Chapter 9: Exercises

Short-Answer Questions, Exercises, and Problems

Short-Answer Questions

  • What is the fundamental principle of responsibility accounting?
  • List five important factors that should be considered in designing reports for a responsibility accounting system.
  • How soon should accounting reports be prepared after the end of the performance measurement period? Explain.
  • Name and describe three types of responsibility centers.
  • Describe a segment of a business enterprise that is best treated as an expense center. List four indirect expenses that may be allocated to such an expense center.
  • Compare and contrast an expense center and an investment center.
  • What purpose is served by setting transfer prices?
  • What is the advantage of using investment centers as a basis for performance evaluation?
  • Which categories of items must a segment manager have control over for the investment center concept to be applicable?
  • What is the connection between the extent of decentralization and the investment center concept?
  • Give some of the advantages of decentralization.
  • Differentiate between a direct cost and an indirect cost of a segment. What happens to these categories if the segment to which they are related is eliminated?
  • Is it possible for a cost to be direct to one cost object and indirect to another cost object? Explain.
  • Describe some of the methods by which indirect expenses are allocated to a segment.
  • Give the general formula for return on investment (ROI). What are its two components?
  • Give the three sets of definitions for income and investment that can be used in ROI calculations, and explain when each set is applicable.
  • Give the various valuation bases that can be used for plant assets in investment center calculations. Discuss some of the advantages and disadvantages of these methods.
  • In what way is the use of the residual income (RI) concept superior to the use of ROI?
  • How is residual income (RI) determined?
  • If the RI for segment manager A is $50,000 while the RI for segment manager B is $100,000, does this necessarily mean that B is a better manager than A? Explain.
  • Real world question Refer to the annual report of a publicly traded company. Which of the company's geographic regions performed better? Explain.
  • (Based on Appendix) Briefly discuss the two methods of allocating service department costs.


Exercises

Exercise A The following information refers to the inspection department of a chemical packaging plant for September:

Amount

Over or (Under) Budget

Supplies

$ 54,000

$ (10,800)

Repairs and maintenance

270,000

21,600

Overtime paid to inspectors

108,000

10,800

Salary of inspection department manager

32,400

(5,400)

Salary of plant manager

43,200

-0-

Allocation of company accounting costs

32,400

10,800

Allocation of building depreciation to the inspection department

21,600

(5,400)

Using this information, prepare a responsibility report for the manager of the inspection department for September. Include those items for which you think the inspection department manager would be held responsible.

Exercise B Present the following information for the Hardware Division of ABC Computer Company,

Sales

$ 1,400,000

Variable selling and administrative expenses

100,000

Fixed direct manufacturing expenses

35,000

Fixed indirect manufacturing expenses

56,000

Variable manufacturing expenses

400,000

Fixed direct selling and administrative expenses

175,000

Fixed indirect selling and administrative expenses

28,000

Exercise C Given the following data, prepare a schedule that shows contribution margin, contribution to indirect expenses, and net income of the Sharks Division of Hockey, Inc.:

Direct fixed expenses

$ 324,000

Indirect fixed expenses

259,200

Sales

2,100,000

Variable expenses

1,500,000

What would be the effect on the company income if the segment were eliminated?

Exercise D Three segments (A, B, and C) of Trump Enterprises have net sales of $300,000, $150,000, and $50,000, respectively. A decision is made to allocate the pool of $25,000 of administrative overhead expenses of the home office to the segments, using net sales as the basis for allocation.

a. How much of the $25,000 should be allocated to each segment?

b. If Segment C is eliminated, how much of the $25,000 will be allocated to A and B?

Exercise E Two segments (Mountain Bike and Road Bike) showed the following data for the most recent year:

Mountain bike

Road bike

Contribution to indirect expenses

$ 840,000

$ 504,000

Assets directly used by and identified with the segment

2,520,000

2,184,000

Sales

3,360,000

6,720,000

a. Calculate return on investment for each segment in the most direct manner.

b. Calculate return on investment using the margin and turnover components.

Exercise F Calculate the new margin, turnover, and return on investment of the Mountain Bike segment for each of the following changes. Consider each change independently of the others.

a. Direct variable expenses were reduced by $33,600. Sales and assets were unaffected.

b. Assets used by the segment were reduced by $540,000, while income and sales were unaffected.

c. An advertising campaign increased sales by $336,000 and income by $50,000. Assets directly used by the segment were unaffected.

