Deck 17: Divisional Performance Evaluation

Question 1

A cost center can be asked to achieve one of two typical objectives. A cost center can either minimize costs for a given output or it can:

A) maximize costs at a variable output.
B) maximize output for a given budget.
C) minimize costs for a variable output.
D) minimize output for a given budget.

Answer 1

B

Question 2

One of the problems of transfer prices comes from the successive impact of the prices as the product moves downstream toward the consumer. At each step the transfer price becomes the ____________ for the next part of the company.

A) market price
B) total cost
C) marginal cost
D) negotiated price

Answer 2

C

Question 3

The CEO of Always Round Tire has decided to open a battery division. He thinks that batteries would sell well with tires at their outlets AND that Always Round's quality reputation will be transferred to the batteries. Should he set up the new division as a Revenue Center, as a Profit Center, or as an Investment Center? Why?

Answer 3

The new division should be set up as a profit center. Batteries are a separate product from tires and therefore the division's profitability can be easily measured and rewarded. A revenue center with pricing authority would set price lower than the profit-maximizing price which would reduce the value of the firm. The CEO should be aware that incentives at the retail level will need to support both tire sales and battery sales. In addition, he should take steps to guard against double markups in transfer pricing from the battery division to the retail outlets.

Question 4

If there exists an external market for an intermediate good produced by a company, then an easy way to set the set a transfer price would be to use:

A) market-based transfer prices.
B) marginal cost transfer prices.
C) full-cost transfer prices.
D) success monopoly transfer prices.

Question 5

A manager in an Investment Center is offered a potential investment that would have an ROA of 15 percent. After the investment, it would make up 20 percent of his total portfolio. Currently, he makes 20 percent on his portfolio, though the company requires only 12 percent. Which of the following is true?

A) He will make the investment since it is 3 percent greater than the company's required return.
B) He will make the investment because a larger portfolio is always better than a smaller portfolio.
C) He will not make the investment because it the company prefers 12 percent
D) He will not make the investment because it lowers his over all return to 19 percent.

Question 6

What are the measures of performance for investment centers? How do they work?

Question 7

If each division of a company with a monopoly niche is allowed to set its transfer price at the profit-maximizing level for the next division as the product flows toward the consumer (assuming no external market for the product), then prices will:

A) be higher and profits lower than with non-divisional organization.
B) be lower and profits higher than with a non-divisional organization.
C) be the same and profits will be the same as with a non-divisional organization.
D) match the competitive benchmark and profits will be zero.

Question 8

Transfer prices or charge-back prices are ________ of most businesses.

A) required by federal law
B) typical
C) unusual
D) only part of the international component

Question 9

Many firms have to transfer partially-produced products among its divisions, often across national borders. One the key issues in establishing a reliable performance system for each subunit or division is the:

A) degree held by the manager of the division.
B) transfer prices used for intra-company product movement.
C) choice of low cost / high volume strategy for production.
D) implementation of government-approved systems.

Question 10

Measuring the success of a divisional Investment Center is closely tied to understanding whether or not the division meets profit expectations. To understand profits, two alternatives are proposed for tracking profitability: ROA and EVA. From the point of view of an economist, why is EVA usually preferred?

Question 11

If a corporation operates two divisions that supply one another, and each division is located in a different country, then transfer prices are:

A) set to allocate profit to the low tax rate country.
B) set to allocate all costs to the low tax rate country.
C) set to allocate profit to the high tax rate country.
D) not allowed between most countries.

Question 12

The accounting department had a plumbing problem and they called the maintenance department to fix this. After the job was done, the maintenance department sent the accounting department a bill for services rendered. Does this make sense? After all they are all a part of the same company?

Question 13

Always Round Tire's new division, Start-up Batteries, finds they have a Total Cost curve: TC = 300 + 2Q + 2Q² and a Demand curve: P = 130 - 2Q.
If the division is operated as an independent Profit Center, what will be the price and quantity sold each day? Will the division make a profit?
If the division is operated purely a Revenue Center, how many batteries will they sell each day?
If the division is operated as a Cost Center and told to produce 20 batteries per day, what would be the cost per battery?

Question 14

One of the reasons that many corporations adopt the M-form of business structure is that it allows for:

A) movement of decision rights to each division.
B) the elimination of unethical incentive programs.
C) companies to separate complementary product lines.
D) a vertical chain of command in each business function.

Question 15

What are the common transfer pricing methods?

Question 16

What is transfer pricing?

Question 17

Clearly, an economist would like to see a profit center implement a system that most closely approximates the rule of profit maximization, MR = MC, in building a system of prices for other divisions. What are the pluses and minuses of allowing a division to engage in this type of activity?

Question 18

Economists regularly make hostile comments about accounting data. It is purely historical. It is aggregated. It doesn't segment by levels of capacity usage. It often is not formatted for information on incremental change. So why is it the key data source for decision control and important in decision management?

