Responsibility Accounting and Transfer Pricing

(A. Decentralization and Performance Evaluation)

MODULE 7

RESPONSIBILITY ACCOUNTING AND TRANSFER PRICING

A. DECENTRALIZATION AND PERFORMANCE EVALUATION

THEORIES:
Centralization vs. decentralization
Centralization
3. In a company with a centralized approach to responsibility accounting, upper-level managers
typically
A. make key decisions only
B. implement key decisions only
C. both make and implement key decisions
D. review the outcomes of key decisions only

Decentralization
1. Why would a company decentralize?
A. to train and motivate division managers
B. to focus top management’s attention to operating decisions
C. to allow division managers to concentrate on strategic planning
D. all of the above

2. Advantages of decentralization include all of the following except

A. divisional management is able to react to changing market conditions more rapidly than top
management
B. divisional management is a source of personnel for promotion to top management positions
C. decentralization can motivate divisional managers
D. decentralization permits divisional management to concentrate on company-wide problems and
long-range planning

4. In a company with a decentralized approach to responsibility accounting, lower-level managers

typically
A. make key decisions only
B. implement key decisions only
C. both make and implement key decisions
D. review the outcomes of key decisions only

7. Decentralization occurs when

A. the firm’s operations are located over a large geographic area to reduce risk
B. authority for important decisions is delegated to lower segments of the organization
C. important decisions are made at the upper levels and the lower levels of the organization are
responsible for implementing the decisions
D. none of the above

Goal congruence, Suboptimization & management by objectives

Goal congruence
8. Consistency between goals of the firm and the goals of its employees is:
A. goal optimization C. goal congruence
B. goal conformance D. goal compensation

16. Goal congruence is most likely to result when

A. reports to managers include all costs
B. managers’ behavior is affected by the criteria used to judge their performance
C. performance evaluation criteria encourage behavior in the company’s best interests as well as in
the manager’s best interests
D. a manager knows the criteria used to judge his or her performance

111
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

35. When a manager takes an action that benefits his or her responsibility center, but not the company as
a whole,
A. it is a non-controllable action
B. there is a lack of goal congruence
C. the center must be an artificial profit center
D. the manager should be fired

Suboptimization
19. A management decision may be beneficial for a given profit center, but not for the entire company.
From the overall company viewpoint, this decision would lead to
A. goal congruence C. centralization
B. suboptimization D. maximization

Management by objectives
17. An emphasis on obtaining goal congruence is consistent with a broad managerial approach called
A. management by crisis
B. management by objectives
C. management through goal congruence
D. just-in-time philosophy

38. In a responsibility accounting system, the process in which a supervisor and a subordinate jointly
determine the subordinate’s goals and plans for achieving these goals is
A. Top-down budgeting C. Bottom-up budgeting
B. Imposed budgeting D. Management by objectives

Responsibility Accounting
5. Responsibility accounting is a system whose attributes include
A. responsibility, liability, and culpability
B. liability, accountability, and performance evaluation
C. performance evaluation, accountability, and responsibility
D. culpability, liability, and accountability

6. Some basic elements of responsibility accounting are

A. chart of accounts classification C. control-based reports
B. budgeting system D. all of the above

9. What term identifies an accounting system in which the operations of the business are
broken down into reportable segments and the control functions of a foreperson, sales
managers, or supervisor is emphasized?
A. Responsibility accounting C. Operations-research accounting
B. Control accounting D. Budgetary accounting

10. The Atwood Company uses a performance reporting system that reflects the company’s
decentralization of decision making. The departmental performance report shows one line of data
for each subordinate who reports to the group vice-president. The data presented shows the actual
costs incurred during the period, the budgeted costs, and all variances from budget for that
subordinate’s department. The Atwood Company is using a type of system called
A. Flexible budgeting C. Responsibility accounting
B. Contribution budgeting D. Cost-benefit accounting

14. The accumulation of accounting data on the basis of the individual manager who has the authority to
make day-to-day decisions about activities in an area is called
A. static reporting. C. responsibility accounting.
B. flexible accounting. D. master budgeting.