Exercise G The following data are available for Segment A of ABC Company:

Net income of the segment

$ 50,000

Contribution to indirect expenses

40,000

Controllable income by manager

48,000

Assets directly used by the manager

360,000

Assets under the control of the segment manager

240,000

Determine the return on investment for evaluating (a) the income performance of the manager of Segment A and (b) the rate of income contribution of the segment.

Exercise H Travel Company has three segments: Air, Land, and Sea. Data concerning income and investment follow:

Air

Land

Sea

Contribution to indirect expenses

$ 43,200

$ 86,400

$ 115,200

Assets directly used by and identified with the segment

288,000

576,000

1,296,000

Assuming that the cost of capital on investment is 12%, calculate the residual income of each of the segments. Do the results indicate that any of the segments should be eliminated?

Problems

Problem A You are given the following information for Farflung Company for the year ended 2009 December 31. The company is organized according to functions:

Plant Manager

Vice President Of Manufacturing

President

Controllable expenses

Budget

Actual

Budget

Actual

Budget

Actual

Office expense

$ 7,200

$ 9,600

$ 12,000

$ 16,800

$ 24,000

$ 16,800

Printing

19,200

16,800

Paging

2,400

2,160

Binding

4,800

4,800

Purchasing

24,000

26,400

Receiving

12,000

14,400

Inspection

19,200

16,800

Vice president of marketing

192,000

168,000

Controller

144,000

120,000

Treasurer

96,000

72,000

Vice president of personnel

48,000

72,000

Prepare the responsibility accounting reports for the three levels of management—plant manager, vice president of manufacturing, and president.

Problem B Joey Bauer Corporation has production plants in Sacramento, Dallas, and Seattle. Following is a summary of the results for past year:

Plant

Revenues

Expenses

Investment base (gross assets)

Sacramento

$ 450,000

$ 225,000

$ 4,500,000

Dallas

450,000

180,000

3,375,000

Seattle

675,000

247,500

7,200,000

a. If the plants are treated as profit centers, which plant manager appears to have done the best job?

b. If the plants are treated as investment centers, which plant manager appears to have done the best job? (Assume the plant managers are evaluated by return on investment on gross assets.)

c. Do the results of profit center analysis and investment center analysis give different findings? If so, why?

Problem C Quinn Company allocates all of its home office expenses to its two segments, A and B. Allocations are based on the following selected expense account balances and additional data:

Expenses (allocation bases)

Home office building expense (net sales)

$ 76,800

Buying expense (net purchases)

67,200

Uncollectible accounts (net sales)

8,000

Depreciation of home office equipment (net sales)

21,120

Advertising expense (indirect, allocated on basis of relative amounts of direct advertising)

86,400

Insurance expense (relative amounts of equipment plus average inventory in department)

23,040

Segment A

Segment B

Total

Purchases (net)

$ 243,200

$ 76,800

$ 320,000

Sales (net)

512,000

128,000

640,000

Equipment (cost)

96,000

64,000

160,000

Advertising (cost)

25,600

12,800

38,400

Average inventory

160,000

64,000

224,000

a. Prepare a schedule showing the amounts of each type of expense allocable to Segments X and Y using these data and bases of allocation.

b. Evaluate and criticize these allocation bases.

Problem D Allentown, Inc., is a company with two segments, X and Y. Its revenues and expenses for 2009 follow:

Segment X

Segment Y

Total

Net sales

$ 96,000

$ 144,000

$ 240,000

Direct expenses:*

Cost of goods sold

45,000

99,000

144,000

Selling

13,680

7,200

20,880

Administrative:

Uncollectible accounts

3,000

1,800

4,800

Insurance

2,400

1,200

3,600

Interest

480

240

720

Indirect expenses (all fixed):

Selling

18,000

Administrative

25,200

* All the direct expenses are variable except insurance and interest, which are fixed.

a. Prepare a schedule showing the contribution margin, the contribution to indirect expenses of each segment, and net income for the company as a whole. Do not allocate indirect expenses to the segments.

b. Assume that indirect selling expenses are to be allocated on the basis of net sales and that indirect administrative expenses are to be allocated on the basis of direct administrative expenses. Prepare a statement (starting with the contribution to indirect expenses) that shows the net income of each segment.

c. Comment on the appropriateness of the income amounts shown in parts (a) and (b) for determining the income contribution of the segments.

