Responsibility Accounting and Transfer Pricing

(A. Decentralization and Performance Evaluation)

MODULE 7 D. review the outcomes of key decisions only

RESPONSIBILITY ACCOUNTING AND TRANSFER PRICING 7. Decentralization occurs when

A. the firm’s operations are located over a large geographic area to reduce risk
B. authority for important decisions is delegated to lower segments of the organization
A. DECENTRALIZATION AND PERFORMANCE EVALUATION C. important decisions are made at the upper levels and the lower levels of the organization
are responsible for implementing the decisions
D. none of the above
THEORIES:
Centralization vs. decentralization Goal congruence, Suboptimization & management by objectives
Centralization Goal congruence
3. In a company with a centralized approach to responsibility accounting, upper-level managers 8. Consistency between goals of the firm and the goals of its employees is:
typically A. goal optimization C. goal congruence
A. make key decisions only B. goal conformance D. goal compensation
B. implement key decisions only
C. both make and implement key decisions 16. Goal congruence is most likely to result when
D. review the outcomes of key decisions only A. reports to managers include all costs
B. managers’ behavior is affected by the criteria used to judge their performance
Decentralization C. performance evaluation criteria encourage behavior in the company’s best interests as well
1. Why would a company decentralize? as in the manager’s best interests
A. to train and motivate division managers D. a manager knows the criteria used to judge his or her performance
B. to focus top management’s attention to operating decisions
C. to allow division managers to concentrate on strategic planning 35. When a manager takes an action that benefits his or her responsibility center, but not the
D. all of the above company as a whole,
A. it is a non-controllable action
2. Advantages of decentralization include all of the following except B. there is a lack of goal congruence
A. divisional management is able to react to changing market conditions more rapidly than top C. the center must be an artificial profit center
management D. the manager should be fired
B. divisional management is a source of personnel for promotion to top management positions
C. decentralization can motivate divisional managers Suboptimization
D. decentralization permits divisional management to concentrate on company-wide problems 19. A management decision may be beneficial for a given profit center, but not for the entire
and long-range planning company. From the overall company viewpoint, this decision would lead to
A. goal congruence C. centralization
4. In a company with a decentralized approach to responsibility accounting, lower-level managers B. suboptimization D. maximization
typically
A. make key decisions only Management by objectives
B. implement key decisions only 17. An emphasis on obtaining goal congruence is consistent with a broad managerial approach
C. both make and implement key decisions called

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A. management by crisis B. flexible accounting. D. master budgeting.

B. management by objectives
C. management through goal congruence 36. Which of the following is critically important for a responsibility accounting system to be
D. just-in-time philosophy effective?
A. Each employee should receive a separate performance report.
38. In a responsibility accounting system, the process in which a supervisor and a subordinate jointly B. Service department costs should be allocated to the operating departments that use the
determine the subordinate’s goals and plans for achieving these goals is service.
A. Top-down budgeting C. Bottom-up budgeting C. Each manager should know the criteria used for evaluating his or her performance.
B. Imposed budgeting D. Management by objectives D. The details on the performance reports for individual managers should add up to the totals
on the report to their supervisor.
Responsibility Accounting
5. Responsibility accounting is a system whose attributes include Responsibility report
A. responsibility, liability, and culpability 13. The report to a territorial sales manager which shows the contribution to profit by each
B. liability, accountability, and performance evaluation salesperson in the territory is called
C. performance evaluation, accountability, and responsibility A. a profit reportA. C. an absorption profit report
D. culpability, liability, and accountability B. a responsibility report D. a distribution report

