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Managerial Accounting 3e Solutions Manual
Chapter 10
Performance Evaluation
Quick Check
Answers:
1. b
3. b
5. d
7. c
9. c
2. d
4. b
6. a
8. d
10. d
Short Exercises
(5 min.) S 10-1
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
A profit center
A responsibility center
Lower
A revenue center
A profit center
A cost center
An investment center
A cost center
An investment center
A profit center
a.
b.
c.
d.
e.
f.
g.
h.
Cost
Profit
Profit
Revenue
Profit
Investment
Cost
Profit
Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall
(5 min.) S 10-2
242

(5 10 min.) S 10-3
Since the business is getting too large for Grandma Jones to handle, she would probably benefit from
decentralizing her business. Some of the advantages of decentralization are:
Frees top managements (Grandma Jones) time

Improves customer relations
Increases employee motivation and satisfaction
Support the use of expert knowledge
Grandma Jones should also be made aware of the potential disadvantages of decentralization.
Problems achieving goal congruence

Duplication of costs or assets
Grandma Jones could decentralize in a number of different ways, for example:
customer type
business function- for example baking, sales and marketing
geographical area
a combination of geographic area, customer type, and function
(5 10 min.) S 10-4
Revenue center
1.
Manager of Holiday Inns central reservation office
Profit center
2.
Managers of various corporate-owned Holiday Inn locations
Investment center
Cost center
3.
4.
Investment center
Cost center
Manager of the Holiday Inn corporate division
Manager of the Housekeeping Department at the Holiday Inn

5.
6.
Manager of the Holiday Inn Express corporate division
Manager of the complimentary breakfast buffet at a Holiday Inn

Express
(10 min.) S 10-5
Midwest Division - Sales Revenue for Shastas Restaurants

For the month ending June 30
Product
Food
Dessert
Bar
Catering
$
$
$
$
Actual Sales
156,000
18,200
65,720
48,960
$
$
$
$
Budgeted Sales
150,000
20,000
62,000
48,000
Variance
$6,000 F
$1,800 U
$3,720 F
$ 960 F
Variance %
4.0% F
9.0% U
6.0% F
2.0% F
243
Chapter 10
(10 min.) S 10-6

Sales
margin
Capital
turnover
ROI
25.0%
10.0%
20.0%
1.80
2.50
1.50
45.00%
25.00%
30.00%
Functional Ingredients
Consumer Markets
Performance Materials
Functional Ingredients
Sales margin $5,445 / $21,780 = 25.0%
Capital turnover $21,780 / $12,100 = 1.8
ROI 25.0% x 1.8 = 45.0%
Consumer Markets
Sales margin $2,075 / $20,750 = 10.0%
ROI 10.0% x 2.5 = 25.0%
Performance Markets
Sales margin $3,000 / $15,000 = 20.0%
ROI 20.0% x 1.5 = 30.0%
(10 min.) S 10-7
1. Enter the formula, then calculate each divisions ROI.
Snow Sports
Non-Snow Sports
Operating Income
$ 1,040,000
$ 1,680,000
/
/
/
Total Assets
$ 4,000,000
$ 6,000,000
=
=
=
ROI
26.0 %
28.0 %
2. Top management has extra funds to invest. Which division will most likely receive those funds? Why?
The Non-Snow Sports division will most likely receive those funds because it has a higher ROI.
3. Can you explain why one divisions ROI is higher?
There is not enough information to explain why one ROI is greater.
How could management gain more insight?
Use the expanded ROI formula.
244

(10 - 15 min.) S 10-8
Req. 1
Snow Sports
$1,040,000
$5,200,000
20%
Operating income
Sales
Sales margin
Non-snow Sports
$1,680,000
$8,400,000
20%
Based on the divisions sales margins, we know that the sales margin was not the reason the divisions had
different ROIs.
Req. 2
Snow Sports
$5,200,000
$4,000,000
1.30
Sales
Total assets
Capital turnover
Non-snow Sports
$8,400,000
$6,000,000
1.40
Based on the divisions capital turnover rates, we know that the capital turnover rate was the reason that the
divisions had different ROIs.
Req. 3
Snow Sports
20%
1.30
26%
Sales margin (from S 10-7)

Capital turnover (from part 1)
ROI
Non-snow Sports
20%
1.40
28%
Do your answers agree with the basic ROI? Yes
(5 - 10 min.) S 10-9
Snow Sports RI
= $1,040,000 ($4,000,000 16%) = $400,000
Non-Snow Sports RI
= $1,680,000 ($6,000,000 16%) = $720,000
Both divisions have positive residual income. This means that the divisions are earning income at a rate that
exceeds managements minimum expectations.
This result is consistent with the ROI calculations.
(5 min.) S 10-10
Lowest Variable cost of $13

Highest Market price of $18
245
Chapter 10
The Electrical Division would not transfer the component for less than its variable cost ($13) or it would be
losing money on each transfer. The Stand Mixer Division would not pay more than the price that it can buy the
component on the market for, or $18.
246
(10 - 15 min.) S 10-11

1.
The master budget indicates that Sunshine planned to sell 5 pools in April.
2.
The actual results indicate that Sunshine sold 6 pools in April.
3. The flexible budget for performance reports is always based on the actual output for the month. This is
done so that managers can compare apples-to-apples, meaning they can compare actual revenues and
expenses to those they would expect to achieve given the same volume. Therefore, Sunshines flexible
budget is based on 6 pools.
4. The budgeted sales price is $18,000 per pool. ($90,000 / 5 = $18,000)
5. The budgeted variable price is $10,000 per pool. ($50,000 / 5 = $10,000)
6. The volume variance is the difference between the static (master) budget and the flexible budget. As the
name suggests, this variance arises only because the number of units actually sold differs from the
volume originally planned for in the static master budget.
7. As the name suggests, the flexible budget variance is the difference between the flexible budget and the
actual results. Since both the actual results and the flexible budget are based on the same volume of
output, this variance highlights unexpected revenues and expenses that are caused by factors other than
volume.
8. See completed Performance Report below.
Sunshine Pools
Income Statement Performance Report
Year Ended April
30
Output units
Actual results
at actual
prices
6
Flexible
budget for
actual
number of
output units
6
Flexible
budget
variance
0
Sales revenue
Variable expenses
Fixed expenses
102,000
57000
21000
$ 6,000
3000
4000
U
F
F
108,000
60000
25000
Total expenses
78,000
$ 7,000
85,000
Operating income
24,000
$ 1,000
23,000
Volume
variance
1
$
18,000
10000
0
$
10,000
$
8,000
Master
budget
5
F
U
$ 90,000
50000
25000
$ 75,000
$ 15,000
247
Chapter 10
(10 -15 min.) S 10-12
Decadent Chocolates
Master Budget Performance Report - Sales and Operating Expenses
For Year Ended December 31
Flexible
Budget
Actual
Variance
12,700
batches
Sales Revenue ($30 per batch)
$
376,500
$
U
4,500
Flexible
Budget
12,700
batches
Volume
Variance
Master
Budget
11,600
batches
$
381,000
$
F
33,000
$
348,000
$
U
2,200
2,000 F
$
25,400
$
23,200
1,600 F
38,100
34,800
8,700
8,700
2,500
$
74,700
$
306,300
$
U
$
F
Variable Operating Expenses:

Sales Expense ($2 per batch sold)
Shipping Expense ($3 per batch
sold)
$
23,400
3,300
36,500
Fixed Operating Expenses:

800
Salaries
9,500
Office Rent
2,500
$
71,900
$
304,600
Total Operating Expenses

Operating Income (Revenue less
Expenses)
$
U
$
2,800
1,700 U
5,500
27,500
2,500
$
69,200
$
278,800
(5 - 10 min.) S 10-13
a.
b.
c.
d.
e.
f.
g.
h.
Customer perspective
Internal business perspective
Financial perspective
Learning and growth perspective
a.
b.
c.
d.
e.
f.

(5 10 min.) S 10-14
248

g.
h.
a.
b.
c.
d.
e.
f.
g.
h.