Problem E The following data pertain to the operating revenues and expenses for Golden State Company for 2009:

Los Angeles

(LA) Segment

San Francisco

(SF) Segment

Total

Sales

$ 180,000

$ 360,000

$ 540,000

Variable expenses

96,000

240,000

336,000

Direct fixed expenses

24,000

30,000

54,000

Indirect fixed expenses

72,000

Regarding the company's total operating assets of $900,000, the following facts exist:

Los Angeles

Segment

San Francisco

Segment

Assets directly used by and identified with the segment

$ 180,000

$ 360,000

a. Prepare a statement showing the contribution margin of each segment, the contribution to indirect expenses of each segment, and the total income of Golden State Company.

b. Determine the return on investment for evaluating (1) the earning power of the entire company and (2) the performance of each segment.

c. Comment on the results of part (b).

Problem F Shaq Company operates with three segments, Louisiana, Orlando, and LA. Data regarding these segments follow:

Louisiana

segment

Orlando

segment

LA

segment

Contribution to indirect expenses

$ 324,000

$ 180,000

$ 144,000

Assets directly used and identified with the segment

1,800,000

1,440,000

720,000

a. Calculate the return on investment for each segment. Rank them from highest to lowest.

b. Assume the cost of capital is 12% for a segment. Calculate residual income for each segment. Rank them from highest to lowest.

c. Repeat (b), but assume the cost of capital is 17% for a segment. Rank them from highest to lowest.

d. Comment on the rankings achieved.

Problem G The manager of the Winston Company faced the following data for the year 2009:

Contribution to indirect expenses

$ 1,800,000

Assets directly used by and identified with the segment

22,500,000

Sales

36,000,000

a. Determine the margin, turnover, and return on investment for the segment in 2009.

b. Determine the effect on margin, turnover, and return on investment of the segment in 2010 if each of the following changes were to occur. Consider each change separately and assume that any items not specifically mentioned remain the same as in 2009:

A campaign to control costs resulted in $180,000 of reduced expenses.

Certain nonproductive assets were eliminated. As a result, investment decreased by $900,000, and expenses decreased by $72,000.

An advertising campaign resulted in increasing sales by $3,600,000, cost of goods sold by $2,700,000, and advertising expense by $540,000.

An investment was made in productive assets costing $900,000. As a result, sales increased by $360,000, and expenses increased by $54,000.

Problem H For the year ended 2009 December 31, Fore Company reported the following information for the company as a whole and for the sports segment of Fore Corporation:

Sports Segment

Fore

company

Woods

Project

Irons

Project

Total

Sales

$12,000,000

$1,350,000

$600,000

$1,950,000

Income

1,125,000

300,000

37,500

337,500

Investment

4,500,000

900,000

105,000

1,005,000

Fore Company anticipates that these relationships (return on investment, margin, and turnover) will hold true for the upcoming year. The sports segment is faced with the possibility of adding a new project in 2010, with the following projected data:

Putters

Project

Sales

$450,000

Income

52,500

Investment

187,500

a. Determine the return on investment for Fore Company, for the sports segment, and for the Woods and Irons projects separately for the year ended 2009 December 31.

b. Using this information, determine the effect of adding the Putters project on the sports segment's return on investment. What problem may be encountered?

Using the data provided in the previous problem, determine the residual income (1) for all three projects and (2) for the sports segment with and without the Putters project, if the cost of capital is 25%. What is the effect on the sport segment's residual income if the Putter project is added? How does this result compare with your answer to the previous problem?

Alternate problems

Alternate problem A Swiss Corporation has three production plants (X, Y, and Z). Following is a summary of the results for January 2009:

Plant

Revenues

Expenses

Investment

Base

(gross assets)

X

$ 720,000

$ 300,000

$ 1,440,000

Y

960,000

180,000

1,920,000

Z

5,040,000

1,920,000

13,200,000

a. If the plants are treated as profit centers, which plant manager appears to have done the best job?

b. If the plants are treated as investment centers, which plant manager appears to have done the best job? (Assume the plant managers are evaluated by return on investment.)

c. Do the results of profit center analysis and investment center analysis give different findings? If so, why?

Alternate problem B Easy Loans, Inc., allocates expenses and revenues to the two segments that it operates. Easy Loans extends credit to customers under a revolving charge plan whereby all account balances not paid within 30 days are charged interest at the rate of 11/2% per month.

Following are selected revenue and expense accounts and some additional data needed to complete the allocation of the one revenue amount and the expenses.