6. Some basic elements of responsibility accounting are Responsibility centers

A. chart of accounts classification C. control-based reports 15. A responsibility center
B. budgeting system D. all of the above A. is an organization unit where management control exists over incurring costs or generating
revenue
9. What term identifies an accounting system in which the operations of the business are broken B. is responsible for all other departments
down into reportable segments and the control functions of a foreperson, sales managers, or C. has a responsible manager in charge of it
supervisor is emphasized? D. all of the above
A. Responsibility accounting C. Operations-research accounting
B. Control accounting D. Budgetary accounting Activity center
32. A segment of an organization for which management wants to report the cost of the activities
10. The Atwood Company uses a performance reporting system that reflects the company’s performed separately is called a(n)
decentralization of decision making. The departmental performance report shows one line of A. cost center C. activity-based costing center
data for each subordinate who reports to the group vice-president. The data presented shows B. activity center D. batch activity center
the actual costs incurred during the period, the budgeted costs, and all variances from budget
for that subordinate’s department. The Atwood Company is using a type of system called Cost center
A. Flexible budgeting C. Responsibility accounting 20. The sequence that reflects increasing breadth of responsibility is
B. Contribution budgeting D. Cost-benefit accounting A. cost center, investment center, profit center
B. cost center, profit center, investment center
14. The accumulation of accounting data on the basis of the individual manager who has the C. profit center, cost center, investment center
authority to make day-to-day decisions about activities in an area is called D. investment center, cost center, profit center
A. static reporting. C. responsibility accounting.

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30. A cost center is used to A. Cost centers and Investment centers

A. show responsibility for scheduling materials, labor, and overhead B. Revenue centers and Profit centers
B. collect costs incurred performing a set of homogeneous activities C. Revenue centers and Investment centers
C. show authority for choosing product markets and sources of supply D. Cost centers and Profit centers
D. assign responsibility for setting the chart of accounts
Controllable & noncontrollable costs
31. Cost centers in a responsibility accounting system 27. In responsibility accounting the most relevant classification of costs is
A. will organize the company into the smallest units of activity – the individual worker A. fixed and variable C. discretionary and committed
B. will have a specific manager in charge of every cost center B. incremental and nonincremental D. controllable and noncontrollable
C. should have the same code number for similar units wherever they appear in an
organization Controllable costs
D. should show the contribution margin in its control report 29. Controllable costs are costs that
A. fluctuate in total in response to small changes in the rate of capacity utilization.
Profit center B. will be unaffected by current managerial decisions.
21. A profit center is C. management decides to incur in the current period to enable the company to achieve
A. a responsibility center that always reports a profit. objectives other than filling customers’ orders.
B. a responsibility center that incurs costs and generates revenues. D. are likely to respond to the amount of attention devoted to them by a specified manager.
C. evaluated by the rate of return earned on the investment allocated to the center.
D. referred to as a loss center when operations do not meet the company's objectives. 23. Overtime conditions and pay were recently set by the personnel department. The production
department has just received a request for a rush order from the sales department. The
22. A responsibility center having control over generating revenue is production department protests that additional overtime costs would be incurred as a result of
A. a cost center C. a profit center the order. The sales department argues the order is from an important customer. The
B. an investment center D. an operation center production department processes the order. In order to control costs, which department should
be charged with the overtime costs generated as a result of the rush order?
Investment center A. Personnel department
24. A distinguishing characteristic of an investment center is that B. Production department
A. revenues are generated by selling and buying stocks and bonds. C. Sales department
B. interest revenue is the major source of revenues. D. Shared by production department and sales department
C. the profitability of the center is related to the funds invested in the center.
D. it is a responsibility center which only generates revenues. 34. Which one of the following would NOT usually be considered a controllable cost for the product
or division manager?
Comprehensive A. factory wages C. maintenance
25. In which type of responsibility center is the manager held accountable for its profits? B. plant salaries D. plant rent expense
A. Cost center C. Investment center
B. Profit center D. Profit centers or Investment centers Profitability accounting
28. Micro Manufacturing uses an accounting system that charges costs to the manager who has
26. Which of the following responsibility centers have managers who are held accountable for been delegated the authority to make the decisions incurring the costs. For example, if the sales
costs? manager accepts a rush order that requires the incurrence of additional manufacturing costs,

