?
b. What will be the change in profits for Walton if the transfer price is $7 per unit?
c. What will be the change in profits for Iowa if the transfer price is $7 per unit?

10-27
115. Sugar Company has two divisions, Lenox and Berkshire. Lenox produces an item that Berkshire could use
in its production. Berkshire currently is purchasing 100,000 units from an outside supplier for $43 per unit.
Lenox is currently operating at full capacity of 750,000 units and has variable costs of $28 per unit. The
full cost to manufacture the unit is $35. Lenox currently sells 750,000 units at a selling price of $44 per
unit.
a. What will be the effect on Sugar Company's operating profit if the transfer is made internally?
b. What will be the change in profits for Lenox if the transfer price is $40 per unit?
c. What will be the change in profits for Berkshire if the transfer price is $40 per unit?

116. Concord Company has two divisions, Rice and Pine. Rice produces an item that Pine could use in its
production. Pine currently is purchasing 12,000 units from an outside supplier for $18 per unit. Rice is
currently operating at less than its full capacity of 500,000 units and has variable costs of $10 per unit. The
full cost to manufacture the unit is $14. Rice currently sells 450,000 units at a selling price of $20 per unit.
a. What will be the effect on Concord Company's operating profit if the transfer is made internally?
b. What is the minimum transfer price from Rice's perspective?
c. What is the maximum transfer price from Pine' perspective?

10-28
117. Tint Company has two divisions, Blue and Green. Blue produces an item that Green could use in its
production. Green currently is purchasing 150,000 units from an outside supplier for $23 per unit. Blue is
currently operating at full capacity of 1,600,000 units and has variable costs of $14 per unit. The full cost
to manufacture the unit is $18. Blue currently sells 1,600,000 units at a selling price of $25 per unit.
a. What will be the effect on Tint Company's operating profit if the transfer is made internally?
b. What is the minimum transfer price from Blue's perspective?
c. What is the maximum transfer price from Green's perspective?

118. Dickens Company has two divisions, Bloom and Heath. Bloom produces an item that Heath could use in
its production. Heath currently is purchasing 5,000 units from an outside supplier for $44 per unit. Bloom
has sufficient capacity and has variable costs of $35 per unit. The full cost to manufacture the unit is $41.
Bloom currently sells 450,000 units at a selling price of $48 per unit.
a. What will be the effect on Dickens Company's operating profit if the transfer is made internally?
b. What will be the change in profits for Bloom if the transfer price is $41 per unit?
c. What will be the change in profits for Heath if the transfer price is $41 per unit?

10-29
119. Washington Company has two divisions, Jefferson and Adams. Jefferson produces an item that Adams
could use in its production. Adams currently is purchasing 100,000 units from an outside supplier for
$78.40 per unit. Jefferson is currently operating at full capacity of 900,000 units and has variable costs of
$46.40 per unit. The full cost to manufacture the unit is $59.20. Jefferson currently sells 900,000 units at a
selling price of $86.40 per unit.
a. What will be the effect on Washington Company's operating profit if the transfer is made internally?
b. What will be the change in profits for Jefferson if the transfer price is $67.20 per unit?
c. What will be the change in profits for Adams if the transfer price is $67.20 per unit?

120. Rapid Industries has multiple divisions. One division, Iron Products, makes a component that another
division, Austin, is currently purchasing on the open market. Iron Products currently has a capacity to
produce 500,000 components at a variable cost of $7.50 and a full cost of $10.00. Iron Products has outside
sales of 460,000 components at a price of $12.50 per unit. Austin currently purchases 50,000 units from an
outside supplier at a price of $12.00 per unit. Assume that Austin desires to use a single supplier for its
component.
a. What will be the effect on Rapid Industries' operating profit if the transfer is made internally? Assume
the 50,000 units Austin needs are either purchased 100% internally or 100% externally.
b. What is the minimum transfer price?
c. What is the maximum transfer price?

10-30
Chapter 10 Decentralized Performance Evaluation Answer Key

True / False Questions

1. In a decentralized organization, lower-level managers are given a great deal of autonomy in decision-
making.

TRUE
In a decentralized organization, decision-making authority is spread throughout the organization.

AACSB: Reflective Thinking
AICPA FN: Measurement
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 List and explain the advantages and disadvantages of decentralization.
Topic: Advantages and disadvantages of decentralization

2. One disadvantage of decentralization is that it fosters competition among divisions.

FALSE
This is considered a benefit of decentralization.

Blooms: Remember
Difficulty: 1 Easy

3. The controllability principle holds that managers should not be held responsible only for what they can
control but are also responsible for allocated costs.

FALSE
The controllability principle holds that managers should be held responsible only for what they can
control.

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-02 Describe the different types of responsibility centers and explain how managers of each type are evaluated.
10-31
Topic: Types of responsibility centers

4. The part of the organization for which managers are responsible is called a related-party center.

FALSE
The part of the organization for which managers are responsible is called a responsibility center.

Blooms: Remember
Difficulty: 1 Easy

5. A legal services department would be an example of a cost center.

TRUE
Cost center managers have the authority to incur costs to support their areas of responsibility; corporate
support functions such as legal services would fall under this category.

Blooms: Remember
Difficulty: 1 Easy

6. A revenue center manager is responsible for more functions than is a profit center manager.

FALSE
Revenue center managers are responsible for revenues, while profit center managers are responsible for
both revenues and costs.

Blooms: Understand
Difficulty: 1 Easy

10-32
7. A profit center manager often also supervises revenue and cost center managers.

TRUE
Because profit center managers are responsible for both costs and revenues, they often supervise
revenue and cost center managers.

Blooms: Remember
Difficulty: 1 Easy

8. The most common method of evaluating a profit center manager is the segmented income statement.

TRUE
The segmented income statement separates costs that are within the profit center manager's control, so it
is a valuable tool for evaluating a profit center manager.

Blooms: Remember
Difficulty: 1 Easy

9. Investment center managers have control over the investment of assets.

TRUE
Investment center managers are responsible for generating a profit and investing assets.

Blooms: Remember
Difficulty: 1 Easy

10. Segment margin and profit margin are identical terms.

FALSE
The segment margin includes only those costs that are within the segment manager's control whereas
the profit margin includes costs that are not controllable by the manager.

10-33
Blooms: Understand
Difficulty: 1 Easy

11. The balanced scorecard attempts to focus managers' attention on more than just financial measures.

TRUE
The balanced scorecard considers measures of long-term success, not just short-term financial results.

Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-03 Describe the four dimensions of the balanced scorecard and explain how they are used to evaluate managerial
performance.
Topic: Balanced scorecard

12. Return on investment is calculated as the return on the segment's assets divided by the value of those
assets.

TRUE
ROI = Operating income/Average invested assets; operating income is a measure of return on the
segment's assets.