Revenue and Expenses (allocation bases)

Revolving charge service revenue (net sales)

$600,000

Home office building occupancy expense (net sales)

45,000

Buying expenses (net purchases)

150,000

General administrative expenses (number of employees in

department)

75,000

Insurance expense (relative average inventory plus cost

of equipment and fixtures in each department)

18,000

Depreciation expense on home office equipment (net sales)

30,000

High Risk

Segment

Low Risk

Segment

Total

Number of employees

3

7

10

Net sales

$ 300,000

$ 600,000

$ 900,000

Net purchases

240,000

360,000

600,000

Averaging inventory

60,000

120,000

180,000

Cost of equipment fixtures

90,000

180,000

270,000

a. Prepare a schedule showing allocation of these items to the High and Low Risk segments.

b. Do you think these are good allocation bases? Why or why not?

Alternate problem C Student Painters, Inc., operates two segments, interior and exterior. The revenue and expense data for 2009 follow:

Interior

Exterior

Total

Net sales

$ 335,700

553,800

$ 889,500

Direct expenses:*

Cost of goods sold

186,000

282,000

468,000

Selling

31,800

27,000

58,800

Administrative

9,000

6,000

15,000

Uncollectible accounts

2,400

6,600

9,000

Indirect expenses (all fixed):

Selling

126,000

Administrative

156,000

*All the direct expenses are variable except administrative expense, which is fixed.

a. Prepare a schedule showing the contribution margin, the contribution to indirect expenses of each segment, and net income for the company as a whole. Do not allocate indirect expenses to the segments.

b. Assume that indirect selling expenses are to be allocated to segments on the basis of net sales (round to the nearest%) and that indirect administrative expenses are to be allocated on the basis of direct administrative expenses. Prepare a statement (starting with the contribution to indirect expenses) which shows the net income of each segment.

c. Comment on the appropriateness of the income amounts shown in parts (a) and (b) for determining the income contribution of the segments.

Alternate problem D Elliott Corporation has three segments. Following are the results of operations for 2009:

Segment A

Segment B

Segment C

Total

Sales

$36,000,000

$ 21,600,000

$ 14,400,000

$ 72,000,000

Variable expenses

25,920,000

12,240,000

9,720,000

47,880,000

Fixed expenses:

Direct

5,040,000

1,800,000

720,000

7,560,000

Indirect

3,600,000

For the company's total operating assets of $100,800,000, the following facts exist:

Segment A

Segment B

Segment C

Assets directly used by and

identified with the segment

$ 50,400,000

$ 28,800,000

$ 14,400,000

a. Prepare a statement (in thousands of dollars) showing the contribution margin, the contribution to indirect expenses for each segment, and the total income of the Elliott Corporation.

b. Determine the return on investment for evaluating (1) the performance of the entire company and (2) performance of each segment.

c. Comment on the results of part (a).

Alternative problem E Goodwin Company has three segments, 1,2, and 3. Data regarding these segments follow:

Segment 1

Segment 2

Segment 3

Contribution to indirect expenses

$ 432,000

$ 208,800

$ 72,000

Assets directly used by and identified

with the segment

3,600,000

1,440,000

360,000

a. Calculate the return on investment for each segment. Rank them from highest to lowest.

b. Assume the cost of capital is 10% for a segment. Calculate the residual income for each segment. Rank them from highest to lowest.

c. Repeat (b), but assume the desired cost of capital is 14%. Rank the segments from highest to lowest.

d. Comment on the rankings achieved.

Beyond the numbers—Critical thinking

Business decision case A Texas Company manufactures skateboards. Because the company's business is seasonal, between August and December skilled manufacturing employees are laid off. To improve morale, the financial vice president suggested that 10 employees not be laid off in the future. Instead, she suggested that they work in general labor from August to December but still be paid their manufacturing wages of $10 per hour. General labor personnel earn $6.60 per hour. What are the implications of this plan for the assignment of costs to the various segments of the business?

Business decision case B Piero Company builds new homes. Sarah Richards is in charge of the construction department. Among other responsibilities, Sarah hires and supervises the carpenters and other workers who build the homes. Piero Company does not do its own foundation work. The construction of foundations is done by subcontractors hired by Leslie Larue of the procurement department.

To start the development of a 500-home community, Larue hired Dire Company to build the foundations for the homes. On the day construction was to begin, Dire Company went out of business. Consequently, construction was delayed six weeks while Larue hired a new subcontractor. Which department should be charged with the cost of the delay in construction? Why?