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these additional costs are charged to the sales manager because the authority to accept or B. success in meeting budgeted goals for controllable costs.
decline the rush order was given to the sales manager. This type of accounting system is known C. amount of controllable margin generated by the profit center.
as D. amount of contribution margin generated by the profit center.
A. Functional accounting C. Contribution accounting
B. Reciprocal allocation D. Profitability accounting 12. When used for performance evaluation, periodic internal reports based on a responsibility
accounting system should not
Budgeting system A. be related to the organization chart
33. A basic budgeting system includes B. include allocated fixed overhead
A. a planning schedule C. involvement of all managers C. include variances between actual and budgeted controllable costs
B. follow-up plan steps D. all of these D. distinguish between controllable and noncontrollable costs

Segmented income statements 39. the most desirable measure of departmental performance for evaluating the departmental
11. Segmented income statements are most meaningful to managers when they are prepared manager is departmental
A. on an absorption cost basis C. on a cost behavior basis A. Revenue less controllable departmental expenses
B. on a cash basis D. in a multi-step format B. Net income
C. Contribution to indirect expenses
Performance evaluation D. Revenue less departmental variable expenses
37. The criteria used for evaluating performance
A. should be designed to help achieve goal congruence 40. Of little or no relevance in evaluating the performance of an activity would be
B. can be used only with profit centers and investment centers A. Flexible budgets for mixed costs
C. should be used to compare past performance with current performance B. Fixed budgets for mixed costs
D. motivate people to work in the company’s best interest C. The difference between planned and actual results
D. The planning and control of future activities
42. Of most relevance in deciding how or which costs should be assigned to a responsibility center
is the degree of Performance measures
A. Avoidability C. Causality Return on Investment
B. Controllability D. Variability 48. Return on investment (ROI) is calculated as
A. divisional operating income/divisional investment
41. Internal reports prepared under the responsibility accounting approach should be limited to B. divisional investment – divisional income
which of the following costs? C. divisional investment/divisional operating income
A. Only variable costs of production D. divisional income – (divisional investment x required rate of return)
B. Only conversion costs
C. Only controllable costs 43. The return on investment calculation only considers the following components:
D. Only costs properly allocable to the cost center under generally accepted accounting S = Sales
principles I = Investment
NI = Net Income
49. The best measure of the performance of the manager of a profit center is the Which of the following formulas best describes the return on investment calculation?
A. rate of return on investment. A. (I/S) x (S/NI) = I/NI C. (S/I) x (NI/S) = NI/I

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B. (I/S) x (NI/S) = (Ix NI) x (S x S) D. (S/I) x (S/NI) = (S x S)/(I x NI)

Residual Income
46. To properly motivate divisional management, the divisional ROIs should be 50. Using residual income for evaluating performance
A. Equal A. penalizes managers whose segments have low ROIs
B. Greater in the less profitable divisions to motivate those divisions to achieve higher ROIs B. penalizes managers of relatively large segment
C. Lower in more profitable divisions in which motivation is necessary C. encourages managers to maximize pesos of profit after a required ROI has been achieved
D. Different based upon strategic goals of the firm D. encourage managers to maximize ROI for the company

51. Evaluating performance using ROI encourages managers to focus on 53. Residual income
A. income and investment A. is always the best measure of divisional performance
B. cost efficiency and operating asset efficiency B. is not as good a measure of performance as ROI
C. both a and b C. overcomes some of the problems associated with ROI
D. neither a nor b D. cannot be used by divisions that deal with others in the same company

58. A measure frequently used to evaluate the performance of the manager of an investment center 59. When a firm uses residual income to make decisions, the firm should favor those projects whose
is residual income
A. the amount of profit generated. A. is closest to the firm’s minimum capital rate
B. the rate of return on funds invested in the center. B. is lowest
C. the percentage increase in profit over the previous year. C. is highest
D. departmental gross profit. D. exceeds a specific target amount

61. In the formula for ROI, idle plant assets are 62. A division's investment in conjunction with the residual income may be
A. included in the calculation of controllable margin. A. operating assets
B. included in the calculation of operating assets. B. operating and non-operating assets
C. excluded in the calculation of operating assets. C. assets minus current liabilities
D. excluded from total assets. D. any of the above