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-04 Compute and interpret return on investment; investment turnover; and profit margin.
Topic: Financial performance measures

13. The DuPont method breaks residual income into profit margin and investment turnover.

FALSE
The DuPont method breaks return on investment into profit margin and investment turnover.

Blooms: Remember
Difficulty: 1 Easy

10-34
14. Investment turnover is defined as the ratio of sales revenue to average invested assets.

TRUE
This is the formula for investment turnover.

Blooms: Remember
Difficulty: 1 Easy

15. Profit margin is defined as the ratio of sales revenue to operating income.

FALSE
Profit margin is defined as the ratio of operating income to sales revenue.

Blooms: Remember
Difficulty: 1 Easy

16. Residual income is the difference between operating profit and the minimum profit the organization
must earn to cover the ROI.

FALSE
Residual income is the difference between operating profit and the minimum profit the organization
must earn to cover the hurdle rate.

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-05 Compute and interpret residual income.

17. The hurdle rate is also called economic value added.

FALSE
The hurdle rate is also called the required rate of return, and represents the company's cost of capital.

Blooms: Remember
10-35
Difficulty: 1 Easy

18. Residual income can avoid the problems of goal incongruence.

TRUE
Any project that earns more than the hurdle rate will have a positive residual income, which avoids the
problems of goal incongruence.

Blooms: Understand
Difficulty: 1 Easy

19. Residual income is a leading indicator of financial performance.

FALSE
Residual income is a lagging indicator of financial performance.

Blooms: Remember
Difficulty: 1 Easy
Topic: Limitations of financial performance measures

20. In transfer pricing, the manager of the buying division is motivated to pay the highest price possible.

FALSE
The manager of the buying division will want to pay the lowest price possible.

Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-06 Explain how transfer prices are set in decentralized organizations.
Topic: Transfer pricing

Multiple Choice Questions

10-36
21. In what type of organization is decision-making authority spread throughout the organization?

A. Centralized organization

B. Decentralized organization
C. Participative organization
D. Top-down organization
In a decentralized organization, decision-making authority is spread throughout the organization, and

managers are given a great deal of autonomy to decide how to manage their individual units.

Blooms: Remember
Difficulty: 1 Easy

22. Which of the following is not an advantage of decentralization?

A. Allows top managers to focus on strategic issues

B. Potential duplication of resources
C. Allows for development of managerial expertise
D. Managers can react quickly to local information
Potential duplication of resources is a disadvantage of decentralization.

Blooms: Remember
Difficulty: 1 Easy

23. Which of the following is a disadvantage of decentralization?

A. Fosters competition among divisions

B. Managers have specialized knowledge
C. Potential duplication of resources
D. Allows top managers to focus on strategic issues
Potential duplication of resources is a disadvantage of decentralization.

Blooms: Remember
Difficulty: 1 Easy
10-37

24. One of the most important concepts in responsibility accounting is the

A. balanced scorecard.

B. controllability principle.
C. related-party transactions.
D. transfer price.
The controllability principle forms the basis of responsibility accounting, holding that managers should
only be held responsible for what they control.

Blooms: Understand
Difficulty: 1 Easy

25. Which of the following is the primary tool used by cost centers to manage costs?

A. Return on investment

B. Budgetary control system
C. Balanced scorecard
D. Transfer pricing
The budget is a primary tool used by cost centers to manage costs.

Blooms: Remember
Difficulty: 1 Easy

26. The responsibility center in which the manager does not have responsibility and authority over revenues
is

A. a cost center.

C. a profit center.
A revenue center manager has responsibility for revenues, and profit and investment center managers
have authority over profit, which includes revenues.

10-38
Blooms: Remember
Difficulty: 1 Easy

27. The responsibility center in which the manager has responsibility and authority over revenues, costs and
assets is

A. a cost center.

C. a profit center.
Investment center managers are responsible for generating a profit (revenue - cost) and investing assets.

Blooms: Remember
Difficulty: 1 Easy

28. The responsibility center in which the manager does not have responsibility and authority over costs is

A. a cost center.

C. a profit center.
A cost center manager has responsibility for costs, and profit and investment center managers have
authority over profit, which includes costs.

Blooms: Remember
Difficulty: 1 Easy

10-39
29. The responsibility center in which the manager has responsibility and authority over only revenues and
costs is

A. a cost center.

C. a profit center.
A profit center manager has responsibility only for revenues and costs. Investment center managers
have responsibility for revenues, costs, and the investment of assets.

Blooms: Remember
Difficulty: 1 Easy

30. Which of the following responsibility centers will use a segmented income statement as an evaluation
tool?

A. cost center

B. revenue center
C. profit center
D. balanced center
A segmented income statement will isolate the portion of profit that is controllable by the profit center
manager.

Blooms: Remember
Difficulty: 1 Easy

10-40
31. Which of the following statements follows from the controllability principle?

A. A profit center manager should be evaluated based on residual income, not return on investment.
B. An investment center manager should be evaluated based on return on investment, not residual
income.
C. A profit center manager should be evaluated based on segment margin, not profit margin.
D. A cost center manager should be evaluated on costs and revenues, not just costs.
Segment margin separates those costs that are within the profit center manager's control from those that
are outside his/her control. Profit margin contains costs that are not controllable by the manager.

Blooms: Remember
Difficulty: 2 Medium

32. Which of the following is not a perspective used by the balanced scorecard?

A. Financial
B. Short-term
C. Customer
D. Learning and growth
The four key dimensions of the balanced scorecard are the customer perspective, the learning and
growth perspective, the internal business processes perspective, and the financial perspective.

Blooms: Remember
Difficulty: 1 Easy
performance.

10-41
33. Which of the following balanced scorecard perspectives measures an organization's ability to change?

A. Customer
D. Financial
The learning and growth perspective measures how the organization will sustain its ability to change
and improve.

Blooms: Remember
Difficulty: 1 Easy
performance.

34. Which of the following balanced scorecard perspectives measures how an organization satisfies its
stakeholders?

A. Customer
D. Financial
The financial perspective measures how the organization satisfies its shareholders, regulators, and other
stakeholders.

Blooms: Remember
Difficulty: 1 Easy
performance.

10-42
35. Which of the following is not something that should be compiled for each dimension of the balanced
scorecard?

A. Performance measures

B. Targets
C. Strategic vision
D. Specific objectives
For each of the balanced scorecard dimensions, managers must devise specific objectives, measures,
and targets that can be used to measure performance and identify what needs to be done to improve in
the future. The strategic vision is organization-wide.

Blooms: Remember
Difficulty: 1 Easy
performance.

36. Almond, Inc. uses a balanced scorecard. One of the measures on the scorecard is the percentage of
revenue from repeat sales. Which balanced scorecard perspective would this measure most likely fit
into?


Percentage of revenue from repeat sales is a measure of how well customers are retained, which belongs
in the customer perspective.