Business decision case C Ken Silva is the supervisor of Department 103 of Laguna Company. The annual budget for Silva's department is as follows:

Annual budget for Department 103

Small tools

$ 6,750

Set up

7,500

Direct labor

8,250

Direct materials

15,000

Supplies

3,750

Supervision

22,500

Property taxes

3,750

Property insurance

750

Depreciation, machinery

1,500

Depreciation, building

1,500

Total

$ 71,250

Silva's salary of $15,000 is included in supervision. The remaining $7,500 in supervision is the salary of the assistant supervisor directly responsible to Silva. Identify the budget items that Silva controls.

Broader perspective – Writing experience D Refer to "A broader perspective: Employee buyouts". Write a brief report explaining the effects of employee buyouts on employee motivation.

Group project E Macrofast Software, Inc., faces stiff competition in selling its products. Macrofast's top management feels considerable pressure from the company's stockholders to increase earnings.

Mac Washington, the vice president of marketing at the company's Production Software Division, received a memorandum from top management that said, in effect, "Increase your division's earnings or look for a new job".

Washington could think of only one way to increase earnings by the end of the year. The Production Software Division had several installations that should be completed early the following year, probably in February or March. For each of those jobs, he asked the customers to sign a Completed Installation document stating the job was completed to the customer's satisfaction. He did this because Macrofast's accounting department would record the revenue from the job when it received the Completed Installation document.

Several customers signed Completed Installation documents even though the jobs were not complete because Washington gave them a personally signed letter stating the Completion Installation document was not legally binding.

The scheme initially worked. Revenues were prematurely recorded for these jobs, sales and earnings for the year were up, Macrofast's top management was delighted with the results, and Washington was rewarded with a large bonus and a promotion to a vice presidency at corporate headquarters.

The following June, a staff accountant discovered the scheme when a customer called to complain that he was being billed for a job that was not yet completed. When the accountant produced the customer's Completed Installation document, the customer produced Washington's letter saying the document was not binding. The accountant did some detective work and unearthed the scheme. When she presented the results to her supervisor, the supervisor said, "This practice is unfortunate and is against company policy. But what is done is done. Do not worry about last year's financial statements. Just be sure it does not happen again."

a. In teams of four, discuss what the staff accountant should do.

b. Then, decide how your solution would change if all jobs had been completed to the customers' satisfaction.

c. As a team, write a memorandum to your instructor describing your solutions. The heading of the memo should contain the date, to whom it is written, from whom, and the subject matter.

Group project F Bleak Prospects, Inc., found that its market share was slipping. Division managers were encouraged to maximize ROI and made decisions consistent with that goal. Nonetheless, there were frequent customer complaints, with resulting loss of business. Moreover, Bleak depended on an established product line and was unable to find new products for expansion while its competitors seemed to be able to generate new products almost yearly. What would you suggest Bleak Prospects' management do to improve the situation? In groups of two or three students, write a memorandum to your instructor addressing this question. The heading of the memorandum should contain the date, to whom it is written, from whom, and the subject matter.

Group project G Management of Division A is evaluated based on residual income measures. The division can either rent or buy a certain asset. Will the performance evaluation technique have an impact on the rent-or-buy decision? Why or why not? In groups or three students, write a memorandum to your instructor addressing this question. The heading of the memorandum should contain the date, to whom it is written, from whom, and the subject matter.

Using the Internet—A view of the real world

Visit the website for PepsiCo, Incorporated.

http://www.pepsico.com

Go to the company's most recent annual report. Compare the performance of PepsiCo's three business segments: (1) beverages, (2) snack foods, and (3) restaurants. (You will find business segment information in the notes to the financial statements.) Which business segment had the most operating profits? Which business performed better using ROI, profit margin, and asset turnover as the performance measures? Use end-of-year "identifiable assets" to measure investment, "operating profits" to measure income, and "net sales" to measure sales. Be sure to submit a copy of PepsiCo's business segment information from the annual report.

Visit the website for PepsiCo, Incorporated.

http://www.pepsico.com

Go to the company's most recent annual report. Using financial information for the most recent year, which of the company's geographic areas had the highest ROI? (You will find business segment information in the notes to the financial statements, including geographic segments.) Use end-of-year "identifiable assets" to measure investment, "operating profits" to measure income, and "net sales" to measure sales. Be sure to submit a copy of PepsiCo's business segment information from the annual report.

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