36. Which of the following is critically important for a responsibility accounting system to be effective?
A. Each employee should receive a separate performance report.
B. Service department costs should be allocated to the operating departments that use the service.
C. Each manager should know the criteria used for evaluating his or her performance.
D. The details on the performance reports for individual managers should add up to the totals on the
112
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

report to their supervisor.

Responsibility report
13. The report to a territorial sales manager which shows the contribution to profit by each salesperson
in the territory is called
A. a profit reportA. C. an absorption profit report
B. a responsibility report D. a distribution report

Responsibility centers
15. A responsibility center
A. is an organization unit where management control exists over incurring costs or generating
revenue
B. is responsible for all other departments
C. has a responsible manager in charge of it
D. all of the above

Activity center
32. A segment of an organization for which management wants to report the cost of the activities
performed separately is called a(n)
A. cost center C. activity-based costing center
B. activity center D. batch activity center

Cost center
20. The sequence that reflects increasing breadth of responsibility is
A. cost center, investment center, profit center
B. cost center, profit center, investment center
C. profit center, cost center, investment center
D. investment center, cost center, profit center

30. A cost center is used to

A. show responsibility for scheduling materials, labor, and overhead
B. collect costs incurred performing a set of homogeneous activities
C. show authority for choosing product markets and sources of supply
D. assign responsibility for setting the chart of accounts

31. Cost centers in a responsibility accounting system

A. will organize the company into the smallest units of activity – the individual worker
B. will have a specific manager in charge of every cost center
C. should have the same code number for similar units wherever they appear in an organization
D. should show the contribution margin in its control report

Profit center
21. A profit center is
A. a responsibility center that always reports a profit.
B. a responsibility center that incurs costs and generates revenues.
C. evaluated by the rate of return earned on the investment allocated to the center.
D. referred to as a loss center when operations do not meet the company's objectives.

22. A responsibility center having control over generating revenue is

A. a cost center C. a profit center
B. an investment center D. an operation center

Investment center
24. A distinguishing characteristic of an investment center is that
A. revenues are generated by selling and buying stocks and bonds.
B. interest revenue is the major source of revenues.
C. the profitability of the center is related to the funds invested in the center.
D. it is a responsibility center which only generates revenues.

Comprehensive
113
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

25. In which type of responsibility center is the manager held accountable for its profits?
A. Cost center C. Investment center
B. Profit center D. Profit centers or Investment centers

26. Which of the following responsibility centers have managers who are held accountable for costs?
A. Cost centers and Investment centers
B. Revenue centers and Profit centers
C. Revenue centers and Investment centers
D. Cost centers and Profit centers

Controllable & noncontrollable costs

27. In responsibility accounting the most relevant classification of costs is
A. fixed and variable C. discretionary and committed
B. incremental and nonincremental D. controllable and noncontrollable

Controllable costs
29. Controllable costs are costs that
A. fluctuate in total in response to small changes in the rate of capacity utilization.
B. will be unaffected by current managerial decisions.
C. management decides to incur in the current period to enable the company to achieve objectives
other than filling customers’ orders.
D. are likely to respond to the amount of attention devoted to them by a specified manager.

23. Overtime conditions and pay were recently set by the personnel department. The production
department has just received a request for a rush order from the sales department. The production
department protests that additional overtime costs would be incurred as a result of the order. The
sales department argues the order is from an important customer. The production department
processes the order. In order to control costs, which department should be charged with the overtime
costs generated as a result of the rush order?
A. Personnel department
B. Production department
C. Sales department
D. Shared by production department and sales department

34. Which one of the following would NOT usually be considered a controllable cost for the product or
division manager?
A. factory wages C. maintenance
B. plant salaries D. plant rent expense

Profitability accounting
28. Micro Manufacturing uses an accounting system that charges costs to the manager who has been
delegated the authority to make the decisions incurring the costs. For example, if the sales manager
accepts a rush order that requires the incurrence of additional manufacturing costs, these additional
costs are charged to the sales manager because the authority to accept or decline the rush order was
given to the sales manager. This type of accounting system is known as
A. Functional accounting C. Contribution accounting
B. Reciprocal allocation D. Profitability accounting

Budgeting system
33. A basic budgeting system includes
A. a planning schedule C. involvement of all managers
B. follow-up plan steps D. all of these