Blooms: Understand
Difficulty: 1 Easy
performance.

10-43
37. Almond, Inc. uses a balanced scorecard. One of the measures on the scorecard is the average education
level of the firm's managers. Which balanced scorecard perspective would this measure most likely fit
into?


The education level of the managers would affect the firm's ability to change and improve, which is the
focus of the learning and growth perspective.

Blooms: Understand
Difficulty: 1 Easy
performance.

38. Almond, Inc. uses a balanced scorecard. One of the measures on the scorecard is the average age of raw
materials inventory. Which balanced scorecard perspective would this measure most likely fit into?


The average age of raw materials inventory is a measure of how effectively such inventory is used,
which is an internal business process.

Blooms: Understand
Difficulty: 1 Easy
performance.

10-44
39. Almond, Inc. uses a balanced scorecard. One of the measures on the scorecard is the change in stock
price. Which balanced scorecard perspective would this measure most likely fit into?


The stock price is an indicator of financial health, so this belongs in the financial perspective.

Blooms: Understand
Difficulty: 1 Easy
performance.

40. Return on investment can be calculated as

A. ROI = sales revenue/average invested assets

B. ROI = operating income/sales revenue
C. ROI = operating income/average invested assets
D. ROI = average invested assets/sales revenue
This is the formula for ROI.

Blooms: Remember
Difficulty: 1 Easy

41. Profit margin can be calculated as


This is the formula for profit margin.

Blooms: Remember
Difficulty: 1 Easy
10-45

42. Investment turnover can be calculated as


This is the formula for investment turnover.

Blooms: Remember
Difficulty: 1 Easy

assets are $500,000, and Avocado Company has an 8% cost of capital. What is the return on
investment?

A. 8%
B. 10%
C. 16%
D. 20%
$80,000/$500,000 = 16%.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

10-46
assets are $500,000 and Avocado Company has an 8% cost of capital. What is the profit margin?

A. 8%
B. 10%
C. 16%
D. 20%
$80,000/$1,000,000 = 8%.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

assets are $500,000 and Avocado Company has an 8% cost of capital. What is the investment turnover?

A. 10
B. 5
C. 2
D. 16%
$1,000,000/$500,000 = 2.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

assets total $750,000; the cost of capital is 10%. Return on investment is

A. 7%
B. 14%
C. $75,000
D. $30,000
$105,000/$750,000 = 14%.

AACSB: Analytic
Blooms: Apply
10-47
Difficulty: 1 Easy

assets total $750,000; the cost of capital is 10%. The profit margin is

A. 7%
B. 14%
C. 2.00
D. 0.50
$105,000/$1,500,000 = 7%.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

assets total $750,000; the cost of capital is 10%. The investment turnover is

A. 7%
B. 14%
C. 2.00
D. 0.50
$1,500,000/$750,000 = 2.00.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

10-48
49. Crawford Corp. has an ROI of 15% and a residual income of $10,000. If operating income equals
$30,000, what is the amount of average invested assets?

A. $200,000
B. $66,667
C. $450,000
D. $150,000
ROI = Operating income/Average invested assets, so Average invested assets = Operating income/ROI
= $30,000/15% = $200,000.

AACSB: Analytic
Blooms: Analyze

50. Devon Inc. has a profit margin of 12% and an investment turnover of 2.5. Sales revenue is $600,000.
What is the operating income?

A. $180,000
B. $28,800
C. $72,000
D. $240,000
Profit margin = Operating income/Sales revenue, so Operating income = Profit margin × Sales revenue
= 12% × $600,000 = $72,000.

AACSB: Analytic
Blooms: Analyze

10-49
51. Devon Inc. has a profit margin of 12% and an investment turnover of 2.5. Sales revenue is $600,000.
What is the amount of average invested assets?

A. $240,000
B. $1,500,000
C. $50,000
D. $72,000
Investment turnover = Sales revenue/Average invested assets, so Average invested assets = Sales
revenue/Investment turnover = $600,000/2.5 = $240,000.

AACSB: Analytic
Blooms: Analyze

52. Palm Inc. has a profit margin of 15% and an investment turnover of 2. Sales revenue is $800,000. What
is the operating income?

A. $240,000
B. $60,000
C. $120,000
D. $400,000
Profit margin = Operating income/Sales revenue, so Operating income = Profit margin × Sales revenue
= 15% × $800,000 = $120,000.

AACSB: Analytic
Blooms: Analyze

10-50
53. Palm Inc. has a profit margin of 15% and an investment turnover of 2. Sales revenue is $800,000. What
is the amount of average invested assets?

A. $240,000
B. $400,000
C. $120,000
D. $60,000
Investment turnover = Sales revenue/Average invested assets, so Average invested assets = Sales
revenue/Investment turnover = $800,000/2 = $400,000.

AACSB: Analytic
Blooms: Analyze

54. Grove Corp. has revenues of $1,500,000 resulting in an operating income of $105,000. Average
invested assets total $750,000. Calculate the ROI if sales increase by 10% and the profit margin and
investment level remain constant.

A. 7.7%
B. 14%
C. 15.4%
D. 7.0%
Profit margin is $105,000/$1,500,000 = 7%. If sales increase by 10%, investment turnover will be
($1,500,000 × 110%)/$750,000 = 2.2. ROI = 7% × 2.2 = 15.4%.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

10-51
55. Grove Corp. has revenues of $1,500,000 resulting in an operating income of $105,000. Average
invested assets total $750,000. If sales increase by 10% and the investment level remains constant, what
is the investment turnover?

A. 2.00
B. 2.20
C. 7.0%
D. 7.7%
If sales increase by 10%, investment turnover will be ($1,500,000 × 110%)/$750,000 = 2.2.

AACSB: Analytic
Blooms: Apply

56. Tropic Corp. has sales revenue of $500,000 resulting in operating income of $54,000. Average invested
assets total $600,000, and the cost of capital is 6%. Calculate the return on investment if sales increase
by 10% and the profit margin and invested assets remain the same.

A. 9.0%
B. 9.9%
C. 10.8%
D. 6.0%
The profit margin is $54,000/$500,000 = 10.8%. If sales increase by 10%, investment turnover will be
[($500,000 × 110%)/$600,000] = .92. ROI = 10.8% × .92 = 9.9%.

AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard

10-52
57. Residual income can be calculated as

A. Operating income - (hurdle rate × average invested assets)

B. Segment margin - (hurdle rate × average invested assets)
C. Operating income - (ROI × average invested assets)
D. Operating income - investment turnover
This is the formula for residual income.

Blooms: Remember
Difficulty: 1 Easy

58. If the ROI of a project is greater than the hurdle rate, the residual income will be

A. equal to operating income.

B. greater than zero.
C. greater than operating income.
D. greater than average invested assets.
When ROI > Hurdle rate, residual income is positive.