(10 min.) S 10-15
Investment center
Direct fixed expenses
Sales margin
Key performance indicators (KPIs)
Master budget variance
Goal congruence
Profit center
Common fixed expenses
(continued) S 10-15
i.
j.
k.
l.
m.
n.
o.
p.
q.
r.
Flexible budget
Flexible budget variance
Return on Investment (ROI)
Favorable variance
Revenue center
Volume variance
Capital turnover
Unfavorable variance
Management by exception
Cost center
Exercises (Group A)
(5 - 10 min.) E 10-16A
a.
b.
c.
d.
e.
f.
g.
Decentralized
Centralized
Centralized
Decentralized
Decentralized
Centralized
Decentralized
a.
b.
c.
d.
e.
f.
g.
h.
Investment
Investment
Cost
Revenue
Profit
Investment
Profit
Cost
(5 10 min.) E 10-17A
249
Chapter 10
i.
j.
k.
Revenue
Cost
Profit
250
(10 - 15 min.) E 10-18A

Req. 1
HazeltonWater Sports
Subunit
Direct Materials
Direct Labor
Actual
$ 16,140
19,020
Budget
$15,000
20,000
Budget
Variance
(U or F)
$1,140 U
980 F
29,300
13,110
25,000
12,000
4,300 U
1,110 U
19,000
3,370
$99,940
19,000
4,000
$95,000
0
630 F
$4,940 U
Indirect Labor
Utilities
Depreciation
Repairs and Maintenance
Total
% Variance
(U or F)
7.60% U
4.90% F
17.20% U
9.25% U
0
15.75% F
5.20% U
Req. 2
This subunit must be a cost center.
Req. 3
Repairs and maintenance
Req. 4
No, favorable variances should be investigated to make sure they are not hurting the business in the long run.
(15 min.) E 10-19A
Performance Report
Northern Division - Sales Revenue for Irvin Chemical Corporation
(Dollars in millions)
Segment
Plastics
Chemicals and
Energy
Hydrocarbons
Actual Sales
$
11,845
$
$
3,710
5,184
Budgeted Sales
$
11,500
$
3,500
$
Variance
$
345
F
$
210
F
$
216
Variance
%
3.0%F
6.0%F
4.0%U
251
Chapter 10
Coatings
11,250
Health Sciences
11,088
5,400
$
12,500
$
9,900
U
1,250
U
$ 1,188
F
10.0%U
12.0%F
252
(15 min.) E 10-20A
Performance Report
Caldrone Industries - Pharmaceutical Segment
For Fiscal Year Ending December 31
(all data is in millions)
Variance
Variance %
Sales
Less Variable Expenses:
Variable Cost of Goods Sold
Variable Operating Expenses
Contribution Margin
Less Direct Fixed Expenses:
Fixed Manufacturing Overhead
Fixed Operating Expenses
Segment Margin
Less Common Fixed Expenses
Budgeted
800,000
80,000
10.00%
$
$
$
200,000
160,000
440,000
$
$
$
4,000
(6,400)
82,400
2.00%
-4.00%
18.73%
$
$
$
$
80,000
21,000
339,000
18,000
$
$
$
$
6,400
1,050
74,950
1,080
8.00%
5.00%
22.11%
6.00%
Operating Income
321,000
73,870
23.01%
(10 - 15 min.) E 10-21A

Req. 1
Operating income
Total assets
Return on investment
Residential
$ 68,000
$200,000
34%
Professional
$153,300
$365,000
42%
Each divisions ROI is very high; however, the Professional Division has an even higher ROI than the
Residential Division.
Req. 2
Operating income
Sales
Sales margin
Residential
$ 68,000
$850,000
8%
Professional
$153,300
$1,095,000
14%
The Professional Division is earning about $0.14 on each dollar of sales whereas the Residential Division is
only earning about $0.08 on each dollar of sales. The Professional Divisions higher sales margin helps to
account for its higher ROI.
253
Chapter 10
Req. 3
Residential
$850,000
$200,000
4.25
Sales
Total assets
Capital turnover
Professional
$1,095,000
$ 365,000
3.00
The Professional Division is generating $3.00 of sales for every dollar of assets invested in the division. The
Residential Division is generating $4.25 of sales for every dollar of assets invested. The Residential Division is
even more efficient.
Req. 4
Residential
8%
4.25
34%
Sales margin
Capital turnover
ROI
Professional
14%
3.00
42%
Does your answer for the residential ROI agree with the basic ROI? Yes
Does your answer for the professional ROI agree with the basic ROI? Yes
What can you conclude?
Even though the Residential Divisions efficiency (as measured by the capital turnover) is higher than that of
the Professional Division, the Professional Divisions profitability (as measured by the sales margin) is so
much higher that it causes the Professional Divisions ROI to be much higher than the Residential Divisions.
Req. 5
Residential RI
Professional RI
= $68,000 ($200,000 26%) = $17,550

= $153,300 ($365,000 26%) = $54,300
Both divisions are exceeding managements expectations.
(10 - 15 min.) E 10-22A
Anderson
Company
Beatty Industries
Carmen Inc.
$102,000
$815,000
$490,000
Operating income (OI)
$35,700
$114,100
$39,200
Total assets (TA)
$85,000
$163,000
$196,000
Sales margin (SM)
35%
14%
8%
Capital turnover (CT)
1.20
5.00
2.50
Return on investment (ROI)
41%
70%
20%
Target rate of return
11%
18%
19%
$26,350
$84,760
$1,960
Sales (S)
Residual income (RI)
254
(10 min.) E 10-23A

Req. 1
Sales Margin
Capital Turnover
ROI
=
=
=
=
$9,240 $38,500
24%
=
=
$38,500 $14,000
2.75 times
$9,240 $14,000
66%
Req. 2
RI
$9,240 (14% x $14,000) = $7,280
(10 - 15 min.) E 10-24A

Req. 1
The original return on investment (ROI) for Sinclair Ceramics is 20%
Req. 2
If this investment opportunity were undertaken, the ROI would be 18%.
If the manager of this division is evaluated based on ROI she would not want to make this investment.
Investing in the new project would decrease the divisions ROI.
Req. 3
The ROI of the investment opportunity is 13%.
From the standpoint of Heisler Corporation this investment is desirable. The ROI of the investment
opportunity exceeds Heislers required rate of return.
Req. 4
The residual income (RI) for Sinclair Ceramics if this investment opportunity were to be undertaken is
$40,180.
If the manager of this division is evaluated based on RI she would want to make this investment. The positive
RI indicates that the division is earning more than managements expectations.
Req. 5
The RI of the investment opportunity is $3,280.
From the standpoint of Heisler Corporation this investment is desirable. The RI of the investment opportunity
is positive, meaning the investment opportunity would earn more than managements target required return.
Req. 6
Of the two performance measurement methods, ROI and RI, RI is more likely to promote goal congruence.
The RI of the investment alone is positive, meaning the investment will increase the divisions RI by that
255
Chapter 10
amount. This would motivate both the division manager and the company management to make the
investment. The arrival at the same conclusion by both the manager and company management indicates
goal congruence.
256
(10 min.) E 10-25A
Req. 1
Lowest Variable cost of $28 ($25 + $3.) Highest Market price of $55
Req. 2
($25 + $3 + $2) x 20% = $6; Transfer price = $25 + $3 + $2 + $6 = $36
Req. 3
Market price; $55
(15 - 20 min.) E 10-26A

Main Street Muffins
Master Budget Performance Report - Sales and Operating Expenses
For Year Ended December 31
Flexible
Budget
Actual
Variance
Sales Revenue ($30 per case)

Variable Operating Expenses:
Packaging Expense ($1 per case
sold)
Shipping Expense ($3 per case sold)
Sales Commissions (2% of sales
price)
8,300 cases
$
215,400
$
F
7,900
$
8,700
$
25,900
$
4,308
$
U
$
U
$
U
400
$
6,900
$
3,500
$
2,500
$
1,800
$
1,200
$
54,808
$
160,592
$
U
$
$
$
F
$
F
$
U
$
F
1,000
158
Flexible
Budget
Volume
Variance
8,300 cases
$
207,500
$
7,500 F
$
8,300
$
24,900
$
4,150
$
U
$
U
$
U
$
6,200
$
3,500
$
2,500
$
1,900
$
900
$
52,350
$
155,150
$
$
$
$
$
$
1,350
U
$
6,150 F
Master
Budget
8,000 cases
$
200,000
300
900
150
$
8,000
$
24,000
$
4,000
Fixed Operating Expenses:

Salaries
Office Rent
Depreciation
Insurance Expense
Office Supplies Expense
Total Operating Expenses
Operating Income (Revenue less
Expenses)
700
100
200
2,458
5,442
$
6,200
$
3,500
$
2,500
$
1,900
$
900
$
51,000
$
149,000
257
Chapter 10
(15-20 min.) E 10-27A
Req. 1
Landeau-Subunit X
Revenue by Product
Downhill
Model RI
Downhill
Model RII
Cross-Country
Model EXI
Cross-Country
Model EXII
Snowboard
Model LXI
Total
Actual
Flexible
Budget
Variance
Flexible Budget
Sales Volume
Variance
Static
(Master)
Budget
$ 328,000
$ 8,000 (F)
$ 320,000
$16,000 (F)
$ 304,000
157,00014,000 (U)
171,000
20,000 (F)
151,000
280,000 2,000 (U)
282,000
18,000 (U)
300,000
253,000 8,000 (F)
245,000
18,500 (U)
263,500
422,000 1,000 (F)

$1,440,000$ 1,000 (F)
421,000
$1,439,000
19,000 (F)
$18,500 (F)
402,000
$1,420,500
Req. 2
This subunit is a revenue center.
Req. 3
The sales volume variance is always due strictly to volume therefore, the number of units sold was different
than budgeted for every model. The company sales mix appears to be shifting in the direction of downhill ski
and snowboard sports. This could result in a build-up of cross-country ski inventory.
Management may need to do a better job marketing their cross-country skis. Additionally, the company may
end up with delivery delays for downhill sports equipment if production schedules are not revised to
accommodate the increasing demand for downhill skis and snowboards.
(15 - 20 min.) E 10-28A

a.
b.
c.
d.
e.
f.
g.

Sales volume variance
28,000 units
$246,000
$173,600
$6,500 favorable
$54,300
258
(10 min.) E 10-29A

Lag indicators are performance measures that tend to reveal the results of past actions. They come after
decisions and actions taken in the past. Lead indicators are performance measures that tend to indicate future
performance. They come before, and drive, future performance.
Financial measures tend to be lag indicators. The financial results of a period are driven by actions taken in
the past. For example, Fords earlier decisions about design, production, planning, pricing and whether to
feature certain models in advertising.
Operational measures tend to be lead indicators. Current customer satisfaction ratings, defect rates, and cycle
times predict how well the company will do in the future. For example, Ford Motor Companys customers
satisfaction can predict whether future sales will increase (if customers are satisfied) or decline (if customers
are not satisfied).
(15 - 20 min.) E 10-30A

Cardinal Corporation
Balanced Scorecard Report
For Quarter Ended December 31
Perspective
Objective
KPI
Goal
Actual
Goal Achieved?
Financial
Increase profitability of core
product line
Core product line profit as

% of core product line
sales
Increase sales of core product

line
Sales revenue growth
12%
12%
2,000,000
2,200,000
259
Chapter 10
Customer
Increase market share
Market Share %
Increase customer satisfaction
Customer Satisfaction
rating
19%
18%
1.3
1.2
(1-5, with 1 being best)

Internal business process
Improve post-sales service
Average repair time (# of

days)
1.0
1.6
Develop new core products
Number of new core

products
26
24
Improve employee job

satisfaction
Employee Turnover rate
3%
6%
Improve employee product

knowledge
Employee training hours
2,400
2,350
Learning and growth
260
(10 - 15 min.) E 10-31A

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.

Internal business perspective OR Customer perspective
Internal business perspective (post-sales service)
(15 - 20 min.) E 10-32A

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
p.
q.
r.
Revenue from recycling packaging materials - Financial

Total liters of water used Internal business
Number of sustainability training hours Learning and growth
Number of employee hours devoted to local volunteering - Community
Charitable contributions as a percent of income - Community
Customer survey rating company's green reputation - Customer
Number of employees on sustainability teams Learning and growth
Cubic meters of natural gas used for heating facilities Internal business
Total megawatt hours of electricity purchased Internal business
Percent of bottles and cans sold recovered through company-supported recovery programs Customer
Cost of water used - Financial
Indirect greenhouse gas emissions from electricity purchased and consumed Internal
business
Number of functions with environmental responsibilities Learning and growth
Number of green products - Customer
Percentage of profit donated to local schools - Community
Volume of Global Greenhouse Gas (GHG) emissions Internal business
Waste disposal costs - Financial
Percentage of products reclaimed after customer use - Customer
(5 10 min.) E 10-33A
a.
b.
c.
d.
e.
f.
g.
Decentralized
Decentralized
Centralized
Decentralized
Decentralized
Centralized
Centralized
261
Chapter 10
Exercises (Group B)
(5 10 min.) E 10-34B
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
Profit
Cost
Profit
Cost
Revenue
Cost
Investment
Revenue
Investment
Profit
Investment
(10 - 15 min.) E 10-35B

Req. 1
Budget
River SportsSubunit X
Direct Materials
Actual
Budget
Variance
% Variance
(U or F)
(U or F)
$ 26,925
$25,000
$1,925 U
7.70% U
Direct Labor
14,235
15,000
765 F
5.10% F
Indirect Labor
29,275
26,000
3,275 U
12.59% U
Utilities
13,170
12,000
1,170 U
9.75% U
Depreciation
15,500
15,500
6,315
7,500
1,825 F
15.80% F
$105,420
$100,000
$5,420 U
5.42% U
Repairs and Maintenance

Total
Req. 2
This subunit is a cost center.
Req. 3
Indirect labor
262

Repairs and maintenance
Req. 4
No, favorable variances should be investigated to make sure they are not hurting the business in the long run.
263
Chapter 10
(15 min.) E 10-36B
Performance Report
Northern Division - Sales Revenue for Wendell Chemical Corporation
(Dollars in millions)
Segment
Actual Sales
Plastics
Chemicals and
Energy
14,872
4,116
Hydrocarbons
7,420
Coatings
10,580
Health Sciences
9,570
Budgeted Sales
$
14,300
$
4,200
$
7,000
$
11,500
$
8,700
Variance
$
572
$
(84)
$
420
$
(920)
$
870
Variance
%
4.0%
-2.0%
6.0%
-8.0%
10.0%
(15 min.) E 10-37B

Performance Report
Noble Industries - Pharmaceutical Segment
For Fiscal Year Ending December 31
(all data is in millions)
Actual
Sales
Less Variable Expenses:
Variable Cost of Goods Sold
Variable Operating Expenses
Contribution Margin
Less Direct Fixed Expenses:
Fixed Manufacturing Overhead
Fixed Operating Expenses
1,248,000
$
652,800
$
225,600
$
369,600
$
640,000
$
240,000
$
320,000
$
156,600
$
$
145,000
$
Budgeted
Variance
Variance
%
1,200,000
$ 48,000
4.00%
$ 12,800
2.00%
$ (14,400)
-6.00%
$ 49,600
15.50%
$ 11,600
$
8.00%
5.00%
264
Segment Margin
Less Common Fixed Expenses
Operating Income
26,250
$
186,750
$
15,450
$
171,300
25,000
$
150,000
$
15,000
$
135,000
1,250
$
36,750
$
450
24.50%
$ 36,300
26.89%
3.00%
(10-15 min.) E 10-38B

Req. 1
Operating income
Total assets
Residential
$ 58,800
$210,000
28%
Professional
$152,000
$380,000
40%
Each divisions ROI is very high; however, the Professional Division has an even higher ROI (46%) than the
Residential Division.
Req. 2
Operating income
Sales
Sales margin
Residential
$ 58,800
$420,000
14%
Professional
$152,000
$608,000
25%
The Professional Division is earning about $0.25 on each dollar of sales whereas the Residential Division is
only earning about $0.14 on each dollar of sales. The Professional Divisions higher sales margin helps to
account for its higher ROI.
Req. 3
Sales
Total assets
Capital turnover
Residential
$420,000
$210,000
2.00 times
Professional
$608,000
$ 380,000
1.60 times
The Professional Division is generating $1.60 of sales for every dollar of assets invested in the division. The
Residential Division is generating $2.00 of sales for every dollar of assets invested. The Residential
Division is even more efficient.
Req. 4
Sales margin
Capital turnover
ROI
Residential
14%
2.00
28%
Professional
25%
1.60
40%
265
Chapter 10
Does your answer for the residential ROI agree with the basic ROI? Yes
Does your answer for the professional ROI agree with the basic ROI? Yes
What can you conclude?
Even though the Residential Divisions efficiency (as measured by the capital turnover) is higher than that of
the Professional Division, the Professional Divisions profitability (as measured by the sales margin)
is so much higher that it causes the Professional Divisions ROI to be much higher than the
Residential Divisions.
Req. 5
RI
Residential RI
Professional RI
= Operating Income Minimum acceptable income