Segmented income statements

11. Segmented income statements are most meaningful to managers when they are prepared
A. on an absorption cost basis C. on a cost behavior basis
B. on a cash basis D. in a multi-step format

Performance evaluation
37. The criteria used for evaluating performance
114
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

A. should be designed to help achieve goal congruence

B. can be used only with profit centers and investment centers
C. should be used to compare past performance with current performance
D. motivate people to work in the company’s best interest

42. Of most relevance in deciding how or which costs should be assigned to a responsibility center is the
degree of
A. Avoidability C. Causality
B. Controllability D. Variability

41. Internal reports prepared under the responsibility accounting approach should be limited to which of
the following costs?
A. Only variable costs of production
B. Only conversion costs
C. Only controllable costs
D. Only costs properly allocable to the cost center under generally accepted accounting principles

49. The best measure of the performance of the manager of a profit center is the
A. rate of return on investment.
B. success in meeting budgeted goals for controllable costs.
C. amount of controllable margin generated by the profit center.
D. amount of contribution margin generated by the profit center.

12. When used for performance evaluation, periodic internal reports based on a responsibility
accounting system should not
A. be related to the organization chart
B. include allocated fixed overhead
C. include variances between actual and budgeted controllable costs
D. distinguish between controllable and noncontrollable costs

39. the most desirable measure of departmental performance for evaluating the departmental manager is
departmental
A. Revenue less controllable departmental expenses
B. Net income
C. Contribution to indirect expenses
D. Revenue less departmental variable expenses

40. Of little or no relevance in evaluating the performance of an activity would be

A. Flexible budgets for mixed costs
B. Fixed budgets for mixed costs
C. The difference between planned and actual results
D. The planning and control of future activities

Performance measures
Return on Investment
48. Return on investment (ROI) is calculated as
A. divisional operating income/divisional investment
B. divisional investment – divisional income
C. divisional investment/divisional operating income
D. divisional income – (divisional investment x required rate of return)

43. The return on investment calculation only considers the following components:
S = Sales
I = Investment
NI = Net Income
Which of the following formulas best describes the return on investment calculation?
A. (I/S) x (S/NI) = I/NI C. (S/I) x (NI/S) = NI/I
B. (I/S) x (NI/S) = (Ix NI) x (S x S) D. (S/I) x (S/NI) = (S x S)/(I x NI)

46. To properly motivate divisional management, the divisional ROIs should be

115
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

A. Equal
B. Greater in the less profitable divisions to motivate those divisions to achieve higher ROIs
C. Lower in more profitable divisions in which motivation is necessary
D. Different based upon strategic goals of the firm

51. Evaluating performance using ROI encourages managers to focus on

A. income and investment
B. cost efficiency and operating asset efficiency
C. both a and b
D. neither a nor b

58. A measure frequently used to evaluate the performance of the manager of an investment center is
A. the amount of profit generated.
B. the rate of return on funds invested in the center.
C. the percentage increase in profit over the previous year.
D. departmental gross profit.

61. In the formula for ROI, idle plant assets are

A. included in the calculation of controllable margin.
B. included in the calculation of operating assets.
C. excluded in the calculation of operating assets.
D. excluded from total assets.

DuPont Model
44. C company’s return on investment is affected by a change in
A. B. C. D.
Capital turnover Yes Yes No No
Profit margin on Yes No No Yes
sales

55. Return on investment for divisions and other company segments is a function of
A. assets employed and expected future cash flows.
B. contribution margin and invested capital.
C. investment turnover and profit margin on sales.
D. physical sales volume, prices, variable costs, and fixed costs.