Blooms: Understand
Difficulty: 1 Easy

assets are $500,000 and Avocado Company has an 8% cost of capital. What is the residual income?

A. $100,000
B. $20,000
C. $120,000
D. $40,000
$80,000 - (8% × $500,000) = $40,000.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
10-53

60. Miami Corp. has an operating income of $120,000, average invested assets of $600,000, and a cost of
capital of 7%. What is the residual income?

A. $100,000
B. $166,667
C. $78,000
D. $42,000
$120,000 - (7% × $600,000) = $78,000.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

61. Dade Corp. has residual income of $10,000. If operating income equals $30,000 and the minimum
required rate of return is 8%, what are average invested assets?

A. $125,000
B. $375,000
C. $250,000
D. $500,000
$30,000 - 8% A = $10,000; A = $250,000.

AACSB: Analytic
Blooms: Analyze

62. Killian Corp. has a residual income of $30,000 on invested assets of $450,000. If the hurdle rate is 10%,
what is the operating income?

A. $30,000
B. $45,000
C. $3,000
D. $75,000
OI - (10% × 450,000) = $30,000; OI = $75,000.

AACSB: Analytic
10-54
Blooms: Analyze

63. Pine Corp. has revenues of $500,000 resulting in an operating income of $54,000. Invested assets total
$600,000. Residual income is $18,000. Calculate the new residual income if sales increase by 10% and
the profit margin and invested assets remain the same.

A. $23,400
B. $0
C. $3,240
D. $36,000
If sales increase by 10% and profit margin remains the same, operating income must also increase by
10%. Residual income will then also increase by 10% of operating income, so RI = $18,000 + (10% ×
$54,000) = $23,400.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

64. Which of the following is not a limitation of return on investment?

A. Use of ROI may lead to goal incongruence.

B. ROI is a lagging indicator of financial performance.
C. ROI evaluates the short-term.
D. ROI is a commonly used measure for financial performance.
The fact that ROI is commonly used is not a limitation.

Blooms: Understand
Difficulty: 1 Easy

10-55
65. Which of the following statements contrasting residual income with return on investment is correct?

A. ROI may lead to goal incongruence while residual income does not.
B. ROI is a lagging indicator while residual income is a leading indicator.
C. Residual income is a financial measure while return on investment emphasizes the customer
perspective.
D. Residual income is a long-term measure while ROI is a short-term measure.
ROI can lead to goal incongruence because a project that earns higher than the hurdle rate but decreases
ROI would be unattractive to a manager. However, any project earning higher than the hurdle rate
increases residual income, avoiding goal incongruence.

Blooms: Understand

66. Howard has an ROI of 16% based on revenues of $400,000. The investment turnover is 2. What is the
residual income if the cost of capital is 9%?

A. $64,000
B. $36,000
C. $4,000 negative
D. $14,000
Investment turnover = 2 = $400,000/Assets; Assets = $200,000. ROI = 16% = Income/$200,000;

Income = $32,000. Residual income = $32,000 - (9% × $200,000) = $14,000.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

10-56
67. Coral has a profit margin of 16% based on revenues of $400,000 and an investment turnover is 2. What
is the residual income when the cost of capital is 10%?

A. $44,000
B. $20,000
C. $40,000
D. $64,000
Profit margin = 16% = Income/$400,000; Income = $64,000. Investment turnover = 2 =

$400,000/Assets; Assets = $200,000. Residual income = $64,000 - (10% × $200,000) = $44,000.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

68. Reef Corp. has revenues of $500,000 resulting in an operating income of $54,000. Invested assets total
$600,000, the cost of capital is 6%. Calculate the increase in residual income if sales increase by 10%
and the profit margin and invested assets remain the same.

A. $5,400
B. $24,000
C. $0
D. $7,500
10%. Residual income will then also increase by 10% of operating income, or 10% × $54,000 = $5,400.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

10-57
69. King Corp. has revenues of $1,500,000 resulting in an operating income of $105,000. Average invested
assets total $750,000, and the hurdle rate is 6%. Calculate the residual income if sales increase by 10%
and the profit margin and invested assets remain constant.

A. $115,500
B. $45,000
C. $0
D. $70,500
10%. Residual income = ($105,000 × 110%) - (6% × $750,000) = $70,500.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

70. Colonial has an ROI of 18% based on revenues of $300,000. The investment turnover is 1.5 and
residual income is $20,000. What is the hurdle rate?

A. 18%
B. 12%
C. 8%
D. 15%
Investment turnover = 1.5 = $300,000/Assets; Assets = $200,000. ROI = 18% = Income/$200,000;

Income = $36,000. Residual income = $20,000 = $36,000 - (HR × $200,000); HR = 8%.

AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard

10-58
71. Estate has an ROI of 16% based on revenues of $400,000. The residual income is $14,000 and the
investment turnover is 2. What is the hurdle rate?

A. 16%
B. 8%
C. 9%
D. 18%
Investment turnover = 2 = $400,000/Assets; Assets = $200,000. ROI = 16% = Income/$200,000;

Income = $32,000. Residual income = $14,000 = $32,000 - (HR × $200,000); HR = 9%.

AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard

72. Indigo Corp. has an ROI of 15% and a residual income of $10,000. If operating income equals $30,000,
what is the hurdle rate?

A. 15%
B. 10%
C. 33.3%
D. 18.3%
ROI = 15% = $30,000/Assets; Assets = $200,000. Residual income = $10,000 = $30,000 - (HR ×
$200,000); HR = 10%.

AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard

10-59
73. A ________________ is the amount that one division charges when it sells goods or services to another
division in the same company

A. residual income

B. negotiated price
C. related price
D. transfer price
This is the definition of a transfer price.

Blooms: Remember
Difficulty: 1 Easy

74. Which of the following is not a method used to determine transfer prices?

A. market price method

B. cost-based method
C. negotiation
D. balanced scorecard method
There are three different ways to determine transfer prices: the market price method, the cost-based
method, and negotiation.

Blooms: Remember
Difficulty: 1 Easy

75. The transfer pricing method that uses the price the company would charge external customers is the


C. negotiation.
The market price is the price that a company would charge to external customers.

Blooms: Remember
Difficulty: 1 Easy
10-60

76. The transfer pricing method that uses either the variable cost or the full cost as the basis for setting the
transfer price is the


C. negotiation.
The cost-based method uses cost as a basis for setting the transfer price.

Blooms: Remember
Difficulty: 1 Easy

77. When negotiating a transfer price, the highest price the buyer will be willing to pay is the
_____________, while the lowest price the seller will be willing to accept is the _______________.

A. market price…full cost

B. full cost…variable cost
C. market price…variable cost
D. variable cost…market price
The seller at least needs to cover the variable costs, and the buyer will be unwilling to pay more than
he/she would be able to pay elsewhere.