= Operating Income (Target rate of return Total assets)
= $58,800 ($210,000 25%) = $17,550
= $152,000 ($380,000 25%) = $54,300
Both divisions are exceeding managements expectations.
(10 min.) E 10-39B

Abercrombie
Benson
Company
Industries
$114,000
$780,000
$484,000
Operating income (OI)
$39,900
$117,000
$48,400
Total assets (TA)
$71,250
$150,000
$220,000
Sales margin (SM)
35%
15%
10%
Capital turnover (CT)
1.60
5.20
2.2.0
Return on investment (ROI)
56%
78%
22%
Target rate of return
10%
22%
20%
$32,775
$84,000
$4,400
Sales (S)
Residual income (RI)
Cappela Inc.
(10 min.) E 10-40B

Req. 1
Sales Margin = Operating income Sales
266

Sales Margin
$8,800 $35,200
25%
Capital Turnover = Sales Total Assets

Capital Turnover
$35,200 $16,000
2.20 times
ROI = Operating income Total Assets

ROI
$8,800 $16,000
55%
Req. 2
RI = Operating Income (Target rate of return Total assets)
RI
$8,800 (14% x $16,000) = $6,560
(10-15 min.) E 10-41B

Req. 1
The original return on investment (ROI) for the McKnight Ceramics division before the additional investment is
15%.
Req. 2
If this investment opportunity were undertaken the ROI would be 14.5%.
If the manager of this division is evaluated based on ROI she would not want to make this investment.
Investing in the new project would decrease the divisions ROI.
Req. 3
The ROI of the investment opportunity is 13%.
From the standpoint of Piper Corporation this investment is desirable. The ROI of the investment opportunity
is more than Pipers required rate of return .
Req. 4
The residual income (RI) for McKnight Ceramics if this investment opportunity were to be undertaken is
$30,800.
If the manager of this division is evaluated based on RI she would want to make this investment. The positive
RI indicates that the division is earning more than managements expectations.
267
Chapter 10
Req. 5
The RI of the investment opportunity is $5,600.
From the standpoint of Piper Corporation this investment is desirable. The RI of the investment opportunity is
positive, meaning the investment opportunity would earn more than managements target required return.
Req. 6
Of the two performance measurement methods, ROI and RI, RI is more likely to promotes goal congruence.
The RI of the investment alone is positive, meaning the investment will increase the divisions RI by that
amount. This would motivate both the division manager and the company management not to make the
investment. The arrival at the same conclusion by both the manager and company management indicates
goal congruence.
(10 min.) E 10-42B

Req. 1
Lowest Variable cost of $26 ($22 + $4.) Highest Market price of $49
Req. 2
($22 + $4 + $2) x 20% = $5.60; Transfer price = $22 + $4 + $2 + $5.60 = $33.60
Req. 3
Market price; $49
268
(15 - 20 min.) E 10-43B
269
Chapter 10
(15-20 min.) E 10-44B

Req. 1
Gutierrez-Subunit
Flexible
Budget
Revenue by
Product
Static
Actual
Variance
Sales Volume
Flexible Budget
Variance
(Master)
Budget
Downhill
Model RI
$ 321,000
$ 6,000 (F)
$ 315,000
$17,000 (F)
158,000
10,000 (U)
168,000
18,000 (F)
289,000
1,000 (U)
290,000
17,000 (U)
254,000
6,000 (F)
248,000
19,500 (U)
423,000
7,000 (F)
416,000
18,000 (F)
$1,445,000
$ 8,000 (F)
$1,437,000
$16,500 (F)
$ 298,000
Downhill
Model RII
Cross-Country
Model EXI
Cross-Country
Model EXII
Snowboard
Model LXI
Total
$1,420,500
Req. 2
This subunit is a revenue center.
Req. 3
Using the flexible budget variance as a guide, the following items will be investigated:
None of the items should be investigated.
Using the sales volume variance as a guide, the following items will be investigated:
Cross-Country Model EXI

Cross-Country Model EXII
Downhill Model R1
Downhill Model RII
270
Snowboard Model LXI
271
Chapter 10
(continued) E 10-44B
Interpret your results.
The sales volume variance is always due strictly to volume therefore, the number of units sold was different
than budgeted for every model. The company sales mix appears to be shifting in the direction of downhill ski
and snowboard sports. This could result in a buildup of cross-country ski inventory.
Management may need to do a better job marketing their cross-country skis. Additionally, the company may
end up with delivery delays for downhill sports equipment if production schedules are not revised to
accommodate the increasing demand for downhill skis and snowboards.
(15 - 20 min.) E 10-45B

a.
b.
c.
d.
e.
f.
g.

Volume variance
27,000 units
$248,000
$166,050
$5,000 favorable
$71,440
(10 min.) E 10-46B
Lag indicators are performance measures that tend to reveal the results of past actions. They come after
decisions and actions taken in the past. Lead indicators are performance measures that tend to indicate future
performance. They come before and drive future performance.
Financial measures tend to be lag indicators. The financial results of a period are driven by actions taken in
the past. For example, iTunes revenue for the second quarter is a result of managements earlier decisions to
feature certain new releases and artists in their weekly emails to subscribers.
Operational measures tend to be lead indicators. Current customer satisfaction ratings, number of active
subscribers and customer error rates predict how well the company will do in the future. For example, iTuness
customers satisfaction can predict whether future sales will increase (if customers are satisfied) or decline (if
customers are not satisfied).
272
(15 - 20 min.) E 10-47B
(10 - 15 min.) E 10-48B

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
273
Chapter 10
(15 - 20 min.) E 10-49B

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
p.
q.
r.
Community
Internal business
Learning and growth
Internal business
Financial
Financial
Internal business
Financial
Community
Customer
Community
Internal business
Learning and growth
Learning and growth
Customer
Customer
Internal business
Customer
Problems (Group A)
(15 - 20 min.) P 10-50A
Req. 1
RacerSubunit X
Actual
Flexible
Flexible
Budget
Budget
Percent
Variance
Variance*
(U or F)
Sales
$430,000
$400,000
$30,000
7.50%
Cost of goods sold
325,000
312,500
12,500
4.00%
Gross margin
105,000
87,500
17,500
20.00%
38,850
37,500
1,350
3.60%
66,150
50,000
16,150
32.30%
Operating expenses
Operating income before
service department
charges
274

Service department
charges (allocated)
37,500
25,000
12,500
50.00%
Operating income
$28,650
$25,000
$3,650
14.60%
*flexible budget variance flexible budget
(15 - 20 min.) P 10-50A

(continued) P 10-50A
Req. 2
This performance report includes both revenue and cost data; therefore, this subunit must be a profit center.
Req. 3
Service department costs
Req. 4
Managers should investigate favorable as well as unfavorable variances. Favorable variances may be due to
bookkeeping or budgeting errors. Management needs to evaluate large favorable as well as unfavorable
variances to determine the root cause of the variance.
Req. 5
The flexible budget variances are not due to sales volume differences between budget and actual.
Differences in sales volume are captured by the sales volume variance, not the flexible budget. The flexible
budget variance is due to something other than sales volume.
Req. 6
Management will not place much weight on the cost of goods sold variance because it does not exceed 10%.
Additionally, they may not place much weight on the service department charges because this is not a direct
cost of the subunit.
Req. 7
This performance report addresses the financial perspective of the balanced scorecard. Financial
performance measures tend to be lag indicators. They typically measure the results of past decisions.
Req. 8
Customer perspectivecustomer satisfaction ratings
Internal business perspectivenumber of new products developed
Learning and Growth perspectivehours spent training employees
Each one of these performance measures is a lead indicator which tend to project future performance. The
performance indicators listed above are often better at projecting future performance than past financial data.
275
Chapter 10
(20 - 25 min.) P 10-51A