Residual Income
50. Using residual income for evaluating performance
A. penalizes managers whose segments have low ROIs
B. penalizes managers of relatively large segment
C. encourages managers to maximize pesos of profit after a required ROI has been achieved
D. encourage managers to maximize ROI for the company

53. Residual income

A. is always the best measure of divisional performance
B. is not as good a measure of performance as ROI
C. overcomes some of the problems associated with ROI
D. cannot be used by divisions that deal with others in the same company

59. When a firm uses residual income to make decisions, the firm should favor those projects whose
residual income
A. is closest to the firm’s minimum capital rate
B. is lowest
C. is highest
D. exceeds a specific target amount

62. A division's investment in conjunction with the residual income may be

A. operating assets
B. operating and non-operating assets

116
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

C. assets minus current liabilities

D. any of the above

65. In order to promote goal congruence a manager of an investment center is best evaluated using
A. standard variable costing income statements
B. return on investment
C. budgets and standard costs
D. residual income

64. An advantage of residual income is that it encourages managers to

A. accept projects which provide returns in excess of the company's required rate of return
B. to increase asset turnover
C. attempt to increase the margin
D. all of the above

Economic value added

60. In contrast to residual income (RI), economic value added (EVA) uses:
A. the firm's minimum rate of return instead of its cost of capital.
B. the firm's cost of capital instead of its minimum rate of return
C. a required rate of return.
D. values determined by using conventional accounting policies

68. Which of the following would promote goal congruence?

A. return on investment C. single measures of performance
B. income based compensation D. economic value added

Sensitivity Analysis
Return on investment
45. Assuming that sales and net income remain the same, a company’s return on investment will
A, Increase if invested capital increases
B. Decrease if invested capital decreases
C. Decrease if the invested capital-employed turnover rate decreases
D. Decrease if the invested capital-employed turnover rate increases

52. The other things remaining constant, if a division doubles its investment turnover, its ROI will
A. decrease C. remain constant
B. increase D. double

54. Other factors remaining unchanged, the rate of return on investment may be improved by
A. increasing investment in assets.
B. increasing expenses.
C. reducing sales
D. decreasing investment in assets.

56.Which of the following will not improve return on investment if other factors remain
constant?
A. Increasing sales volume while holding fixed expenses constant.
B. Decreasing assets.
C. Increasing selling prices.
D. None of the above.

57. Assuming that sales and net income remain the same, a company’s return on investment (ROI)
would
A. increase if the invested capital-employed turnover rate decreases.
B. Increase if the invested capital-employed turnover rate increases.
C. Increase if invested capital increases.
D. Decrease if invested capital decreases.

63. To improve asset turnover in conjunction with ROI computations,

A. sales may be increased C. assets may be decreased
117
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

B. assets may be increased D. a and c

66. How can an investment center improve its return on investment (ROI)?
A. increase margin, increase investments
B. decrease margin, decrease turnover
C. increase margin, increase turnover
D. decrease margin, increase investments

Economic value added

67. Economic value added would decrease if:
A. operating income increases
B. the division invests in a project wherein the after-tax operating income is more than the cost of
capital
C. operating expenses increase
D. cost of capital decreases

Estimating Current Market Value of Assets

47. Which of the following is NOT a method for developing or estimating the current market value of
assets?
A. Gross Book Value. C. Liquidation Value.
B. Replacement Cost. D. Economic Value Added.

Comprehensive
18. Which of the following is not a true statement?
A. Many costs are controllable at some level with a company.
B. Responsibility accounting applies to both profit and not-for-profit entities.
C. Fewer costs are controllable as one moves up to each higher level of managerial
responsibility.
D. The term segment is sometimes used to identify areas of responsibility in decentralized operations.

PROBLEMS:
DuPont Model
Return on sales
1
. The Dela Merced Company’s Household Products Division reported in 2007 sales of P15,000,000,
an asset turnover ratio of 3.0, and a rate of return on average assets of 18 percent. The percentage of
net income to sales is
A. 6 percent. C. 3 percent
B. 12 percent. D. 5 percent.

