Exam 11: How Do Managers Evaluate Performance in Decentralized Organizations

Which of the following ratios can managers use to break down return on investment (ROI)for improving performance?

Exhibit 11-5 Sports Products Inc.sells skis and snowboards.Below is some financial information for each division at Sports Products for the most recent fiscal year. Skis Snowboards Division Division Income Statement Information Marketing expenses \ 200,000 \ 150,000 Operating income 750,000 600,000 Income tax expense (30\% tax rate) 225,000 180,000 Balance Sheet Information Average operating assets \ 1,100,000 \ 525,000 Non-interest bearing current liabilities 100,000 75,000 Percent cast of capital 18\% 18\% To calculate economic value added (EVA),management requires adjustments for marketing and non-interest bearing current liabilities as outlined below. Marketing will be capitalized and amortized over several years resulting in an increase to average operating assets of $125,000 for the Skis division and $82,500 for the Snowboards division.On the income statement,marketing expenses for the year will be added back to operating income,then marketing amortization expense for one year will be deducted.The current year amortization expense will total $60,000 for the Ski division and $45,000 for the Snowboards division. Non-interest bearing liabilities will be deducted from average operating assets. -Refer to Exhibit 11-5.What is the EVA for the Snowboards division?

Exhibit 11-4 The following information is for two divisions at Wiley Company. Couch Division Chair Division Sales ? \ 6,000,000 Operating income ? \ 560,000 Operating profit margin 11.0\% ? Average operating assets \ 1,250,000 \ 4,000,000 Asset turnover 2.0 ? ROI ? ? -Refer to Exhibit 11-4.What is the asset turnover for the Chair Division (rounded to the nearest tenth)?

Exhibit 11-5 Sports Products Inc.sells skis and snowboards.Below is some financial information for each division at Sports Products for the most recent fiscal year. Skis Snowboards Division Division Income Statement Information Marketing expenses \ 200,000 \ 150,000 Operating income 750,000 600,000 Income tax expense (30\% tax rate) 225,000 180,000 Balance Sheet Information Average operating assets \ 1,100,000 \ 525,000 Non-interest bearing current liabilities 100,000 75,000 Percent cast of capital 18\% 18\% To calculate economic value added (EVA),management requires adjustments for marketing and non-interest bearing current liabilities as outlined below. Marketing will be capitalized and amortized over several years resulting in an increase to average operating assets of $125,000 for the Skis division and $82,500 for the Snowboards division.On the income statement,marketing expenses for the year will be added back to operating income,then marketing amortization expense for one year will be deducted.The current year amortization expense will total $60,000 for the Ski division and $45,000 for the Snowboards division. Non-interest bearing liabilities will be deducted from average operating assets. -Refer to Exhibit 11-5.After the EVA adjustments to operating income,what would be the amount of net operating profit after tax (adjusted)for the Skis Division?

Which of the following statements is true regarding the use of the operating profit margin as a performance measure?

A cost center is an organizational segment in which the manager is responsible for costs and revenues,but not investments in assets.

Exhibit 11-5 Sports Products Inc.sells skis and snowboards.Below is some financial information for each division at Sports Products for the most recent fiscal year. Skis Snowboards Division Division Income Statement Information Marketing expenses \ 200,000 \ 150,000 Operating income 750,000 600,000 Income tax expense (30\% tax rate) 225,000 180,000 Balance Sheet Information Average operating assets \ 1,100,000 \ 525,000 Non-interest bearing current liabilities 100,000 75,000 Percent cast of capital 18\% 18\% To calculate economic value added (EVA),management requires adjustments for marketing and non-interest bearing current liabilities as outlined below. Marketing will be capitalized and amortized over several years resulting in an increase to average operating assets of $125,000 for the Skis division and $82,500 for the Snowboards division.On the income statement,marketing expenses for the year will be added back to operating income,then marketing amortization expense for one year will be deducted.The current year amortization expense will total $60,000 for the Ski division and $45,000 for the Snowboards division. Non-interest bearing liabilities will be deducted from average operating assets. -Refer to Exhibit 11-5.After the EVA adjustments to operating income,what would be the amount of net operating profit after tax (adjusted)for the Snowboards Division?

The cost-plus approach is the best approach for establishing transfer prices for all companies.

Division A has a building with the same original cost as Division B,except that it was purchased four years before Division B's building.If both divisions have identical operating incomes and use the net book value approach for calculating return on investment (ROI),which of the following will be true?

Attley Inc.has three separate divisions: Division A,Division B,and Division C.Information about the three divisions follows: Division A Division B Division C Operating income \ 26,750 \ 121,000 \ 22,400 Average operating assets \ 250,000 \ 412,000 \ 83,000 The company has recently implemented a new performance evaluation system.Based on this new system,a division manager would only receive a bonus if the ROI of the division was greater than 25% and residual income was in excess of $20,000.If management uses a cost of capital rate of 18%,which division manager(s)would be eligible for a bonus?