Req. 1
Great Bubbles, Inc.
Flexible Budget Income Statement
Month Ended March 31
Flexible
Budget per
Output Unit
Output Units (Kits)

65,000
70,000
75,000
$2.90
$188,500
$203,000
$217,500
Cost of goods sold
1.25
81,250
87,500
93,750
Sales commissions
0.30
19,500
21,000
22,500
Utilities expense
0.05
3,250
3,500
3,750
Salary expense
30,000
30,000
33,000
Depreciation expense
20,000
20,000
23,000
Rent expense
8,000
8,000
12,000
Utilities expense
6,000
6,000
6,000
168,000
176,000
194,000
$ 20,500
$ 27,000
$ 23,500
Sales revenue
Variable expenses:
Fixed expenses:
Total expenses
Operating income
276
Req. 2
Req. 3
The advantage of the graph in the previous step is that Great Bubbles managers can look at the graph to
estimate total expenses at any output level up to 75,000 bubble kits, not just the three levels shown in the
columnar format in the first step. The disadvantage of the graph is that looking at the graph provides only an
estimate of the budgeted cost.
277
Chapter 10
(15 - 20 min.) P 10-52A

Req. 1
Great Bubbles, Inc.
Actual Results
at Actual
Prices
Output units (kits)
70,000
Flexible Budget
for Actual
Flexible
Number of
Budget
Output Units
Variance
-0-
70,000
Sales Volume
Static
Variance
(Master)
Budget
5,000F
65,000
Sales revenue
$208,000
$5,000F
$203,000
$14,500F
$188,500
88,000
500U
87,500
6,250U
81,250
24,000
3,000U
21,000
1,500U
19,500
3,500
1,500U
3,250
Variable expenses:
Cost of goods
sold
Sales
commissions
expense
Utilities expense
3,500
Fixed expenses:
Salary expense
32,300
Depreciation
20,000
2,300U
0
30,000
30,000
20,000
20,000
8,000
8,000
6,000
6,000
expense
Rent expense
7,000
Utilities expense
6,000
Total
1,000F
0
180,800
4,800U
176,000
8,000U
168,000
$ 27,200
$200F
$ 27,000
$ 6,500F
$ 20,500
expenses
Operating income
278

Req. 2
The favorable sales volume variance for operating income is much larger than the favorable flexible budget
variance. Most of the difference between master budget operating income and actual operating income
resulted from selling 5,000 more bubble kits than expected.
279
Chapter 10
(15 - 20 min.) P 10-53A

Req. 3
Great Bubbles static target budget variance is $6,700 favorable, meaning that its operating income is higher
than expected per the static budget.
A favorable sales volume variance reveals whether profits increased due to more units being sold.
A favorable sales revenue flexible budget variance means the sale price was higher.
(15 - 20 min.) P 10-53A

Req. 1
Operating income
Total assets
Paint Stores
$ 507,000
$1,500,000
33.8%
Consumer
$ 175,000
$1,562,500
11.2%
Paint Stores
$ 507,000
$3,900,000
13%
Consumer
$ 175,000
$1,250,000
14%
Req. 2
Operating income
Sales
Sales margin
The Consumer Division is more profitable on each dollar of sales.

Req. 3
Sales
Total assets
Capital turnover
Paint Stores
$3,900,000
$1,500,000
2.6 times
Consumer
$1,250,000
$1,562,500
0.8 times
The Paint Stores Division is more efficient in generating sales with its assets.
Req. 4
Paint Stores
Consumer
Sales margin
13%
14%
Capital turnover
2.6
0.8
ROI
33.8%
11.2%
The Consumer Divisions profitability on each dollar of sales is higher than the Paint Stores Divisions
profitability. However, the Paint Stores Divisions efficiency is significantly higher than the Consumer
Divisions efficiency. These results cause the Paint Stores Divisions ROI to be higher than the Consumer
Divisions ROI.
280

Req. 5
RI
= Operating income Minimum acceptable income

= Operating income (Target rate of return Total assets)
Paint Stores RI = $507,000 ($1,500,000 18%) = $237,000

Consumer RI = $175,000 ($1,562,500 18%) = $(106,250)
281
Chapter 10
Only the Paint Stores Division is meeting managements target rate of return. The Consumer Division should
work on improving its capital turnover rate. Improving the capital turnover rate may help the division achieve
positive residual income.
Req. 6
Most companies use the average asset balance since the income used in the ROI calculation is earned over
the course of the entire year.
Management must also decide whether they wish to use the gross book value of assets or the net book
value of assets. The net book value is often used since the figure is easily pulled straight from the balance
sheet. However, ROI using that value will artificially rise over time due to depreciation.
Req. 7
Risk level of the divisions business
Interest rates on company debt
Investors expectations
Competitors rate of return
Return being earned by other divisions
General economic conditions
Req. 8
RI does a better job of goal congruence.
Req. 9
Investment centers are responsible for both generating profit and efficiently managing the divisions assets.
Budget versus actual performance reports are insufficient because they do not measure how efficiently the
division uses its assets.
(15 - 20 min.) P 10-54A

Req. 1
(Millions of dollars)
Home furnishings
Office furniture
Store displays
Health care furnishings
Net Revenue
Operating Profit
Total Assets
$11,250
$3,150
$7,500
9,000
1,710
7,500
12,500
1,500
15,625
2,250
765
1,250
Operating Profit
$3,150
Net Revenue
$11,250
Req. 2
Home furnishings
Sales Margin
28.00%
282
Office furniture
Store displays
1,710
9,000
19.00%
1,500
12,500
12.00%
765
2,250
34.00%
The Store Displays Division of QuickCo has a much lower sales margin than the other divisions. Store
Displays is only earning $0.12 on every $1 of sales, whereas the other divisions range from $0.19 to $0.34
on every dollar of sales. Health-care Furnishings has the highest sales margin.
Req. 3
Home furnishings
Office furniture
Store displays
Net Revenue
Total Assets
Capital Turnover
$11,250
$7,500
1.5
9,000
7,500
1.2
12,500
15,625
0.8
2,250
1,250
1.8
The divisions have very different capital turnover rates. This means that the divisions vary greatly in their
ability to generate sales revenue from their assets. Health-care furnishings has the highest capital turnover
while Store Displays has the lowest capital turnover.
Req. 4
Home furnishings
Office furniture
Store displays
Operating Profit
Total Assets
ROI
$3,150
$7,500
42.00%
1,710
7,500
22.80%
1,500
15,625
9.60%
765
1,250
61.20%
Home furnishings and Health-care furnishings have the highest ROI. Both of these divisions had the highest
sales margins which is a factor as to why they have the highest ROI. Store Displays had the lowest ROI, in
part driven by the fact that it had the lowest sales margin of the four divisions.
283
Chapter 10
Req. 5
Financial reporting is for the benefit of external users, not internal management. Therefore, not all company
information is disclosed in the financial statements. Residual income (RI) calculations involve managements
target rate of return. Since this information is not presented, residual income cannot be calculated by an
external user without making an assumption about the rate.
284
Problems (Group B)
(15 - 20 min.) P 10-55B
Req. 1
SpeedSubunit X
Actual
Flexible
Flexible
Budget
Budget
Percent
Variance
Variance*
(U or F)
Sales
$490,500
$450,000
$40,500
9%
Cost of goods sold
261,500
250,000
11,500
4.6%
Gross margin
229,000
200,000
29,000
14.5%
83,440
80,000
3,440
4.3%
145,560
120,000
25,560
21.3%
57,500
46,000
11,500
25%
$88,060
$74,000
$14,060
19%
Operating expenses
Operating income before
service department
charges
Service department charges
(allocated)
Operating income
*flexible budget variance flexible budget
Req. 2
This performance report includes both revenue and cost data; therefore, this subunit must be a profit center.
Req. 3
Service department costs
Req. 4
Managers should investigate favorable as well as unfavorable variances. Favorable variances may be due to
bookkeeping or budgeting errors. Management needs to evaluate large favorable as well as unfavorable
variances to determine the root cause of the variance.
285
Chapter 10
Req. 5
The flexible budget variances are not due to differences in sales volume between budget and actual.
Differences in sales volume are captured by the sales volume variance, not the flexible budget. The flexible
budget variance is due to something other than sales volume.
Req. 6
Management will not place much weight on the cost of goods sold variance because it does not exceed 10%.
Additionally, they may not place much weight on the service department charges because this is not a direct
cost of the subunit.
286
(continued) P 10-55B
Req. 7
This performance report addresses the financial perspective of the balanced scorecard. Financial
performance measures tend to be lag indicators. They typically measure the results of past decisions.
Req. 8
Customer perspectivecustomer satisfaction ratings
Internal business perspectivenumber of new products
Learning and Growth perspectivehours spent training
developed
employees
Each one of these performance measures is a lead indicator which tends to project future performance. The
performance indicators listed above are often better at projecting future performance than past financial data.
(20 - 25 min.) P 10-56B