Blooms: Remember
Difficulty: 1 Easy

10-61
Widgets sell on the open market for $105 each. Evergreen's policy is that internal transfers will be made
at variable cost. If Bark purchases the widgets from Fern, what will be the transfer price?

A. $60
B. $96
C. $100
D. $175
The transfer price is set at variable cost.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

at full cost. If Bark purchases the widgets from Fern, what will be the transfer price?

A. $60
B. $96
C. $105
D. $175
Full cost is $60 + $36 = $96.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

10-62
at variable cost plus 20%. If Bark purchases the widgets from Fern, what will be the transfer price?

A. $72.00
B. $115.20
C. $126.00
D. $210.00
Variable cost plus 20% is $60.00 × 1.2 = $72.00.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

at full cost plus 20%. If Bark purchases the widgets from Fern, what will be the transfer price?

A. $72.00
B. $115.20
C. $126.00
D. $210.00
Full cost plus 20% is ($60 + $36) × 1.2 = $115.20.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy

10-63
market for $12 each. If Quail has excess capacity, what would be the minimum transfer price if Marlin

A. $4.00
B. $5.00
C. $7.00
D. $12.00
The minimum transfer price when there is excess capacity is the variable cost.

AACSB: Analytic
Blooms: Apply

market for $12 each. If Quail has excess capacity, what would be the maximum transfer price if Marlin

A. $4.00
B. $5.00
C. $7.00
D. $12.00
The maximum transfer price is the market price.

AACSB: Analytic
Blooms: Apply

10-64
market for $12 each. If Quail has excess capacity, what would be the cost savings if the transfer was

A. $0
B. $700,000
C. $800,000
D. $1,200,000
Holiday currently pays $12.00 on the open market. If Quail manufactures the widgets, it will cost $4.00
each. Cost savings is ($12.00 - $4.00) × 100,000 = $800,000.

AACSB: Analytic
Blooms: Apply

market for $12 each. If Quail is operating at capacity, what would be the minimum transfer price if
Marlin currently is purchasing 100,000 units on the open market?

A. $4.00
B. $5.00
C. $7.00
D. $12.00
The minimum transfer price if there is no excess capacity is the market price.

AACSB: Analytic
Blooms: Apply

10-65
market for $12 each. If Quail is operating at capacity, what would be the maximum transfer price if
Marlin currently is purchasing 100,000 units on the open market?

A. $4.00
B. $5.00
C. $7.00
D. $12.00

AACSB: Analytic
Blooms: Apply

market for $12 each. If Quail is operating at capacity, what would be the cost savings if the transfer was

A. $0
B. $700,000
C. $800,000
D. $1,200,000
If Quail is operating at capacity, both the minimum and maximum transfer price will be the market
price. Since Marlin is currently paying market price, there will be no cost savings.

AACSB: Analytic
Blooms: Apply

10-66
88. Spring Corp. has two divisions, Daffodil and Tulip. Daffodil produces a gadget that Tulip could use in
its production. Tulip currently purchases 100,000 gadgets for $12.50 on the open market. Daffodil's
variable costs are $6 per widget while the full cost is $9.35. Daffodil sells gadgets for $13 each. If
Daffodil is operating at capacity, what would be the maximum transfer price Tulip would pay
internally?

A. $6.00
B. $9.35
C. $12.50
D. $13.00

AACSB: Analytic
Blooms: Apply

Daffodil is operating at less than full capacity, what would be the maximum transfer price Tulip would
pay internally?

A. $6.00
B. $9.35
C. $12.50
D. $13.00

AACSB: Analytic
Blooms: Apply

10-67
Daffodil is operating at capacity, what would be the minimum transfer price Daffodil would accept for
an internal transfer?

A. $6.00
B. $9.35
C. $12.50
D. $13.00
The minimum transfer price if there is no excess capacity is the market price.

AACSB: Analytic
Blooms: Apply

Daffodil is operating at less than full capacity, what would be the minimum transfer price Daffodil
would accept for an internal transfer?

A. $6.00
B. $9.35
C. $12.50
D. $13.00
The minimum transfer price when there is excess capacity is the variable cost.

AACSB: Analytic
Blooms: Apply

10-68
production. Sage currently is purchasing 50,000 units from an outside supplier for $50. Parsley is
operating at less than its full capacity of 550,000 and has variable costs of $27 per unit. The full cost to
manufacture the unit is $38. Parsley currently sells 450,000 units at a selling price of $54. If an internal
transfer is made, variable shipping and administrative costs of $2 per unit could be avoided. What
would be the impact on Spice Company's overall profits if the internal transfer were made?

A. no change in overall profits

B. $1,250,000 increase in profits
C. $200,000 decrease in profits
D. $700,000 increase in profits
The company is currently purchasing at $50 per unit. If the company manufactures the units instead, the
cost will be $25 per unit. ($50 - $25) × 50,000 = $1,250,000.

AACSB: Analytic
Blooms: Apply

operating at less than full capacity and has variable costs of $27 per unit. The full cost to manufacture
the unit is $38. Parsley currently sells 450,000 units at a selling price of $54. If an internal transfer is
made, variable shipping and administrative costs of $2 per unit could be avoided. What would be the
minimum transfer price?

A. $25
B. $27
C. $36
D. $52
The minimum transfer price when there is excess capacity is the variable cost, $27 - $2 = $25.

AACSB: Analytic
Blooms: Apply

10-69
operating at less than full capacity and has variable costs of $27 per unit. The full cost to manufacture
the unit is $38. Parsley currently sells 450,000 units at a selling price of $54. If an internal transfer is
made, variable shipping and administrative costs of $2 per unit could be avoided. What would be the
maximum transfer price?

A. $25
B. $27
C. $38
D. $50
The maximum transfer cost is the market price.

AACSB: Analytic
Blooms: Apply

production. Silver currently is purchasing 50,000 units from an outside supplier for $25. Gold is
operating at less than full capacity and has variable costs of $13.50 per unit. The full cost to
manufacture the unit is $20. Gold currently sells 450,000 units at a selling price of $27. If an internal
transfer is made, variable shipping and administrative costs of $1 per unit could be avoided. If the
internal transfer is made, what would be the impact on Tiffany Company's overall profits?

A. $625,000 increase

B. $1,125,000 increase
C. $225,000 decrease
The company currently purchases the units for $25. If the units are manufactured instead, the cost will
be $13.50 - $1 = $12.50. ($25 - $12.50) × 50,000 = $625,000.

AACSB: Analytic
Blooms: Apply

10-70
transfer is made, variable shipping and administrative costs of $1 per unit could be avoided. How much
profit will Gold receive from the transfer if a transfer price of $22.50 is agreed upon?