Question 19

If a company division is operated as Revenue Center and its demand curve is P = 200 - 2Q, how many units should it produce per day?

A) 0
B) 25
C) 50
D) 100

Question 20

If final demand is P = 220 - 5Q and MC = 20, then explain the problem of successive monopoly transfer pricing showing the different outcomes if (1) the product is priced and sold in a single organization firm as opposed to (2) a firm with a manufacturing division and a sales/distribution division, both of which are given total independent control over pricing.

Question 21

Transfer price refers to the price at which:

A) goods are being transferred from one location to another.
B) services are being transferred overseas for a cheaper rate.
C) goods are sold to loyal customers without shipping and delivery cost.
D) goods and services are transferred within a business.

Question 22

MC transfer prices creates incentives for manufacturing to distort MC:

A) upwards and then downwards.
B) downwards and then upwards.
C) downwards.
D) upwards.

Question 23

In the Celtex case study, Leo Garcia, President of the synthetic chemical division, regularly fails to sell his products to and through the consumer products division. This is because:

A) there is a market-based alternative to his products that are cheaper.
B) Celtex has a faulty organizational structure that regularly cheats Garcia.
C) the head of the consumer products division does not understand the difference between price and value.
D) Garcia produces inferior products.

Question 24

If a company adds up all the costs of producing an intermediate product - direct labor, materials, and overhead - to establish a transfer price, then it is using:

A) market-based transfer prices.
B) marginal cost transfer prices.
C) full-cost transfer prices.
D) success monopoly transfer prices.

Question 25

Full-cost transfer pricing frequently:

A) understates the opportunity costs of external transfers.
B) overstates the opportunity costs of external transfers.
C) understates the opportunity costs of internal transfers.
D) overstates the opportunity costs of internal transfers.

Question 26

Which one of the following is not a method to set transfer prices?

A) market price
B) marginal production cost
C) full cost
D) opportunity cost

Question 27

You can manufacture a product in the US and transfer it to Europe. In the MC = $3 per unit, and the market price in Europe is $5 per unit. Should you manufacture the unit or not?

A) No, the net receipt of $5 is larger than the MC in the US.
B) Yes, the gross receipt of $3 is larger than the MC in the US.
C) No, the net receipt of $3 is the same as the MC in the US.
D) Yes, the net receipts in Europe exceed MC in the US.

Question 28

The choice of transfer-pricing method:

A) merely reallocates total company profits among its smaller units.
B) does nothing to profits of sub-units.
C) merely reallocates total company profits among its bigger units.
D) affects the firm's total profits.

Question 29

Full-cost transfer pricing creates an incentive for:

A) distribution to be inefficient.
B) distribution to be over-efficient.
C) manufacturing to be over-efficient.
D) manufacturing to be less efficient.

Question 30

You can manufacture a product in the US and transfer it to Europe. In the MC = $3 per unit, and the market price in Europe is $5 per unit. Should you manufacture the unit or not?

A) Yes, the total net gain is $5 from selling in Europe.
B) No, MC of $3 has to be forgone.
C) No, the net receipt of $3 is the same as the MC in the US.
D) Yes, the net receipts in Europe exceed MC in the US.

Question 31

Which one of the following is not a method to set transfer prices?

A) market price
B) marginal production cost
C) negotiated pricing
D) opportunity cost

Question 32

If a company has two profit centers where one supplies the other with necessary ingredients to a company product, and if the relationship between two centers is clearly inimical to company success, then:

A) it is time to use the market-based transfer price system.
B) it is time to implement a marginal cost based transfer system.
C) the company should change its management control system.
D) the company should probably reorganize.

Question 33

In terms of using accounting data to build an effective management control system, what is the nirvana fallacy?

A) It is the tendency to use market-based transfer prices.
B) It is the system of using accounting data for both decision management and decision control.
C) It is the tendency to use cost centers rather than profit centers as the core of business structure.
D) It is the belief that a perfect control system can be invented that will stop all fraud.

Question 34

Holmstrom and Tirole note "The economist's first instinct is to set transfer price equal to marginal cost." However, a distinct plurality of companies uses the full-cost method. That is because:

A) most companies do not employ economists.
B) it is simple and has a low cost of implementation.
C) it is identical to using a marginal cost approach to transfer prices.
D) the results are much better in the field with full-cost method

Question 35

The basic incentive problem associated with internal transfers is:

A) divisional managers have private information about opportunity costs.
B) divisional managers have only public information about opportunity costs.
C) senior management have private information about opportunity costs.
D) senior management must make all information about opportunity costs public.

Question 36

In general, the use of accounting systems performance analysis is more effective in:

A) decision management.
B) decision control.
C) audit review of failed enterprises.
D) residual income