Starline Inc.manufactures and sells commercial coffee makers and coffee grinders.The Coffee Grinder Division incurs the following costs for the production of each coffee grinder when 4,000 coffee grinders are produced each year. Direct materials \ 12.00 Direct labor 10,50 Variable overhead 7.50 Fixed overhead 6.00 Total cost \ The company sells the coffee grinders to various retail stores for $60.00.The Coffee Maker Division is doing a promotion whereby each customer that purchases a coffee maker will receive a free coffee grinder.The Coffee Maker Division would like to purchase these coffee grinders from the Coffee Grinder Division. Assuming the Coffee Grinder Division has excess capacity and there would be no lost sales by selling internally,what is the optimal transfer price that should be charged to the Coffee Maker Division?

Becky's Bikes Inc.has two divisions: Retail and Service.The following information is for each division at Becky's Bikes for the most recent fiscal year. Retail Division Service Division Income Statement Sales \ 1,200,000 \ 1,000,000 Cost of sales 550,000 400,000 Gross margin 650,000 600,000 Allocated overhead (from corporate) 210,000 180,000 Marketing expense 130,000 120,000 Administrative expense 60,000 55,000 Operating income 250,000 245,000 Income tax expense (40\% rate) 100,000 98,000 Net income 150,000 147,000 Balance Sheet Information Average operating assets \ 600,000 \ 375,000 Non-interest bearing current liabilities 100,000 75,000 Percent cost of capital 12\% 12\% To calculate EVA,management requires adjustments for marketing and non-interest bearing current liabilities as outlined below. Marketing will be capitalized and amortized over several years resulting in an increase to average operating assets of $50,000 for the Retail division and $32,500 for the Services division.On the income statement,marketing expense for the year will be added back to operating income,then marketing amortization expense for one year will be deducted.The current year amortization expense will total $30,000 for the Retail division and $20,000 for the Services division. Non-interest bearing liabilities will be deducted from average operating assets. Calculate economic value added (EVA)for each division and comment on your results.

When residual income is used to evaluate division managers,the goal for each division manager is to increase residual income over time.

The term decentralized organization refers to an organization that delegates decision-making and operational responsibilities to managers of each segment of the organization.

Petra Company has the following information available for one of its divisions: Average operating assets \ 2,500,000 Sales \ 4,000,000 Return on investment (ROI) 40\% If Petra's cost of capital is 25%,what is the division's residual income?

Pete's Paint Company produces paint and has two divisions: Consumer and Commercial.Each division manager is evaluated based on profit produced by each division.The Commercial division sells paint to the Consumer division for $12 per gallon to cover variable costs.The Commercial division also sells to outside customers for $15 per gallon. a.Using the general economic transfer pricing rule,calculate the optimal transfer price assuming the Commercial division is below capacity. b.Using the general economic transfer pricing rule,calculate the optimal transfer price assuming the Commercial division is at capacity.

Exhibit 11-5 Sports Products Inc.sells skis and snowboards.Below is some financial information for each division at Sports Products for the most recent fiscal year. Skis Snowboards Division Division Income Statement Information Marketing expenses \ 200,000 \ 150,000 Operating income 750,000 600,000 Income tax expense (30\% tax rate) 225,000 180,000 Balance Sheet Information Average operating assets \ 1,100,000 \ 525,000 Non-interest bearing current liabilities 100,000 75,000 Percent cast of capital 18\% 18\% To calculate economic value added (EVA),management requires adjustments for marketing and non-interest bearing current liabilities as outlined below. Marketing will be capitalized and amortized over several years resulting in an increase to average operating assets of $125,000 for the Skis division and $82,500 for the Snowboards division.On the income statement,marketing expenses for the year will be added back to operating income,then marketing amortization expense for one year will be deducted.The current year amortization expense will total $60,000 for the Ski division and $45,000 for the Snowboards division. Non-interest bearing liabilities will be deducted from average operating assets. -Refer to Exhibit 11-5.After the EVA adjustments to average operating assets,what would be the amount of average operating assets (adjusted)for the Skis Division?

Exhibit 11-2 Manford Inc.has two divisions -Refrigerators and Dish Washer. Manford Company Segmented Income Statements For the Current Fiscal Year Ended December 31 Refrigerator Dish Washer Division Division Sales \ 10,000,000 \ 5,400,000 Cost of goods sold 4,200,000 2,660,000 Gross margin 5,800,000 2,740,000 Allocated overhead (from corporate) 940,000 740,000 Selling and administrative expenses 780,000 360,000 Operating income 4,080,000 1,640,000 Income tax expense (45\%) 1,836,000 738,000 Net income \ 2.244,000 \ 902.000 -Refer to Exhibit 11-2.Using the segmented income statements,what is the profit margin ratio for the Dish Washer Division (to the nearest hundredth of a percent)?

A profit center is an organizational segment in which the manager is responsible for costs and revenues,but not investments in assets.

When using the net book value to calculate return on investment (ROI),division managers controlling newer assets with little accumulated depreciation have an advantage over division managers controlling older assets with more accumulated depreciation.