DuPont Model 65. In order to promote goal congruence a manager of an investment center is best evaluated using
44. C company’s return on investment is affected by a change in A. standard variable costing income statements
A. B. C. D. B. return on investment
Capital turnover Yes Yes No No C. budgets and standard costs
Profit margin on sales Yes No No Yes D. residual income

55. Return on investment for divisions and other company segments is a function of 64. An advantage of residual income is that it encourages managers to
A. assets employed and expected future cash flows. A. accept projects which provide returns in excess of the company's required rate of return
B. contribution margin and invested capital. B. to increase asset turnover
C. investment turnover and profit margin on sales. C. attempt to increase the margin
D. physical sales volume, prices, variable costs, and fixed costs. D. all of the above

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A. increase if the invested capital-employed turnover rate decreases.

Economic value added B. Increase if the invested capital-employed turnover rate increases.
60. In contrast to residual income (RI), economic value added (EVA) uses: C. Increase if invested capital increases.
A. the firm's minimum rate of return instead of its cost of capital. D. Decrease if invested capital decreases.
B. the firm's cost of capital instead of its minimum rate of return
C. a required rate of return. 63. To improve asset turnover in conjunction with ROI computations,
D. values determined by using conventional accounting policies A. sales may be increased C. assets may be decreased
B. assets may be increased D. a and c
68. Which of the following would promote goal congruence?
A. return on investment C. single measures of performance 66. How can an investment center improve its return on investment (ROI)?
B. income based compensation D. economic value added A. increase margin, increase investments
B. decrease margin, decrease turnover
Sensitivity Analysis C. increase margin, increase turnover
Return on investment D. decrease margin, increase investments
45. Assuming that sales and net income remain the same, a company’s return on investment will
A, Increase if invested capital increases Economic value added
B. Decrease if invested capital decreases 67. Economic value added would decrease if:
C. Decrease if the invested capital-employed turnover rate decreases A. operating income increases
D. Decrease if the invested capital-employed turnover rate increases B. the division invests in a project wherein the after-tax operating income is more than the cost
of capital
52. The other things remaining constant, if a division doubles its investment turnover, its ROI will C. operating expenses increase
A. decrease C. remain constant D. cost of capital decreases
B. increase D. double
Estimating Current Market Value of Assets
54. Other factors remaining unchanged, the rate of return on investment may be improved by 47. Which of the following is NOT a method for developing or estimating the current market value
A. increasing investment in assets. of assets?
B. increasing expenses. A. Gross Book Value. C. Liquidation Value.
C. reducing sales B. Replacement Cost. D. Economic Value Added.
D. decreasing investment in assets.
Comprehensive
56. Which of the following will not improve return on investment if other factors remain constant? 18. Which of the following is not a true statement?
A. Increasing sales volume while holding fixed expenses constant. A. Many costs are controllable at some level with a company.
B. Decreasing assets. B. Responsibility accounting applies to both profit and not-for-profit entities.
C. Increasing selling prices. C. Fewer costs are controllable as one moves up to each higher level of managerial
D. None of the above. responsibility.
D. The term segment is sometimes used to identify areas of responsibility in decentralized
57. Assuming that sales and net income remain the same, a company’s return on investment (ROI) operations.
would

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PROBLEMS: A. 15 percent C. 13 percent

