Multiple Choice Questions
1. The biggest challenge in making a
decentralized organization function effectively is:
A. earning maximum profits through fair
practices.
B. minimizing losses.
C. taking advantage of the specialized knowledge
and skills of highly talented managers.
D. obtaining goal congruence among division
managers.
E. developing an adequate budgetary control
system.
Answer:
D LO: 1 Type: RC
2. What practice is present when divisional
managers throughout an organization work together in an effort to achieve the
organization's goals?
A. Participatory management.
B. Goal attainment.
C. Goal congruence.
D. Centralization of objectives.
E. Negotiation by subordinates.
Answer:
C LO: 1 Type: RC
3. Consider the following statements about goal
congruence:
I.
Goal
congruence is obtained when managers of subunits throughout an organization
strive to achieve the goals set by top management.
II.
Managers
are often more concerned about the performance of their own subunits rather
than the performance of the entire organization.
III.
Achieving
goal congruence in most organizations is relatively straightforward and easy to
accomplish.
Which
of the above statements is (are) true?
A. I only.
B. II only.
C. I and II.
D. II and III.
E. I, II, and III.
Answer:
C LO: 1 Type: RC
4. Which of the following performance measures
is (are) used to evaluate the financial success or failure of investment
centers?
A. Residual income.
B. Return on investment.
C. Number of suppliers.
D. Economic value added.
E. All of the above measures are used except
"C."
Answer:
E LO: 1 Type: RC
5. ROI is most appropriately used to evaluate
the performance of:
A. cost center managers.
B. revenue center managers.
C. profit center managers.
D. investment center managers.
E. both profit center managers and investment
center managers.
Answer:
D LO: 2 Type: RC
6. Which of the following is not
considered in the calculation of divisional ROI?
A. Divisional income.
B. Earnings velocity.
C. Capital turnover.
D. Sales margin.
E. Sales revenue.
Answer:
B LO: 2 Type: RC
7. Which of the following is the correct
mathematical expression for return on investment?
A. Sales margin ÷ capital turnover.
B. Sales margin + capital turnover.
C. Sales margin - capital turnover.
D. Sales margin x capital turnover.
E. Capital turnover ÷ sales margin.
Answer:
D LO: 2 Type: RC
8. The ROI calculation will indicate:
A. the percentage of each sales dollar that is
invested in assets.
B. the sales dollars generated from each dollar
of income.
C. how effectively a company used its invested
capital.
D. the invested capital generated from each
dollar of income.
E. the overall quality of a company's earnings.
Answer:
C LO: 2 Type: RC
9. A company's sales margin:
A. must, by definition, be greater than the
firm's net sales.
B. has basically the same meaning as the term
"contribution margin."
C. is computed by dividing sales revenue into
income.
D. is computed by dividing income into sales
revenue.
E. shows the sales dollars generated from each
dollar of income.
Answer:
C LO: 2 Type: RC
10. Which of the following is the correct
mathematical expression to derive a company's capital turnover?
A. Sales revenue ÷ invested capital.
B. Contribution margin ÷ invested capital.
C. Income ÷ invested capital.
D. Invested capital ÷ sales revenue
E. Invested capital ÷ income
Answer:
A LO: 2 Type: RC
11. Capital turnover shows:
A. the amount of income generated by each dollar
of capital investment.
B. the number of sales dollars generated by each
dollar of capital investment.
C. the amount of contribution margin generated
by each dollar of capital investment.
D. the amount of capital investment generated by
each sales dollar.
E. the amount of capital investment generated by
each dollar of income.
Answer:
B LO: 2 Type: RC
12. Webster Company had sales revenue and
operating expenses of $5,000,000 and $4,200,000, respectively, for the year
just ended. If invested capital amounted
to $6,000,000, the firm's ROI was:
A. 13.33%.
B. 83.33%.
C. 120.00%.
D. 750.00%.
E. some other figure.
Answer:
A LO: 2 Type: A
13. Zang Enterprises had a sales margin of 7%,
sales of $5,000,000, and invested capital of $4,000,000. The company's ROI was:
A. 5.60%.
B. 8.75%.
C. 11.43%.
D. 17.86%.
E. some other figure.
Answer: B LO: 2
Type: A
14. Mission, Inc., reported a return on
investment of 12%, a capital turnover of 5, and income of $180,000. On the basis of this information, the
company's invested capital was:
A. $300,000.
B. $900,000.
C. $1,500,000.
D. $7,500,000.
E. some other amount.
Answer:
C LO: 2 Type: A
15. The information that follows relates to Katz
Corporation:
Sales
margin: 7.5%
Capital
turnover: 2
Invested
capital: $20,000,000
On
the basis of this information, the company's sales revenue is:
A. $1,500,000.
B. $3,000,000.
C. $10,000,000.
D. $40,000,000.
E. some other amount.
Answer:
D LO: 2 Type: A
16. A division's return on investment may be
improved by increasing:
A. cost of goods sold and expenses.
B. sales margin and cost of capital.
C. sales revenue and cost of capital.
D. capital turnover or sales margin.
E. capital turnover or cost of capital.
Answer:
D LO: 3 Type: RC
17. All of the following actions will increase
ROI except:
A. an increase in sales revenues.
B. a decrease in operating expenses.
C. a decrease in a company's invested capital.
D. a decrease in the number of units sold.
E. an improvement in manufacturing efficiency.
Answer:
D LO: 3 Type: N
18. Which of the following is used in the
calculation of both return on investment and residual income?
A. Total stockholders' equity.
B. Retained earnings.
C. Invested capital.
D. Total liabilities.
E. The cost of capital.
Answer:
C LO: 2 Type: RC
19. Consider the following statements about
residual income:
I.
Residual
income incorporates a firm's cost of acquiring investment capital.
II.
Residual
income is a percentage measure, not a dollar measure.
III.
If
used correctly, residual income may result in division managers making
decisions that are in their own best interest and not in the best
interest of the entire firm.
Which
of the above statements is (are) true?
A. I only.
B. II only.
C. I and II.
D. II and III.
E. I and III.
Answer:
A LO: 2, 4 Type: RC
20. The basic idea behind residual income is to
have a division maximize its:
A. earnings per share.
B. income in excess of a corporate imputed
interest charge.
C. cost of capital.
D. cash flows.
E. invested capital.
Answer:
B LO: 2, 4 Type: N
21. Sunrise Corporation has a return on
investment of 15%. A Sunrise division,
which currently has a 13% ROI and $750,000 of residual income, is contemplating
a massive new investment that will (1) reduce divisional ROI and (2) produce
$120,000 of residual income. If Sunrise
strives for goal congruence, the investment:
A. should not be acquired because it reduces
divisional ROI.
B. should not be acquired because it produces
$120,000 of residual income.
C. should not be acquired because the division's
ROI is less than the corporate ROI before the investment is considered.
D. should be acquired because it produces
$120,000 of residual income for the division.
E. should be acquired because after the
acquisition, the division's ROI and residual income are both positive numbers.
Answer:
D LO: 4 Type: N
22. The Fitzhugh Division of General Enterprises
has a negative residual income of $540,000.
Fitzhugh's management is contemplating an investment opportunity that
will reduce this negative amount to $400,000. The investment:
A. should be pursued because it is attractive
from both the divisional and corporate perspectives.
B. should be pursued because it is attractive
from the divisional perspective although not from the corporate perspective.
C. should be pursued because it is attractive
from the corporate perspective although not from the divisional perspective.
D. should not be pursued because it is
unattractive from both the divisional and corporate perspectives.
E. should not be pursued because it is
unattractive from the divisional perspective although it is attractive from the
corporate perspective.
Answer:
A LO: 4 Type: N
23.
The Magellan
Division of Global Corporation, which has income of $250,000 and an asset
investment of $1,562,500, is studying an investment opportunity that will cost
$450,000 and yield a profit of $67,500.
Assuming that Global uses an imputed interest charge of 14%, would the
investment be attractive to:
1—Divisional management if ROI is used to evaluate
divisional performance?
2—Divisional management if residual income (RI) is
used to evaluate divisional performance?