Req. 1
Everlasting Bubbles, Inc.
Flexible Budget Income Statement
Month Ended January 31
Flexible
Budget per
Output Unit
Output Units (Kits)

55,000
60,000
55,000
$3.10
$170,500
$186,000
$201,500
Cost of goods sold
1.25
68,750
75,000
81,250
Sales commissions
0.25
13,750
15,000
16,250
Utilities expense
0.10
5,500
6,000
16,5001,250
30,000
30,000
33,000
1820000
20,000
23,000
15,000
15,000
19,000
7,000
7,000
7,000
Sales revenue
Variable expenses:
Fixed expenses:
Salary expense
Depreciation expense
Rent expense
Utilities expense
287
Chapter 10
Total expenses
Operating income
160,000
168,000
186,000
$ 10,500
$ 18,000
$ 15,500
Req. 2
Req. 3
The advantage of the graph in the previous step is that Everlasting Bubbles managers can look at the graph
to estimate total expenses at any output level up to 65,000 bubble kits, not just the three levels shown in the
columnar format in the first step. The disadvantage of the graph is that looking at the graph provides only an
estimate of the budgeted cost.
288
(15 - 20 min.) P 10-57B

Req. 1
Req. 2
The favorable sales volume variance for operating income is much larger than the favorable flexible budget
variance. Most of the difference between master budget operating income and actual operating income
resulted from selling 5,000 more bubble kits than expected.
Req. 3
Everlasting Bubbles static budget variance is $7,800 favorable, meaning that its operating income is higher
than expected per the static budget.
A favorable sales volume variance reveals whether profits increased due to more units being sold.
289
Chapter 10
A favorable sales revenue flexible budget variance means the sale price was higher.
P 10-58B
Req. 1
Operating income
Total assets
Paint Stores
$ 480,000
$1,500,000
32.00%
Consumer
$ 150,000
$1,250,000
12.00%
Paint Stores
$ 480,000
$3,750,000
12.8%
Consumer
$ 150,000
$1,000,000
15%
Req. 2
Operating income
Sales
Sales margin
The Consumer Division is more profitable on each dollar of sales.

Req. 3
Paint Stores
$3,750,000
$1,500,000
2.5 times
Sales
Total assets
Capital turnover
Consumer
$1,000,000
$1,250,000
0.80 times
The Paint Stores Division is more efficient in generating sales with its assets.
Req. 4
Paint Stores
Consumer
Sales margin
12.8%
15.00%
Capital turnover
2.5
0.80
ROI
32.00%
12.00%
The Consumer Divisions profitability on each dollar of sales is higher than the Paint Stores Divisions
profitability. However, the Paint Stores Divisions efficiency is significantly higher than the Consumer
Divisions efficiency. These results cause the Paint Stores Divisions ROI to be higher than the Consumer
Divisions ROI.
Req. 5
RI
= Operating income Minimum acceptable income

= Operating income (Target rate of return Total assets)
290

Paint Stores RI = $480,000 ($1,500,000 20%) = $180,000
Consumer RI = $150,000 ($1,250,000 20%) = $(100,000)
Only the Paint Stores Division is meeting managements target rate of return. The Consumer Division should
work on improving its capital turnover rate. Improving the capital turnover rate may help the division achieve
positive residual income.
Req. 6
Most companies use the average asset balance since the income used in the ROI calculation is earned over
the course of the entire year.
Management must also decide whether they wish to use the gross book value of assets or the net book
value of assets. The net book value is often used because it is easily pulled straight from the balance sheet.
However, ROI calculated using the net book value of assets may artificially rise over time simply due to
depreciation.
Req. 7
Risk level of the divisions business
Interest rates on company debt
Investors expectations
Competitors rate of return
Return being earned by other divisions
General economic conditions
Req. 8
RI does a better job of goal congruence.
Req. 9
Investment centers are responsible for both generating profit and efficiently managing the divisions assets.
Budget versus actual performance reports are insufficient because they do not measure how efficiently the
division uses its assets.
(15 - 20 min.) P 10-59B
291
Chapter 10
Req. 1
Home furnishings
Office furniture
Store displays
Net Revenue
Operating Profit
Total Assets
$11,000
$2,530
$6,875
9,100
1,820
6,500
12,100
1,210
11,000
1,500
495
625
292
Req. 2
Home furnishings
Office furniture
Store displays
Operating Profit
Net Revenue
Sales Margin
$2,530
$11,000
23.00%
1,820
9,100
20.00%
1,210
12,100
10.00%
495
1,500
33.00%
The Store Displays Division of Stride Inc. has a much lower sales margin than the other divisions. They are
only earning $0.10 on every $1 of sales, whereas the other divisions range from $0.20 to $0.33 on every
dollar of sales. Health Care Furnishings has the highest sales margin.
Req. 3
Home furnishings
Office furniture
Store displays
Net Revenue
Total Assets
Capital Turnover
$11,000
$6,875
1.6
9,100
6,500
1.4
12,100
11,000
1.1
1,500
625
2.4
The divisions have very different capital turnover rates. This means that the divisions vary greatly in their
ability to generate sales revenue from their assets. Health-care furnishings has the highest capital turnover
while Store Displays has the lowest capital turnover.
Req. 4
Home furnishings
Office furniture
Store displays
Operating Profit
Total Assets
ROI
$2,530
$6,875
36.8%
1,820
6,500
28%
1,210
11,000
11%
495
625
79.2%
Home furnishings and Health-care furnishings have the highest ROI. Both of these divisions had the highest
sales margins and capital turnover rates which accounts for their high ROI. Store Displays had the lowest ROI,
in part driven by the fact that it had the lowest sales margin of the four divisions.
293
Chapter 10
Req. 5
Financial reporting is for the benefit of external users, not internal management. Therefore, not all company
information is disclosed in the financial statements. Residual income (RI) calculations involve managements
target rate of return. Since this information is not presented, residual income cannot be calculated by an
external user without making an assumption about the rate.
EVA calculations involve the WACC, divisional current liabilities, and the effective income tax rate. This
information is not presented on a divisional basis, so divisional EVA cannot be calculated by an external user
without making several assumptions.
Discussion & Analysis