DuPont Model B. 25 percent D. 20 percent
Return on sales
i. The Dela Merced Company’s Household Products Division reported in 2007 sales of Required sales
P15,000,000, an asset turnover ratio of 3.0, and a rate of return on average assets of 18 percent. v. The manager of the Mac Division of Power Company expects the following results in 2006
The percentage of net income to sales is (pesos in millions):
A. 6 percent. C. 3 percent Sales P49.60
B. 12 percent. D. 5 percent. Variable costs (60%) 29.76
Contribution margin P19.84
Return on assets Fixed costs 12.00
Required unit sales Profit P 7.84
ii. The Valve Division of Industrial Company produces a small valve that is used by various Investment:
companies as a component part in their products. Industrial Company operates its divisions Plant equipment P19.51
as autonomous units, giving its divisional manager great discretion in pricing and other Working capital 14.88 P34.39
decisions. Each division is expected to generate a rate of return of at least 14 percent on its ROI P7.84/P34.39 22.80%
operating assets. The Valve Division has average operating assets of P700,000. The valves The division has a target ROI of 30 percent, and the manager has asked you to determine
are sold for P5 each. Variable costs are P3 per valve, and fixed costs total P462,000 per how much sales volume the division would need to reach that. He states that the sales mix is
year. The Division has a capacity of 300,000 units. relatively constant so variable costs and equipment should be close to 60 percent of sales,
How many valves must the Valve Division sell each year to generate the desired rate of return fixed cost and plant and equipment should remain constant, and working capital (cash,
on its assets? receivables, and inventories) should vary closely with sales in the percentage reflected above.
A. 280,000 C. 355,385 The peso sales that the division needs in order to reach the 30 percent ROI target is
B. 350,000 D. 265,000 A. P19,829,032 C. P57,590,322
B. P44,373,871 D. P59,510,000
Divisional ROI
iii. Marsh Company that had current operating assets of one million and net income of P200,000 Residual income
had an opportunity to invest in a project that requires an additional investment of P250,000 and vi. The current income for a subunit is P36,000. Its current invested capital is P200,000. The
increased net income by P40,000. After the investment, the company's ROI will be subunit is considering purchasing for P20,000 equipment that will increase annual income by
A. 16.0% C. 19.2% an estimated P2,800. The firm's cost of capital is 12%. If the equipment is purchased, the
B. 18.0% D. 20.2% residual income of the subunit will
A. increase by P2,800 C. increase by P400
iv. The following data relate to the Motor Division of Eurosun Company: B. increase by P16,000 D. increase by 4%
Sales P10,000,000
Variable costs 3,000,000 Minimum selling price
Direct fixed costs 5,000,000 vii. Matipid Division of Expenditures Company expects the following results for 2007:
Invested capital 8,000,000 Unit sales 70,000
Allocated actual interest costs 800,000 Unit selling price P 10
Capital charge 12% Unit variable cost P 4
The divisional return on investment is: Total fixed costs P300,000

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Total investment P500,000 Segmented Income Statement

The minimum required ROI is 15 percent, and divisions are evaluated on residual income. A Controllable segment profit margin
foreign customer has approached Matipid’s manager with an offer to buy 10,000 units at P7 x. Segment A generated sales revenues of P400,000 and variable operating expenses of
each. If Matipid accepts the order, it would not lose any of the 70,000 units at the regular P180,000. Its controllable fixed expenses were P40,000. It was assigned 20% of P200,000 of
price. Accepting the order would increase fixed costs by P10,000 and investment by P40,000. fixed costs controlled by others. The common fixed costs were P25,000. What was Segment
What is the minimum price that Matipid could accept for the order and still maintain its A's controllable segment profit margin?
expected residual income? A. P220,000 C. P140,000
A. P5.00 C. P5.60 B. P180,000 D. P160,000
B. P4.75 D. P9.00
Sensitivity Analysis
Maximum lost unit sales xi. If the investment turnover increased by 30% and ROS decreased by 20%, the ROI would
viii. Magastos Division of Expenditures Company expects the following results for 2006: A. increase by 30% C. increase by 6%
Unit sales 70,000 B. increase by 4% D. none of these
Unit selling price P 10
Unit variable cost P 4 xii. If the investment turnover decreased by 10% and ROS decreased by 30%, the ROI would
Total fixed cost A. increase by 30% C. decrease by 10%
Total fixed costs P 300,000 B. decrease by 37% D. none of the above
Total investment P 500,000
The minimum required ROI is 15 percent, and divisions are evaluated on residual income. A Comprehensive
foreign customer has approached Magastos’ manager with an offer to buy 10,000 units at P7 Use the following information to answer questions 2 thru 6:
each. Magastos Division has capacity of 75,000 units and the foreign customer will not accept Carlyle Company had the following information pertaining to 2005:
fewer than 10,000 units. Accepting the order would increase fixed costs by P10,000 and Profit P100,000
investment by P40,000. Sales P1,000,000
At the price of P7 offered by foreign customer, what is the maximum number of units in regular Asset Turnover ratio 2 times
sales that Magastos Division could sacrifice and still maintain its expected residual income? The desired minimum rate of return is 15 percent.
A. 2,333 C. 3,333
B. 2,667 D. 3,667 xiii. What is the ROI?
A. 10 percent C. 20 percent
Economic Value Added B. 5 percent D. 15 percent
ix. Consider the following:
Investment center’s after-tax operating profit P 50,000 xiv. What is the return on sales?
Investment center’s total assets 800,000 A. 10 percent C. 20 percent
Investment center’s current liabilities 80,000 B. 5 percent D. 15 percent
Weighted-average cost of capital 6.5%
What is the economic value added (EVA)? xv. What is the amount of assets?
A. P60,000 C. P 6,000 A. P250,000 C. P1,000,000
B. P 3,200 D. P50,000 B. P500,000 D. P2,000,000