3—The management of Global Corporation?
|
|
Attractive to
Magellan: ROI
|
Attractive to Magellan: RI
|
Attractive to Global
|
||||||
|
A.
|
|
Yes
|
|
Yes
|
|
Yes
|
|||
|
B.
|
|
Yes
|
|
No
|
|
No
|
|||
|
C.
|
|
Yes
|
|
No
|
|
Yes
|
|||
|
D.
|
|
No
|
|
Yes
|
|
Yes
|
|||
|
E.
|
|
No
|
|
Yes
|
|
No
|
|||
Answer: D LO:
4 Type: A, N
24. The Georgia Division of Carter Companies
currently reports a profit of $3.4 million. Divisional invested capital totals
$12.5 million; the imputed interest rate is 14%. On the basis of this information, Georgia's
residual income is:
A. $476,000.
B. $1,274,000.
C. $1,650,000.
D. $1,750,000.
E. some other amount.
Answer:
C LO: 2 Type: A
25. The following information relates to the Mountain
Division of Adler Enterprises:
Income
for the period just ended: $1,500,000
Invested
capital: $12,000,000
If
the firm has an imputed interest rate of 11%, Mountain's residual income would
be:
A. $165,000.
B. $180,000.
C. $187,500.
D. some other dollar amount.
E. a percentage greater than 11%.
Answer:
B LO: 2 Type: A
26. Extron Division reported a residual income of
$200,000 for the year just ended. The
division had $8,000,000 of invested capital and $1,000,000 of income. On the basis of this information, the imputed
interest rate was:
A. 2.5%.
B. 10.0%.
C. 12.5%.
D. 20.0%.
E. some other figure.
Answer:
B LO: 2 Type: A
27. Barber Corporation uses an imputed interest
rate of 13% in the calculation of residual income. Division X, which is part of Barber, had
invested capital of $1,200,000 and an ROI of 16%. On the basis of this information, X's
residual income was:
A. $24,960.
B. $36,000.
C. $156,000.
D. $192,000.
E. some other amount.
Answer:
B LO: 2 Type: A, N
Use the
following to answer questions 28-31:
The following
information pertains to Bingo Concrete:
|
Sales revenue
|
$1,500,000
|
|
Gross margin
|
600,000
|
|
Income
|
90,000
|
|
Invested
capital
|
450,000
|
The company's
imputed interest rate is 8%.
28. The capital turnover is:
A. 3.33.
B. 5.00.
C. 16.67.
D. 20.00.
E. 30.00.
Answer:
A LO: 2 Type: A
29. The sales margin is:
A. 6%.
B. 15%.
C. 20%.
D. 30%.
E. 40%.
Answer:
A LO: 2 Type: A
30. The ROI is:
A. 6%.
B. 15%.
C. 20%.
D. 30%.
E. 40%.
Answer:
C LO: 2 Type: A
31. The residual income is:
A. $30,000.
B. $36,000.
C. $42,000.
D. $54,000.
E. $82,800.
Answer:
D LO: 2 Type: A
32. For the period just ended, United
Corporation's Delta Division reported profit of $31.9 million and invested
capital of $220 million. Assuming an
imputed interest rate of 12%, which of the following choices correctly denotes
Delta's return on investment (ROI) and residual income?
|
|
Return on
Investment
|
|
Residual
Income
|
|
|
A.
|
12.0%
|
|
$(5.5) million
|
|
|
B.
|
12.0%
|
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$5.5 million
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C.
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14.5%
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$(5.5) million
|
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D.
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14.5%
|
|
$5.5 million
|
|
|
E.
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14.5%
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$26.4 million
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|
Answer: D LO: 2
Type: A
33. For the period just ended, Price
Corporation's Ohio Division reported profit of $49 million and invested capital
of $350 million. Assuming an imputed
interest rate of 16%, which of the following choices correctly denotes Ohio's
return on investment (ROI) and residual income?
|
|
Return
on
Investment
|
|
Residual
Income
|
|
|
A.
|
14%
|
|
$7 million
|
|
|
B.
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14%
|
|
$(7) million
|
|
|
C.
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16%
|
|
$7 million
|
|
|
D.
|
$7 million
|
|
14%
|
|
|
E.
|
None of the above choices
shows both the correct ROI and residual income.
|
|||
Answer:
B LO: 2 Type: A
34. Which of the following elements is not
used when calculating the weighted-average cost of capital?