(30-45 min.) A 10-60
1. Describe at least four advantages of decentralization. Also describe at least two
disadvantages to decentralization.
Decentralization provides many potential benefits. It frees top management time. By delegating
responsibility for daily operations to segment managers, top management can concentrate on longterm strategic planning and higher-level decisions that affect the entire company. Decentralization
encourages the use of expert knowledge by allowing top management to hire the expertise each
business segment needs to excel in its specific operations. Specialized knowledge often helps
segment managers make better decisions than the top company managers could make. Segment
managers can focus on just one segment of the company, allowing them to maintain close contact
with important customers and suppliers. Thus, decentralization often leads to improved customer and
supplier relations, which can result in quicker customer response times. Decentralization also
provides segment managers with training and experience necessary to become effective top
managers. Companies often groom their lower-level managers to move up through the company,
taking on additional responsibility and gaining more knowledge of the company with each step.
Finally, empowering segment managers to make decisions increases managers motivation and job
satisfaction, which often improves job performance and retention.
Decentralization may also cause potential problems. Decentralization may cause a company to
duplicate certain costs or assets. Also, decentralized companies often struggle to achieve goal
congruence. Segment managers may not fully understand the big picture, or the ultimate goals that
upper management is trying to achieve. They may make decisions that are good for their segment but
may be detrimental to another segment of the company or the company as a whole.
2. Compare and contrast a cost center, a revenue center, a profit center, and an investment
center. List a specific example of each type of responsibility center. How is the performance
of managers evaluated in each type of responsibility center?
In a cost center, managers are accountable for costs only. Manufacturing operations, such as the
Campbells Chicken Noodle Soup manufacturing plant, are cost centers. The plant manager controls
costs by ensuring that the entire production process runs efficiently. The plant manager is not
responsible for generating revenues because he or she is not involved in selling the product. The
plant manager is evaluated on his or her ability to control costs by comparing actual costs to budgeted
294

costs. In a revenue center, managers are accountable primarily for revenues. Many times, revenue
centers are sales territories, such as Campbells Soups Midwest and Southeast sales regions.
Managers of revenue centers may also be responsible for the costs of their own sales operations.
Revenue center performance reports compare actual revenues to budgeted revenues. In a profit
center, managers are accountable for both revenues and costs and, therefore, profits. For example, at
Campbells, a manager is responsible for the entire line of Campbells ready- to- serve and
condensed soup products. This manager is accountable for increasing sales revenue and controlling
costs to achieve profit goals for the entire line of soups. Superiors evaluate the managers
performance by comparing actual revenues, expenses, and profits to the budget.
(continued) A 10-60
In an investment center, managers are responsible for: generating revenues, controlling costs, and
efficiently managing the divisions assets. Investment centers are generally large divisions of a
corporation. Investment centers are treated almost as if they were stand-alone companies. Division
managers generally have broad responsibility, including deciding how to use assets. As a result,
managers are held responsible for generating as much profit as they can with those assets.
3. Explain the potential problem which could arise from using ROI as the incentive measure for
managers. What are some specific actions a company might take to resolve this potential
problem?
One serious drawback of ROI is the short-term focus of this measure. Companies usually prepare
performance reports and calculate ROI using a time frame of one year or less. If upper management
uses a short time frame, division managers have an incentive to take actions that will lead to an
immediate increase in these measures, even if such actions may not be in the companys long-term
interest. On the other hand, many potentially positive actions may take longer than one year to
generate income at the targeted level. Many product life cycles start slow, even incurring losses in the
early stages, before generating profit. As a potential remedy, management can measure financial
performance using a longer time horizon, such as three to five years. Extending the time frame gives
segment managers the incentive to think long term rather than short term and make decisions that will
positively impact the company over the next several years.
4. Describe at least two specific actions that a company could take to improve its ROI.
The ROI formula can be expanded to sales margin multiplied by capital turnover. By improving either
of these ratios, the ROI will be improved. The sales margin can be improved by increasing the amount
of operating income earned on every dollar of revenue. This can be achieved by cutting costs.
Reducing or eliminating nonproductive assets can improve the capital turnover ratio. There are many
specifics actions that may be used to achieve these objectives; therefore, student answers will vary.
5. Define residual income. How is it calculated? Describe the major weakness of residual
income.
Residual income determines whether operations have created any excess income above and beyond
managements expectations. Residual income is calculated as: Operating Income Minimum
acceptable income, or Operating Income (Target rate of return x Total assets).
295
Chapter 10
6. Compare and contrast a master budget and a flexible budget.

A master budget is prepared before the beginning of the period. The master budget does not change
with the actual volume of production. A flexible budget can be prepared for a different volume that was
originally anticipated in the master budget.
7. Describe two ways managers can use flexible budgets.
Student answers will vary.
8. Define key performance indicator (KPI). What is the relationship between KPIs and a
companys objectives? Select a company of any size with which you are familiar. List at least
four examples of specific objectives that company might have and one potential KPI for each
of those specific objectives.
A key performance indicator (KPI) is a summary performance measure to assess how well a
company is achieving its goals. The KPI is a measurement used by managers to determine is the
company is achieving its objectives. Student answers for a specific company will vary.
296
(continued) A 10-60
9. List and describe the four perspectives found on a balanced scorecard. For each perspective,
list at least two examples of KPIs which might be used to measure performance on that
perspective.
The financial perspective helps managers answer the question, How do we look to shareholders?
Shareholders are primarily concerned with the companys profitability. Managers must continually
attempt to increase profits through: increasing revenue, controlling costs, or increasing productivity.
The customer perspective helps managers evaluate the question, How do customers see us?
Customer satisfaction is a top priority for long-term success. If customers arent happy, they wont
come back. Therefore, customer satisfaction is critical for the company to achieve its financial goals.
Customers are typically concerned with four product or service attributes: price, quality, sales service,
and delivery time. The internal business perspective helps managers address the question, At what
business processes must we excel to satisfy customer and financial objectives? In other words, a
company needs to tend to its internal operations if it is to please customers. And only by pleasing
customers will it achieve its financial goals. Answer to that question incorporates three factors:
innovation, operations, and post-sales support. The learning and growth perspective helps managers
assess the question, Can we continue to improve and create value? Much of a companys success
boils down to its people. A company cannot be successful in the other perspectives (financial,
customer, internal operations) if it does not have the right people in the right positions, a solid and
ethical leadership team, and the information systems that employees need. Therefore, the learning
and growth perspective lays the foundation needed for success in the other perspectives. The
learning and growth perspective focuses on three factors: employee capabilities, information system
capabilities, and the companys climate for action.
10. Contrast lag indicators with lead indicators. Provide an example of each type of indicator.
Lag indicators reveal the results of past decisions. Financial performance measures such as ROI or
RI, are lag indicators because they convey trends based on historical information. Lead indicators are
performance measures that predict future performance.
11. Some companies integrate sustainability measures into the traditional four perspectives in
their balanced scorecards. Other companies create a new perspective (or two) for
sustainability. Which method do you think would result in better supporting sustainability
efforts throughout the organization? Explain your viewpoint.
12. Find an annual report for a publicly held company (go to the companys website and look for
Investor Relations or a similar link.) How many sustainability initiatives can you find in the
annual report? What internal balanced scorecard measures do you think they might use to
measure progress on each sustainability initiative? (You will have to use your imagination,
since typically most balanced scorecard measures are not publicly disclosed.)
(30-45 min.) A 10-61
297
Chapter 10
Basic Discussion Questions

1. Locate the companys annual report as outlined previously. Find the companys segment
information; it should be in the Notes to Consolidated Financial Statements or other similarly
named section. Look for the word Segment in a headingthat is usually the section you need.
To create this SAMPLE set of solutions for this question, Starbucks Corporation was used.
Student answers will vary, depending upon the company chosen and the year used.
Starbucks Corporation has three reportable operating segments: United States, International, and Global
CPG (Consumer Products Group).
2. List the segments as reported in the annual report. Make a table listing each operating segment,
its revenues, income, and assets.
(in millions)
Segment
Revenues
Income
Assets
US
$7,882.0
$528.01
$2,362.9
International
2,103.4
110.0
1,272.7
Global CPG
392.6
205.3
116.0
3. Use the data you collected in Requirement 2 to calculate each segments sales margin. Interpret
your results.
Sales margin = Operating income/Sales
US: $528.01/$7,882.0 = 6.7%
International: $110.1/$2,103.4 = 5.2%
Global CPG: $205.3/$392.6 = 52.3%
The CPG segment has the highest sales margin of the three segments at 52.3%. For every dollar of
sales, the US segment earned $0.67 and the International segment earned $0.52.
4. Use the data you collected in Question 2 to calculate each segments capital turnover. Interpret
your results.
Capital turnover = Sales/Total assets
US: $7,882.0/$2,362.9 = 3.3
International: $2,103.4/$1,272.7 = 1.7
Global CPG: $392.6/$116.0 = 3.4
The capital turnover for the CPG and US segments are almost the same. The CPG segment generated
$3.40 of sales for every $1 of assets and the US generated $3.30. The International segment only
generated $1.70 of sales for every $1 of assets. The US and CPG segments use its assets more
efficiently than the International segment.
298