Return on assets
Required unit sales
2
. The Valve Division of Industrial Company produces a small valve that is used by various companies
as a component part in their products. Industrial Company operates its divisions as autonomous
units, giving its divisional manager great discretion in pricing and other decisions. Each division is
expected to generate a rate of return of at least 14 percent on its operating assets. The Valve
Division has average operating assets of P700,000. The valves are sold for P5 each. Variable costs
are P3 per valve, and fixed costs total P462,000 per year. The Division has a capacity of 300,000
units.
How many valves must the Valve Division sell each year to generate the desired rate of return on its
assets?
A. 280,000 C. 355,385
B. 350,000 D. 265,000

Divisional ROI
3
. Marsh Company that had current operating assets of one million and net income of P200,000 had an
opportunity to invest in a project that requires an additional investment of P250,000 and increased
net income by P40,000. After the investment, the company's ROI will be
A. 16.0% C. 19.2%
B. 18.0% D. 20.2%

118
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

4
. The following data relate to the Motor Division of Eurosun Company:
Sales P10,000,000
Variable costs 3,000,000
Direct fixed costs 5,000,000
Invested capital 8,000,000
Allocated actual interest costs 800,000
Capital charge 12%
The divisional return on investment is:
A. 15 percent C. 13 percent
B. 25 percent D. 20 percent

Required sales
5
. The manager of the Mac Division of Power Company expects the following results in 2006 (pesos
in millions):
Sales P49.60
Variable costs (60%) 29.76
Contribution margin P19.84
Fixed costs 12.00
Profit P 7.84
Investment:
Plant equipment P19.51
Working capital 14.88 P34.39
ROI P7.84/P34.39 22.80%
The division has a target ROI of 30 percent, and the manager has asked you to determine how much
sales volume the division would need to reach that. He states that the sales mix is relatively constant
so variable costs and equipment should be close to 60 percent of sales, fixed cost and plant and
equipment should remain constant, and working capital (cash, receivables, and inventories) should
vary closely with sales in the percentage reflected above.
The peso sales that the division needs in order to reach the 30 percent ROI target is
A. P19,829,032 C. P57,590,322
B. P44,373,871 D. P59,510,000

Residual income
6
. The current income for a subunit is P36,000. Its current invested capital is P200,000. The subunit is
considering purchasing for P20,000 equipment that will increase annual income by an estimated
P2,800. The firm's cost of capital is 12%. If the equipment is purchased, the residual income of the
subunit will
A. increase by P2,800 C. increase by P400
B. increase by P16,000 D. increase by 4%

Minimum selling price

7
. Matipid Division of Expenditures Company expects the following results for 2007:
Unit sales 70,000
Unit selling price P 10
Unit variable cost P 4
Total fixed costs P300,000
Total investment P500,000
The minimum required ROI is 15 percent, and divisions are evaluated on residual income. A foreign
customer has approached Matipid’s manager with an offer to buy 10,000 units at P7 each. If Matipid
accepts the order, it would not lose any of the 70,000 units at the regular price. Accepting the order
would increase fixed costs by P10,000 and investment by P40,000.
What is the minimum price that Matipid could accept for the order and still maintain its expected
residual income?
A. P5.00 C. P5.60
B. P4.75 D. P9.00

Maximum lost unit sales

8
. Magastos Division of Expenditures Company expects the following results for 2006:
Unit sales 70,000

119
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

Unit selling price P 10

Unit variable cost P 4
Total fixed cost
Total fixed costs P 300,000
Total investment P 500,000
The minimum required ROI is 15 percent, and divisions are evaluated on residual income. A foreign
customer has approached Magastos’ manager with an offer to buy 10,000 units at P7 each. Magastos
Division has capacity of 75,000 units and the foreign customer will not accept fewer than 10,000
units. Accepting the order would increase fixed costs by P10,000 and investment by P40,000.
At the price of P7 offered by foreign customer, what is the maximum number of units in regular
sales that Magastos Division could sacrifice and still maintain its expected residual income?
A. 2,333 C. 3,333
B. 2,667 D. 3,667

Economic Value Added

9
. Consider the following:
Investment center’s after-tax operating profit P 50,000
Investment center’s total assets 800,000
Investment center’s current liabilities 80,000
Weighted-average cost of capital 6.5%
What is the economic value added (EVA)?
A. P60,000 C. P 6,000
B. P 3,200 D. P50,000

Segmented Income Statement

Controllable segment profit margin
10
. Segment A generated sales revenues of P400,000 and variable operating expenses of P180,000. Its
controllable fixed expenses were P40,000. It was assigned 20% of P200,000 of fixed costs controlled
by others. The common fixed costs were P25,000. What was Segment A's controllable segment
profit margin?
A. P220,000 C. P140,000
B. P180,000 D. P160,000