A. Before-tax cost of debt capital.
B. After-tax cost of debt capital.
C. Cost of equity capital.
D. Market value of debt capital.
E. Market value of equity capital.
Answer:
A LO: 2 Type: RC
35. The following information relates to the
Atlantic Division of Ocean Enterprises:
Interest
rate on debt capital: 8%
Cost
of equity capital: 12%
Market
value of debt capital: $50 million
Market
value of equity capital: $80 million
Income
tax rate: 30%
On
the basis of this information, Atlantic's weighted-average cost of capital is:
A. 7.3%.
B. 8.3%.
C. 9.5%.
D. 10.8%.
E. some other figure.
Answer:
C LO: 2 Type: A
36.
The market value
of Glendale’s debt and equity capital totals $180 million, 80% of which is
equity related. An analysis conducted by
the company’s finance department revealed a 7% after-tax cost of debt capital
and a 10% cost of equity capital. On the
basis of this information, Glendale’s weighted-average cost of capital:
A.
is 7.6%.
B.
is 8.5%.
C.
is 9.4%.
D.
cannot be
determined based on the data presented because the cost of debt capital must be
stated on a before-tax basis.
E.
cannot be
determined based on the data presented because the cost of equity capital must
be stated on an after-tax basis.
Answer:
C LO: 2 Type: A, N
37. Which of the following measures of
performance is, in part, based on the weighted-average cost of capital?
A. Return on investment.
B. Capital turnover.
C. Book value.
D. Economic value added (EVA).
E. Gross margin.
Answer:
D LO: 2 Type: RC
38. Which of the following elements is not
used in the calculation of economic value added for an investment center?
A. An investment center's after-tax operating
income.
B. An investment center's total assets.
C. An investment center's return on investment.
D. An investment center's current liabilities.
E. A company's weighted-average cost of capital.
Answer:
C LO: 2 Type: RC
39. Carolina Corporation has an after-tax
operating income of $3,200,000 and a 9% weighted-average cost of capital. Assets total $7,000,000 and current
liabilities total $1,800,000. On the
basis of this information, Carolina's economic value added is:
A. $2,408,000.
B. $2,732,000.
C. $3,668,000.
D. $3,992,000.
E. some other amount.
Answer: B LO: 2
Type: A
40. The following information relates to Houston,
Inc.:
|
Total assets
|
$9,000,000
|
|
After-tax operating income
|
1,500,000
|
|
Current liabilities
|
800,000
|
If the company has a 10% weighted-average
cost of capital, its economic value added would be:
A. $(200,000).
B. $530,000.
C. $680,000.
D. $970,000.
E. some other amount.
Answer:
C LO: 2 Type: A
41. Given that ROI measures performance over a period
of time, invested capital would most appropriately be figured by using:
A. beginning-of-year assets.
B. average assets.
C. end-of-year assets.
D. total assets.
E. only current assets.
Answer:
B LO: 5 Type: RC
42. When an organization allows divisional
managers to be responsible for short-term loans and credit, the division's
invested capital should be measured by
A. total assets minus total liabilities.
B. average total assets minus average current
liabilities.
C. average total assets minus average total
liabilities.
D. average total liabilities minus average
current assets.
E. average total liabilities minus total assets.
Answer:
B LO: 5 Type: RC
43. Hayes Division has been stagnant over the
past five years, neither growing nor contracting in size and profitability. Investments in new property, plant, and
equipment have been minimal. Would the
division's use of total assets (valued at net book value) when measuring ROI
result in (1) using numbers that are consistent with those on the balance sheet
and (2) a rising ROI over time?
|
|
Consistent
with Numbers
on the Balance Sheet?
|
Produce a Rising Return on
Investment Over Time?
|
||
|
A.
|
Yes
|
Yes
|
||
|
B.
|
Yes
|
No
|
||
|
C.
|
No
|
Yes
|
||
|
D.
|
No
|
No
|
||
|
E.
|
Yes
|
Need more information to judge
|
||
Answer:
A LO: 5 Type: RC
44. The income calculation for a division
manager's ROI should be based on:
A. divisional contribution margin.
B. profit margin controllable by the division
manager.