A. $225,000
B. $275,000
C. $500,000
D. $725,000
[$22.50 - ($13.50 - $1)] × 50,000 = $500,000.

AACSB: Analytic
Blooms: Apply

transfer is made, variable shipping and administrative costs of $1 per unit could be avoided. How much
will Silver save by not purchasing from outside if a transfer price of $22.50 is agreed upon?

A. $225,000
B. $250,000
C. $175,000
D. $125,000
($25 - $22.50) × 50,000 = $125,000.

AACSB: Analytic
Blooms: Apply

10-71
production. Paradise currently is purchasing 5,000 units from an outside supplier for $56. Hill is
manufacture the unit is $43.40. Hill currently sells 450,000 units at a selling price of $61.60. What
would be the impact on Swan Company's overall profits if the internal transfer is made?

A. $28,000 increase

B. $126,000 increase
C. $7,000 decrease
The company currently pays $56 for the units. If they are manufactured instead, they will cost $30.80.
($56 - $30.80) × 5,000 = $126,000.

AACSB: Analytic
Blooms: Apply

manufacture the unit is $43.40. Hill currently sells 450,000 units at a selling price of $61.60. How much
profit will Hill receive from the transfer if a transfer price of $42 is agreed upon?

A. $7,000 loss

B. $98,000 loss
C. $35,000 profit
D. $56,000 profit
($42 - $30.80) × 5,000 = $56,000.

AACSB: Analytic
Blooms: Apply

10-72
manufacture the unit is $43.40. Hill currently sells 450,000 units at a selling price of $61.60. How much
will Paradise save by not purchasing from outside if a transfer price of $42 is agreed upon?

A. $70,000
B. $56,000
C. $7,000 more cost
D. $28,000
($56 - $42) × 5,000 = $70,000.

AACSB: Analytic
Blooms: Apply

Essay Questions


a. 12.4% = 6.2% × 2
b. 7% = 21%/3
c. 1.75 = 21%/12%
d. 20% = 15%/0.75
Feedback: ROI = Profit margin × Investment turnover.

AACSB: Analytic
10-73
Blooms: Apply


a. 20.75 = 8.3% × 2.5

b. 4.8% = 24%/5
c. 1.5 = 18%/12%
d. 8% = 14%/1.75
Feedback: ROI = Profit margin × Investment turnover.

AACSB: Analytic
Blooms: Apply

10-74
103. Eureka Corp has a hurdle rate of 8%. Calculate the missing values:

a. 15% = $105,0000/$700,000
b. $49,000 = $105,000 - (8% × $700,000)
c. $192,000 = $1,200,000 × 16%
d. $96,000 = $192,000 - (8% × $1,200,000)
e. $400,000 = ($75,000 - $43,000)/8%
f. 18.75% = $75,000/$400,000
g. $32,000 = $12,000 + 8% × $250,000
h. 12.8% = $32,000/$250,000
i. $320,000 = $48,000/15%
j. $22,400 = $48,000 - (8% × $320,000)
Feedback: ROI = Operating income/Average invested assets. Residual income = Operating income -
Hurdle rate × Average invested assets.

AACSB: Analytic
Blooms: Apply

10-75
104. The Marine Division of Pacific Corp has average invested assets of $110,000,000. Sales revenue of


a. 9.06% = $9,967,000/$110,000,000
b. 19.83% = $9,967,000/$50,250,000
c. 0.4568 = $50,250,000/$110,000,000
d. $2,267,000 = $9,967,000 - (7% × $110,000,000)
Feedback: ROI = Operating income/Average invested assets. Profit margin = Operating income/Sales
revenue. Investment turnover = Sales revenue/Average invested assets. Residual income = Operating
income - Hurdle rate × Average invested assets.

AACSB: Analytic
Blooms: Apply

105. Hubbard Division of the Market Company has an opportunity to invest in a new project. The project
will yield an incremental operating income of $36,750 on average invested assets of $460,000. Hubbard
currently has operating income of $210,000 on average invested assets of $2,050,000. Market Company
requires a 6% rate of return on new projects.
a. What is Hubbard's ROI before making an investment in the project?

b. What is Hubbard's residual income before making an investment in the project?
c. What is Hubbard's ROI after making the investment in the project?
d. What is Hubbard's residual income after making the investment in the project?

a. 10.24% = $210,000/$2,050,000
b. $87,000 = $210,000 - (6% × $2,050,000)
c. 9.83% = ($210,000 + $36,750)/($2,050,000 + $460,000)
d. $96,150 = ($210,000 + $36,750) - [6% × ($2,050,000 + $460,000)]

AACSB: Analytic
10-76
Blooms: Apply

106. Ontario Company has two divisions with the following results:

Ontario Company has a hurdle rate of 10%.


a. Jackson: 15% = $120,000/$800,000; Canal: 12.5% = $250,000/$2,000,000

b. Jackson: 40% profit margin = $120,000/$300,000; 0.375 investment turnover = $300,000/$800,000
Canal: 41.67% profit margin = $250,000/$600,000; 0.300 investment turnover = $600,000/$2,000,000
c. Jackson: $40,000 = $120,000 - (10% × $800,000)
Canal: $50,000 = $250,000 - (10% × $2,000,000)

AACSB: Analytic
Blooms: Apply

10-77
107. Madison Corp has a hurdle rate of 9%. Calculate the missing values:

a. 14.375% = $115,0000/$800,000
b. $43,000 = $115,000 - (9% × $800,000)
c. $229,500 = $1,350,000 × 17%
d. $108,000 = $229,500 - (9% × $1,350,000)
e. $1,600,000 = ($175,000 - $31,000)/9%
f. 10.9375% = $175,000/$1,600,000
g. $103,500 = $36,000 + 9% × $750,000
h. 13.8% = $103,500/$750,000
i. $360,000 = $46,800/13%
j. $14,400 = $46,800 - (9% × $360,000)

AACSB: Analytic
Blooms: Apply

10-78
108. The Walnut Division of Benton Corp has average invested assets of $22,500,000. Sales revenue of


a. 10.58% = $2,379,500/$22,500,000
b. 8.81% = $2,379,500/$27,000,000
c. 1.2 = $27,000,000/$22,500,000
d. $579,500 = $2,379,500 - (8% × $22,500,000)

AACSB: Analytic
Blooms: Apply

109. Superior Division of the Monroe Company has an opportunity to invest in a new project. The project
will yield an incremental operating income of $73,350 on average invested assets of $900,000. Superior
Division currently has operating income of $425,000 on average invested assets of $4,325,000. Monroe
Company has a 7% hurdle rate for new projects.
a. What is Superior Division's ROI before making an investment in the project?

b. What is Superior Division's residual income before making an investment in the project?
c. What is Superior Division's ROI after making the investment in the project?
d. What is Superior Division's residual income after making the investment in the project?