5. Use the data you collected in Requirement 2 to calculate each segments ROI. Interpret your
results.
ROI = Operating income/Total assets
US: $528.01/$2,362.9 = 22.3%
International: $110.0/$1,272.7 = 8.6%
CPG: $205.3/$116.0 = 177.0%
The CPG segment has a very high ROI in comparison to the other two segments. This is due to its
having the highest sales margin of the three segments.
299
Chapter 10
(continued) A 10-61
6. Can you calculate RI using the data presented? Why or why not?
RI cannot be calculated for Starbucks because the target rate of return and WACC is not known.
7. The rules for how segments should be presented in the annual report are governed by external
financial accounting rules. The information you gathered for the previous requirements would be
used by investors and other external stakeholders in their analysis of the company and its stock.
Internally, the company most likely has many segments. Based on what you know about the
company and its products or services, list at least five potential segments that the company might
use for internal reporting. Explain why this way of segmenting the company for internal reporting
could be useful to managers.
Five potential segments for internal reporting for Starbucks are:
1. Regional territories
2. Product lines
3. Brand lines
4. Customer base
5. Business function
(30-45 min.) A 10-62
Req. 1
The two product segments are: 1) Oral, Personal and Home Care, and 2) Pet Nutrition.
Oral, Personal and Home Care
Pet Nutrition
Operating Profit
$3,062.6
541.8
Net Sales
$13,182.4
2,147.5
Identifiable Assets
$8,870.5
1,025.1
Req. 2
ROI calculation:
Pet Nutrition
Operating Profit
$3,062.6
541.8
Identifiable Assets
$8,870.5
1,025.1
ROI
34.53%
52.85%
300

Req. 3
The Pet Nutrition Division has a much higher ROI than the Oral, Personal and Home Care Division. The
expanded ROI formula may offer some clues as to why this is the case. Sales margin and capital turnover
are calculated below:
301
Chapter 10
(continued) A 10-62
Sales Margin calculation:
Pet Nutrition
Operating Profit
$3,062.6
541.8
Net Sales
$13,182.4
2,147.5
Sales Margin
23.23%
25.23%
Capital Turnover calculation:
Pet Nutrition
Net Sales
$13,182.4
2,147.5
Identifiable
Assets
$8,870.5
1,025.1
Capital
Turnover
1.49
2.09
The primary reason Pet Nutrition has a higher ROI is that it has a much higher capital turnover. The Pet
Nutrition Division has been able to generate $2.09 of sales on each dollar of its assets, whereas the Oral,
Personal and Home Care Division has only been able to generate $1.49 of sales on each dollar of its assets.
Additionally, the Pet Nutrition Division is earning about two cents more of income on every dollar of sales
(25.23% vs. 23.23%). Both factors combined give the Pet Nutrition Division an extremely high ROI.
Req. 4
The management team would most likely choose to allocate additional funds to the Pet Nutrition Division.
The Pet Nutrition Division is earning about $0.53 on every dollar invested whereas the Oral, Personal and
Home Care division is only earning about $0.35 on every dollar invested. The Pet Nutrition Division is
yielding over 50% more return than the other division.
302
(30-45 min.) A 10-63

Req. 1
Roland Films, Inc.
Output units (DVD
Actual Results
Flexible
at Actual Prices
Budget for
82,000
Flexible
Actual Number
Budget
of Output
Variance
Units
-0-
82,000
Sales Volume
Static (Master)
Variance
Budget
16,000 U
98,000
movies)
Sales revenue
$1,640,000
$1,640,000
$320,000U
$1,960,000
Variable expenses:
Cost of goods
773,750
46,250F
820,000 c
160,000F
980,000
77,375
12,825F
90,200 c
17,600F
107,800
42,850
2,250F
45,100 c
8,800F
53,900
Salary expense
311,450
10,950U
300,500
300,500
Depreciation
208,750
5,250F
214,000
214,000
128,250
20,000U
108,250
108,250
81,100
12,600U
68,500
68,500
1,623,525
23,025F
1,646,550
16,475
$23,025F
sold
Sales
commissions
Shipping expense
Fixed expenses:
expense
Rent expense
Advertising
expense
Total expenses
Operating income
(6,550)
186,400F
1,832,950
$133,600U
$ 127,050
__________
a
Actual number of movies = $1,640,000 / $20 = 82,000
Static budget number of movies = $1,960,000 / $20 = 98,000
303
Chapter 10
c
Variable expenses
Static budget amounts

98,000 movies
82,000 actual movies
(continued) A 10-63
Req. 2
The large unfavorable sales volume variance certainly requires investigation. The roughly 16% (16,000/98,000 =
0.163) shortfall in sales volume led to a $133,600U sales volume variance for operating income. Thus, the primary
reason for the disappointing income is lower than expected sales volume, not rising costs.
Managers will also want to investigate all significant flexible budget variances. For example, a 5% variance
from standard investigation rule would suggest investigating the favorable sales commission variance and the
unfavorable advertising and rent expense variances. Considering the poor sales volume, both the sales
commission and advertising variances are of concern. Sales staff will not be very motivated if their
commissions are below budget. The large unfavorable flexible budget variance for advertising may reflect
higher advertising costs in an effort to stimulate sales but, if so, the ad campaign does not appear to have
been successful. Management may also want to investigate the favorable cost of goods sold variance. It is
just over 5% ($46,250 / $820,000 = 0.0564) and it is a relatively large dollar amount. Hopefully, Roland Films
did not try to save money by skimping on the quality of the DVDs and perhaps exacerbating the unfavorable
sales volume variance.
Req. 3
If the shortfall in sales volume is attributable to concerns about a new format for recordable DVD players,
Roland Films management has done a good job controlling costs in light of lower than expected sales.
Operating income would have been $23,025 less than it actually was if the company had not done such a
good job keeping operating expenses below flexible budget levels.
Perhaps management could have better anticipated customer demand falling, and taken steps to offset it,
such as reducing the selling price or further increasing advertising to stimulate demand. However, the
unfavorable advertising expense variance suggests that the sales shortfall may well have been beyond
Roland Films control. A concern now is whether Roland Films will have the right DVD movie product mix in
place to take advantage of the pent-up demand for DVD movies with any new DVD format.
Students responses to Reqs. 2 and 3 will probably be less detailed.
304

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Managerial Accounting 3e Solutions Manual

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

Managerial Accounting 3e Solutions Manual

Frees top managements (Grandma Jones) time

Problems achieving goal congruence

Grandma Jones could decentralize in a number of different ways, for example:

Manager of Holiday Inns central reservation office

Managers of various corporate-owned Holiday Inn locations

Manager of the Holiday Inn corporate division

Manager of the Housekeeping Department at the Holiday Inn

Manager of the Holiday Inn Express corporate division

Manager of the complimentary breakfast buffet at a Holiday Inn

(10 min.) S 10-5

Midwest Division - Sales Revenue for Shastas Restaurants

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

(10 min.) S 10-6

(10 min.) S 10-7

1. Enter the formula, then calculate each divisions ROI.

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

Managerial Accounting 3e Solutions Manual

Sales margin (from S 10-7)

Do your answers agree with the basic ROI? Yes

= $1,040,000 ($4,000,000 16%) = $400,000

= $1,680,000 ($6,000,000 16%) = $720,000

Lowest Variable cost of $13

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

Managerial Accounting 3e Solutions Manual

(10 - 15 min.) S 10-11

The actual results indicate that Sunshine sold 6 pools in April.

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

(10 -15 min.) S 10-12

Variable Operating Expenses:

Fixed Operating Expenses:

Total Operating Expenses

Internal business perspective

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

Managerial Accounting 3e Solutions Manual

Learning and growth perspective

(10 min.) S 10-15

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

Managerial Accounting 3e Solutions Manual

(10 - 15 min.) E 10-18A

(15 min.) E 10-19A

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

Managerial Accounting 3e Solutions Manual

(15 min.) E 10-20A

(10 - 15 min.) E 10-21A

Copyright 2013 Pearson Education, Inc. publishing as Prentice Hall

= $68,000 ($200,000 26%) = $17,550

Both divisions are exceeding managements expectations.

(10 - 15 min.) E 10-22A

Operating income (OI)

Total assets (TA)

Sales margin (SM)

Capital turnover (CT)

Return on investment (ROI)

Target rate of return