C. profit margin traceable to the division.
D. divisional income before interest and taxes.
E. divisional net income.
Answer:
B LO: 5 Type: RC
45. To partially eliminate the problems that are
associated with the short-term focus of return on investment, residual income,
and EVA, the performance of a division's major investments is commonly
evaluated through:
A. postaudits.
B. sensitivity analysis.
C. performance operating plans.
D. horizontal analysis.
E. segmented reporting.
Answer:
A LO: 5 Type: RC
46. The amounts charged for goods and services
exchanged between two divisions are known as:
A. opportunity costs.
B. transfer prices.
C. standard variable costs.
D. residual prices.
E. target prices.
Answer:
B LO: 6 Type: RC
47. Nevada, Inc., has two divisions, one located
in Las Vegas and the other located in Reno.
Las Vegas sells selected goods to Reno for use in various
end-products. Assuming that the transfer
prices set by Las Vegas do not influence the decisions made by the two
divisions, which of the following correctly describes the impact of the
transfer prices on divisional profits and overall company profit?
|
|
Las Vegas Profit
|
|
Reno Profit
|
|
Nevada Profit
|
|
|
A.
|
Affected
|
|
Affected
|
|
Affected
|
|
|
B.
|
Affected
|
|
Affected
|
|
Not
affected
|
|
|
C.
|
Affected
|
|
Not affected
|
|
Affected
|
|
|
D.
|
Not
affected
|
|
Not affected
|
|
Affected
|
|
|
E.
|
Not
affected
|
|
Not affected
|
|
Not
affected
|
|
Answer:
B LO: 6 Type: RC
48. Thurmond, Inc., has two divisions, one located in New
York and the other located in Arizona.
New York sells a specialized circuit to Arizona and just recently raised
the circuit’s transfer price. This price
hike had no effect on the volume of circuits transferred nor on Arizona’s
option of acquiring the circuit from either New York or from an external supplier. On the basis of this information, which of
the following statements is most correct?
A. The profit reported by New York will increase and the
profit reported by Arizona will decrease.
B. The profit reported by New York will increase, the
profit reported by Arizona will decrease, and Thurmond’s profit will be
unaffected.
C. The profit reported by New York will decrease, the
profit reported by Arizona will increase, and Thurmond’s profit will be
unaffected.
D. The profit reported by New York will increase and the
profit reported by Arizona will increase.
E. The profit reported by New York and the profit
reported by Arizona will be unaffected.
Answer:
B LO: 6 Type: RC, N
49. Which
of the following describes the goal that should be pursued when setting
transfer prices?
A. Maximize profits of the buying division.
B. Maximize profits of the selling division.
C. Allow top management to become actively
involved when calculating the proper dollar amounts.
D. Establish incentives for autonomous division
managers to make decisions that are in the overall organization's best
interests (i.e., goal congruence).
E. Minimize opportunity costs.
Answer:
D LO: 6 Type: RC
50. A general calculation method for transfer
prices that achieves goal congruence begins with the additional outlay cost per
unit incurred because goods are transformed and then
A. adds the opportunity cost per unit to the
organization because of the transfer.
B. subtracts the opportunity cost per unit to
the organization because of the transfer.
C. adds the sunk cost per unit to the
organization because of the transfer.
D. subtracts the sunk cost per unit to the
organization because of the transfer.
E. adds the sales revenue per unit to the
organization because of the transfer.
Answer:
A LO: 6 Type: RC
51. Suddath Corporation has no excess
capacity. If the firm desires to
implement the general transfer-pricing rule, opportunity cost would be equal
to:
A. zero.
B. the direct expenses incurred in producing the
goods.
C. the total difference in the cost of
production between two divisions.
D. the contribution margin forgone from the lost
external sale.
E. the summation of variable cost plus fixed
cost.
Answer:
D LO: 6 Type: RC
52. Tulsa Corporation has excess capacity. If the firm desires to implement the general
transfer-pricing rule, opportunity cost would be equal to:
A. zero.
B. the direct expenses incurred in producing the
goods.
C. the total difference in the cost of
production between two divisions.
D. the contribution margin forgone from the lost
external sale.