Sensitivity Analysis
11
. If the investment turnover increased by 30% and ROS decreased by 20%, the ROI would
A. increase by 30% C. increase by 6%
B. increase by 4% D. none of these
12
. If the investment turnover decreased by 10% and ROS decreased by 30%, the ROI would
A. increase by 30% C. decrease by 10%
B. decrease by 37% D. none of the above

Comprehensive
Use the following information to answer questions 2 thru 6:
Carlyle Company had the following information pertaining to 2005:
Profit P100,000
Sales P1,000,000
Asset Turnover ratio 2 times
The desired minimum rate of return is 15 percent.
13
. What is the ROI?
A. 10 percent C. 20 percent
B. 5 percent D. 15 percent
14
. What is the return on sales?
A. 10 percent C. 20 percent
B. 5 percent D. 15 percent
15
. What is the amount of assets?
A. P250,000 C. P1,000,000
120
 Responsibility Accounting and Transfer Pricing
(A. Decentralization and Performance Evaluation)

B. P500,000 D. P2,000,000
16
. The manager of Carlyle is paid a bonus based on ROI. Would the manager invest in a project that
will pay a return on investment of 18 percent?
A. Yes, because the project's ROI exceeds the desired minimum rate of return.
B. Yes, because the project's ROI is greater than the company's current ROI.
C. Yes, because the project's ROI is equal than the company's current ROI.
D. No, because the project's ROI is less than the company's current ROI.
17
. What is Carlyle's residual income?
A. P 25,000 C. P(200,000)
B. P( 50,000) D. P 150,000

121
1
. Answer: A
Return on Sales: 18% ÷ 3 = 6%
2
. Answer: A
Operating profit: (0.14 x P700,000) P98,000
Units sold = (Fixed costs + Profit) ÷ UCM (P462,000 + P98,000) ÷ P2 280,000
3
. Answer: C
New ROI: (200,000 + 40,000) ÷ (1M + 0.25M) 19.2%
4
. Answer: B
Operating income: 10M – 3M – 5M = P2 Million
ROI = P2M ÷ P8M = 25%
5
. Answer: C
Let S = Sales
0.3(19,510,000 + 0.3S) = (.4S – 12,000,000)
S = 57,590,322.58
6
. Answer: C
Increase in annual income P2,800
Additional required returns (P20,000 x 0.12) 2,400
Increase in residual value P 400
7
. Answer: C
Unit variable cost P4.00
Incremental unit fixed cost (P10,000/10) 1.00
Minimum return per P1 of additional asset requirement 40,000 x 0.15 /10,000
0.60
Minimum selling price P5.60
8
. Answer: A
Contribution provided by 10,000 units
10,000 x (7.00 – 5.60) 14,000
Divided by regular contribution margin per unit ÷ 6
Maximum decrease in regular sales 2,333
9
. Answer: B
EVA = Investment center's after-tax operating income - (Investment center's total
assets - Investment center's current liabilities) x Weighted-average cost of
capital].
Net operating profit P50,000
Cost of investment (P800,000 – P80,000) x 0.075 46,800
Economic Value Added P 3,200
10
. Answer: B
Controllable segment profit margin = Revenue - (Segment's variable operating
costs + Controllable fixed costs).
(P400,000 – P180,000 – P40,000) P180,000
11
. Answer: B
(1.3 x 0.8) – 100% = 4.0%
12
. Answer: B
Decrease in ROI: (0.90 x 0.70) – 1.00 = 37.0%
13
. Answer: C
ROI = Operating Profit ÷ Average investment
Average Operating assets: (P1,000,000 ÷ 2) = P500,000
ROI: (P100,000 ÷ P500,000) = 20%
14
. Answer: A
Return on sales = Profit ÷ Net sales
P100,000 ÷ P1,000,000 = 10%
15
. Answer: B
Total assets = Sales ÷ Asset turnover
P1,000,000 ÷ 2 = P500,000
16
. Answer: D
No, because the manager's bonus would go down because the company's ROI is 20
percent only.
17
. Answer: A
Operating profit P100,000
Less Required return on average assets: (P500,000 x 15%) 75,000
Residual income P 25,000