a. 9.83% = $425,000/$4,325,000
b. $122,250 = $425,000 - (7% × $4,325,000)
c. 9.54% = ($425,000 + $73,350)/($4,325,000 + $900,000)
d. $132,600 = ($425,000 + $73,350) - [7% × ($4,325,000 + $900,000)]

AACSB: Analytic
10-79
Blooms: Apply

110. Warren Company has two divisions with the following results:

Warren Company has a hurdle rate of 12%.


a. Ashland: 15% = $180,000/$1,200,000; Erie: 11.25% = $450,000/$4,000,000

b. Ashland: 40% profit margin = $180,000/$450,000; 0.375 investment turnover = $450,000/$1,200,000
Erie: 37.5% profit margin = $450,000/$1,200,000; 0.300 investment turnover = $1,200,000/$4,000,000
c. Ashland: $36,000 = $180,000 - (12% × $1,200,000)
Erie: $-30,000 = $450,000 - (12% × $4,000,000)

AACSB: Analytic
Blooms: Apply

10-80
111. The following information is available about the status and operations of the Manufacturing Division of
Taylor Company, which has a hurdle rate of 6%.

a. Compute the ROI for the Manufacturing Division.

b. Break the Manufacturing Division ROI down using the DuPont formula.
c. Compute the residual income for the Manufacturing Division.

a. 4.6% = $18,924/$411,637
b. 5.14% profit margin = $18,924/$368,363; 0.89 = investment turnover = $368,363/$411,637
c. $-5,774 = $18,924 - (6% × $411,637)

AACSB: Analytic
Blooms: Apply

10-81
112. Avery Company has two divisions, Polk and Bishop. Polk produces an item that Bishop could use in its
production. Bishop currently is purchasing 25,000 units from an outside supplier for $24 per unit. Polk
is currently operating at less than its full capacity of 600,000 units and has variable costs of $12 per unit.
The full cost to manufacture the unit is $18. Polk currently sells 450,000 units at a selling price of
$25.50 per unit.
a. What will be the effect on Avery Company's operating profit if the transfer is made internally?
b. What is the minimum transfer price from Polk's perspective?
c. What is the maximum transfer price from Bishop's perspective?

a. $300,000 more profit = 25,000 × ($24 - $12)

b. $12: minimum price would be the variable cost for Polk
c. $24: maximum price would be the $24 market price for Bishop
Feedback: Profit will increase by the difference between the variable cost to manufacture and the market
price to purchase. The minimum transfer price with excess capacity is the variable cost. The maximum
transfer price is the buying division's market price.

AACSB: Analytic
Blooms: Apply

10-82
113. Sandy Company has two divisions, Huron and Cortez. Huron produces an item that Cortez could use in
its production. Cortez currently is purchasing 50,000 units from an outside supplier for $24 per unit.
Huron is currently operating at full capacity of 600,000 units and has variable costs of $13.50 per unit.
The full cost to manufacture the unit is $19.50. Huron currently sells 600,000 units at a selling price of
$25.50 per unit.
a. What will be the effect on Sandy Company's operating profit if the transfer is made internally?
b. What is the minimum transfer price from Huron's perspective?
c. What is the maximum transfer price from Cortez' perspective?

a. $75,000 less profits = 50,000 × ($25.50 - $24)

b. $25.50 market price. Since Huron is at full capacity, any price less its current market price will create
an opportunity cost.
c. $24 market price for Cortez.
Feedback: Profit will decrease by the difference between the market price for the selling division and
the market price for the buying division. The minimum transfer price without excess capacity is the
selling division's market price. The maximum transfer price is the buying division's market price.

AACSB: Analytic
Blooms: Apply

10-83
114. National Company has two divisions, Walton and Iowa. Walton produces an item that Iowa could use in
its production. Iowa currently is purchasing 50,000 units from an outside supplier for $9.10 per unit.
Walton has sufficient capacity and has variable costs of $5.25 per unit. The full cost to manufacture the
unit is $7.70. Walton currently sells 450,000 units at a selling price of $9.80 per unit.
a. What will be the effect on National Company's operating profit if the transfer is made internally?
b. What will be the change in profits for Walton if the transfer price is $7 per unit?
c. What will be the change in profits for Iowa if the transfer price is $7 per unit?

a. $192,500 more profit = 50,000 × ($9.10 - $5.25)

b. $87,500 more profit = 50,000 × ($7 - $5.25)
c. $105,000 more profit = 50,000 × ($9.10 - $7)
Feedback: Profit for the firm will increase by the difference between the variable cost to manufacture
and the market price to purchase. Profit for the selling division will increase by the difference between
the variable cost to manufacture and the transfer price. Profit for the buying division will increase by the
difference between the transfer price and the market price to purchase.

AACSB: Analytic
Blooms: Apply

10-84
115. Sugar Company has two divisions, Lenox and Berkshire. Lenox produces an item that Berkshire could
use in its production. Berkshire currently is purchasing 100,000 units from an outside supplier for $43
per unit. Lenox is currently operating at full capacity of 750,000 units and has variable costs of $28 per
unit. The full cost to manufacture the unit is $35. Lenox currently sells 750,000 units at a selling price
of $44 per unit.
a. What will be the effect on Sugar Company's operating profit if the transfer is made internally?
b. What will be the change in profits for Lenox if the transfer price is $40 per unit?
c. What will be the change in profits for Berkshire if the transfer price is $40 per unit?

a. $100,000 less profits = 100,000 × ($43 - $44)

b. $400,000 less profits = 100,000 × ($40 - $44)
c. $300,000 more profits = 100,000 × ($43 - $40)
Feedback: Profit for the firm will decrease by the difference between the market price for the selling
division and the market price for the buying division. Profit for the selling division will decrease by the
difference between the market price for the selling division and the transfer price. Profit for the buying
division will increase by the difference between the transfer price and the market price to purchase.

AACSB: Analytic
Blooms: Apply

10-85
116. Concord Company has two divisions, Rice and Pine. Rice produces an item that Pine could use in its
production. Pine currently is purchasing 12,000 units from an outside supplier for $18 per unit. Rice is
currently operating at less than its full capacity of 500,000 units and has variable costs of $10 per unit.
The full cost to manufacture the unit is $14. Rice currently sells 450,000 units at a selling price of $20
per unit.
a. What will be the effect on Concord Company's operating profit if the transfer is made internally?
b. What is the minimum transfer price from Rice's perspective?
c. What is the maximum transfer price from Pine' perspective?

a. $96,000 more profit = 12,000 × ($18 - $10)

b. $10: minimum price would be the variable cost for Rice
c. $18: maximum price would be the $18 market price for Pine
price to purchase. The minimum transfer price with excess capacity is the variable cost. The maximum

AACSB: Analytic
Blooms: Apply

117. Tint Company has two divisions, Blue and Green. Blue produces an item that Green could use in its
production. Green currently is purchasing 150,000 units from an outside supplier for $23 per unit. Blue
is currently operating at full capacity of 1,600,000 units and has variable costs of $14 per unit. The full
cost to manufacture the unit is $18. Blue currently sells 1,600,000 units at a selling price of $25 per unit.
a. What will be the effect on Tint Company's operating profit if the transfer is made internally?
b. What is the minimum transfer price from Blue's perspective?
c. What is the maximum transfer price from Green's perspective?

a. $300,000 less profits = 150,000 × ($25 - $23)

b. $25 market price. Since Blue is at full capacity, any price less its current market price will create an
opportunity cost.
c. $23 market price for Green.
Feedback: Profit will decrease by the difference between the market price for the selling division and
the market price for the buying division. The minimum transfer price without excess capacity is the
selling division's market price. The maximum transfer price is the buying division's market price.