E. the summation of variable cost plus fixed
cost.
Answer:
A LO: 6 Type: RC
53. McKenna's Florida Division is currently
purchasing a part from an outside supplier.
The company's Alabama Division, which has excess capacity, makes and
sells this part for external customers at a variable cost of $22 and a selling
price of $34. If Alabama begins sales to
Florida, it (1) will use the general transfer-pricing rule and (2) will be able
to reduce variable cost on internal transfers by $4. If sales to outsiders will not be
affected, Alabama would establish a transfer price of:
A. $18.
B. $22.
C. $30.
D. $34.
E. some other amount.
Answer:
A LO: 6 Type: A
54. AutoTech's Northern Division is currently
purchasing a part from an outside supplier.
The company's Southern Division, which has no excess capacity,
makes and sells this part for external customers at a variable cost of $19 and
a selling price of $31. If Southern
begins sales to Northern, it (1) will use the general transfer-pricing rule and
(2) will be able to reduce variable cost on internal transfers by $3. On the basis of this information, Southern
would establish a transfer price of:
A. $16.
B. $19.
C. $28.
D. $31.
E. some other amount.
Answer:
C LO: 6 Type: A
Use the
following to answer questions 55-57:
Laissez Faire
has two divisions: the Cologne Division and the Bottle Division. The Bottle Division produces containers that can
be used by the Cologne Division. The
Bottle Division's variable manufacturing cost is $2, shipping cost is $0.10,
and the external sales price is $3. No
shipping costs are incurred on sales to the Cologne Division, and the Cologne
Division can purchase similar containers in the external market for $2.60.
55. The Bottle Division has sufficient capacity
to meet all external market demands in addition to meeting the demands of the
Cologne Division. Using the general
rule, the transfer price from the Bottle Division to the Cologne Division would
be:
A. $2.00.
B. $2.10.
C. $2.60.
D. $2.90.
E. $3.00.
Answer:
A LO: 6 Type: A
56. Assume the Bottle Division has no
excess capacity and could sell everything it produced externally. Using the general rule, the transfer price
from the Bottle Division to the Cologne Division would be:
A. $2.00.
B. $2.10.
C. $2.60.
D. $2.90.
E. $3.00.
Answer:
D LO: 6 Type: A
57. The maximum amount the Cologne Division would
be willing to pay for each bottle transferred would be:
A. $2.00.
B. $2.10.
C. $2.60.
D. $2.90.
E. $3.00.
Answer:
C LO: 6 Type: A
58. Transfer prices can be based on:
A. variable cost.
B. full cost.
C. an external market price.
D. a negotiated settlement between the buying
and selling divisions.
E. all of the above.
Answer:
E LO: 7 Type: RC
59. Which of the following transfer-pricing
methods can lead to dysfunctional decision-making behavior by managers?
A. Variable cost.
B. Full cost.
C. External market price.
D. A professionally negotiated, amicable
settlement between the buying and selling divisions.
E. None of the above.
Answer:
B LO: 7 Type: RC
60. The Pro Division of Custom Industries is in
need of a particular service. The
service can be obtained from another division of Custom at "cost,"
with cost defined as the summation of variable cost ($9) and fixed cost
($3). Alternatively, Pro can secure the
service from a source external to Custom for $10. Which of the following statements is true?
A. Pro should compare $10 vs. $3 in deciding
where to acquire the service.
B. Pro should compare $10 vs. $9 in deciding
where to acquire the service.
C. Pro should compare $10 vs. $12 in deciding
where to acquire the service.
D. From Custom's perspective, the proper
decision is reached by comparing $10 vs. $9.
E. Both "C" and "D" are
true.
Answer:
E LO: 7 Type: A, N
61. Division A transfers item no. 78 to Division
B. Consider the following situations:
1—A is
located in Texas and B is located in California.
2—A is
located in Texas and B is located in Mexico.