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

i. Answer: A Contribution provided by 10,000 units

Return on Sales: 18% ÷ 3 = 6% 10,000 x (7.00 – 5.60) 14,000
Divided by regular contribution margin per unit ÷ 6
ii. Answer: A Maximum decrease in regular sales 2,333
Operating profit: (0.14 x P700,000) P98,000
Units sold = (Fixed costs + Profit) ÷ UCM (P462,000 + P98,000) ÷ P2 280,000 ix. Answer: B
EVA = Investment center's after-tax operating income - (Investment center's total assets -
iii. Answer: C Investment center's current liabilities) x Weighted-average cost of capital].
New ROI: (200,000 + 40,000) ÷ (1M + 0.25M) 19.2% Net operating profit P50,000
Cost of investment (P800,000 – P80,000) x 0.075 46,800
iv. Answer: B Economic Value Added P 3,200
Operating income: 10M – 3M – 5M = P2 Million
ROI = P2M ÷ P8M = 25% x. Answer: B
Controllable segment profit margin = Revenue - (Segment's variable operating costs +
v. Answer: C Controllable fixed costs).
Let S = Sales (P400,000 – P180,000 – P40,000) P180,000
0.3(19,510,000 + 0.3S) = (.4S – 12,000,000)
S = 57,590,322.58 xi. Answer: B
(1.3 x 0.8) – 100% = 4.0%
vi. Answer: C
Increase in annual income P2,800 xii. Answer: B
Additional required returns (P20,000 x 0.12) 2,400 Decrease in ROI: (0.90 x 0.70) – 1.00 = 37.0%
Increase in residual value P 400
xiii. Answer: C
vii. Answer: C ROI = Operating Profit ÷ Average investment
Unit variable cost P4.00 Average Operating assets: (P1,000,000 ÷ 2) = P500,000
Incremental unit fixed cost (P10,000/10) 1.00 ROI: (P100,000 ÷ P500,000) = 20%
Minimum return per P1 of additional asset requirement 40,000 x 0.15 /10,000 0.60
Minimum selling price P5.60 xiv. Answer: A
Return on sales = Profit ÷ Net sales
viii. Answer: A P100,000 ÷ P1,000,000 = 10%
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xvii. Answer: A
xv. Answer: B Operating profit P100,000
Total assets = Sales ÷ Asset turnover Less Required return on average assets: (P500,000 x 15%) 75,000
P1,000,000 ÷ 2 = P500,000 Residual income P 25,000

xvi. Answer: D
No, because the manager's bonus would go down because the company's ROI is 20 percent
only.

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