AACSB: Analytic
10-86
Blooms: Apply

118. Dickens Company has two divisions, Bloom and Heath. Bloom produces an item that Heath could use
in its production. Heath currently is purchasing 5,000 units from an outside supplier for $44 per unit.
Bloom has sufficient capacity and has variable costs of $35 per unit. The full cost to manufacture the
unit is $41. Bloom currently sells 450,000 units at a selling price of $48 per unit.
a. What will be the effect on Dickens Company's operating profit if the transfer is made internally?
b. What will be the change in profits for Bloom if the transfer price is $41 per unit?
c. What will be the change in profits for Heath if the transfer price is $41 per unit?

a. $45,000 more profit = 5,000 × ($44 - $35)

b. $30,000 more profit = 5,000 × ($41 - $35)
c. $15,000 more profit = 5,000 × ($44 - $41)
Feedback: Profit for the firm will increase by the difference between the variable cost to manufacture
and the market price to purchase. Profit for the selling division will increase by the difference between
the variable cost to manufacture and the transfer price. Profit for the buying division will increase by the
difference between the transfer price and the market price to purchase.

AACSB: Analytic
Blooms: Apply

10-87
119. Washington Company has two divisions, Jefferson and Adams. Jefferson produces an item that Adams
could use in its production. Adams currently is purchasing 100,000 units from an outside supplier for
$78.40 per unit. Jefferson is currently operating at full capacity of 900,000 units and has variable costs
of $46.40 per unit. The full cost to manufacture the unit is $59.20. Jefferson currently sells 900,000
units at a selling price of $86.40 per unit.
a. What will be the effect on Washington Company's operating profit if the transfer is made internally?
b. What will be the change in profits for Jefferson if the transfer price is $67.20 per unit?
c. What will be the change in profits for Adams if the transfer price is $67.20 per unit?

a. $800,000 less profits = 100,000 × ($78.40 - $86.40)

b. $1,920,000 less profits = 100,000 × ($67.20 - $86.40)
c. $1,120,000 more profits = 100,000 × ($78.40 - $67.20)
Feedback: Profit for the firm will decrease by the difference between the market price for the selling
division and the market price for the buying division. Profit for the selling division will decrease by the
difference between the market price for the selling division and the transfer price. Profit for the buying
division will increase by the difference between the transfer price and the market price to purchase.

AACSB: Analytic
Blooms: Apply

10-88
120. Rapid Industries has multiple divisions. One division, Iron Products, makes a component that another
division, Austin, is currently purchasing on the open market. Iron Products currently has a capacity to
produce 500,000 components at a variable cost of $7.50 and a full cost of $10.00. Iron Products has
outside sales of 460,000 components at a price of $12.50 per unit. Austin currently purchases 50,000
units from an outside supplier at a price of $12.00 per unit. Assume that Austin desires to use a single
supplier for its component.
a. What will be the effect on Rapid Industries' operating profit if the transfer is made internally? Assume
the 50,000 units Austin needs are either purchased 100% internally or 100% externally.
b. What is the minimum transfer price?
c. What is the maximum transfer price?

a. $175,000 increase in profits = $425,000 inside cost - $600,000 outside cost

Outside cost: 50,000 units × $12 = $600,000
Inside cost: 40,000 units from excess capacity × variable cost $7.50 = $300,000 +
10,000 units × ($7.50 variable cost + $5.00 opportunity cost) = $125,000 for a total inside cost of
$425,000
b. $8.50 = $425,000 inside cost/50,000 units
c. $12.00 outside market price to Austin
price to purchase, minus the opportunity cost to the selling division. The minimum transfer price with
excess capacity is the variable cost, plus the opportunity cost to the selling division. The maximum
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

10-89

Decentralized Performance Evaluation: True / False Questions

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Decentralized Performance Evaluation: True / False Questions

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Chapter 10

Decentralized Performance Evaluation

True / False Questions

Multiple Choice Questions

A. Allows top managers to focus on strategic issues

A. Fosters competition among divisions

A. a cost center.

A. a cost center.

A. a cost center.

A. a cost center.

A. ROI = sales revenue/average invested assets

A. Sales revenue/average invested assets

A. Sales revenue/average invested assets

A. Operating income - (hurdle rate × average invested assets)

A. equal to operating income.

A. Use of ROI may lead to goal incongruence.

A. market price method

A. market price method.

A. market price method.

A. market price…full cost

A. no change in overall profits

a. Calculate the return on investment.

a. What is Hubbard's ROI before making an investment in the project?

Ontario Company has a hurdle rate of 10%.

a. Calculate the return on investment for each division.

a. Calculate the return on investment.

a. What is Superior Division's ROI before making an investment in the project?

Warren Company has a hurdle rate of 12%.

a. Calculate the return on investment for each division.

a. Compute the ROI for the Manufacturing Division.

True / False Questions

In a decentralized organization, decision-making authority is spread throughout the organization.

This is considered a benefit of decentralization.

This is the formula for investment turnover.

Profit margin is defined as the ratio of operating income to sales revenue.

Residual income is a lagging indicator of financial performance.

Multiple Choice Questions

A. Centralized organization

In a decentralized organization, decision-making authority is spread throughout the organization, and

A. Allows top managers to focus on strategic issues

Potential duplication of resources is a disadvantage of decentralization.

A. Fosters competition among divisions

Potential duplication of resources is a disadvantage of decentralization.

A. balanced scorecard.

A. Return on investment

The budget is a primary tool used by cost centers to manage costs.

A. a cost center.

A. a cost center.

A. a cost center.

A. a cost center.

A. cost center

A. Performance measures

A. Customer perspective

A. Customer perspective

A. Customer perspective

A. Customer perspective

A. ROI = sales revenue/average invested assets

This is the formula for ROI.

A. Sales revenue/average invested assets

This is the formula for profit margin.

A. Sales revenue/average invested assets

This is the formula for investment turnover.

If sales increase by 10%, investment turnover will be ($1,500,000 × 110%)/$750,000 = 2.2.