Assuming that item no. 78 is
unavailable in the open market, which of the following choices correctly
depicts the probable importance of federal income taxes when determining the
transfer price that is established for item no. 78?
|
|
Situation 1
|
|
Situation 2
|
||
|
A.
|
Important
|
|
Important
|
||
|
B.
|
Important
|
|
Not important
|
||
|
C.
|
Not important
|
|
Important
|
||
|
D.
|
Not important
|
|
Not important
|
||
|
E.
|
It is not
possible to judge based on the information presented.
|
||||
Answer:
C LO: 7 Type: N
62. Division A transfers a profitable subassembly
to Division B, where it is assembled into a final product. A is located in a European country that has a
high tax rate; B is located in an Asian country that has a low tax rate. Ideally, (1) what type of before-tax income
should each division report from the transfer and (2) what type of transfer
price should be set for the subassembly?
|
|
Division A
Income
|
|
Division B
Income
|
|
Transfer
Price
|
|
A.
|
Low
|
|
Low
|
|
Low
|
|
B.
|
Low
|
|
High
|
|
Low
|
|
C.
|
Low
|
|
High
|
|
High
|
|
D.
|
High
|
|
Low
|
|
High
|
|
E.
|
High
|
|
High
|
|
Low
|
Answer:
B LO: 7 Type: N
63. Consider the following statements about
transfer pricing:
I.
Income
taxes and import duties are an important consideration when setting a transfer
price for companies that pursue international commerce.
II.
Transfer
prices cannot be used by organizations in the service industry.
III.
Transfer
prices are totally cost-based in nature, not market-based.
Which
of the above statements is (are) true?
A. I only.
B. II only.
C. I and II.
D. II and III.
E. I, II, and III.
Answer:
A LO: 7 Type: RC
EXERCISES
Components
of Return on Investment
64. The following data pertain to Corkscrew
Corporation:
|
Income
|
$ 8,000,000
|
|
Sales revenue
|
40,000,000
|
|
Average
invested capital
|
50,000,000
|
Required:
Calculate
Corkscrew Corporation's sales margin, capital turnover, and return on
investment.
LO: 2 Type: A
Answer:
Sales margin:
$8,000,000 ÷ $40,000,000 = 20%
Capital turnover: $40,000,000 ÷ $50,000,000 = 0.8
Return on investment: $8,000,000 ÷ $50,000,000 = 16%
Components of ROI and Residual Income: Working Backward
65. Midland Division, which is part of Courtyard
Enterprises, recently reported a sales margin of 30%, ROI of 21%, and residual
income of $220,000. Courtyard uses an
imputed interest rate of 10%.
Required:
A.
Briefly
define sales margin, capital turnover, and return on investment.
B.
Compute
Midland's capital turnover and invested capital.
C.
Ignoring
your work in requirement "B," assume that invested capital amounted
to $2,500,000. On the basis of this
information, calculate Midland's income and sales revenue.
LO: 2 Type: A, N
Answer:
A.
Sales
margin—the income generated from each sales dollar.
Computed as: Income ÷ sales revenue.
Capital
turnover—the sales dollars produced from each dollar of invested capital. Computed as: Sales revenue ÷ invested
capital.
Return on
investment—the income generated from each dollar of invested capital. Computed as: Income ÷ invested capital, or
sales margin x capital turnover.
B.
Capital
turnover:
Capital
turnover x sales margin = ROI
Capital
turnover x 30% = 21%
Capital
turnover = 0.7
Invested
capital:
ROI = Income ÷ invested capital
21% = Income ÷ invested capital
Income = Invested capital x 21%
Residual income = Income - (invested capital x imputed
interest rate)
$220,000 = Income - (invested capital x 10%)
$220,000 = (Invested capital x 21%) - (invested capital x
10%)
$220,000 = Invested capital x 11%
Invested capital = $2,000,000
C. Income:
ROI = Income ÷ invested capital
21% = Income ÷ $2,500,000
Income = $525,000
Sales revenue:
Sales margin = Income ÷ sales revenue
30% = $525,000 ÷ sales revenue
Sales revenue = $1,750,000
Economic Value Added, Weighted-Average Cost of Capital
66.
The following
data pertain to Dana Industries:
Interest rate
on debt capital: 9%
Cost of equity
capital: 12%
Before-tax
operating income: $35 million
Market value of
debt capital: $60 million
Market value of
equity capital: $120 million
Total assets:
$150 million
Income tax
rate: 30%
Total current
liabilities: $15 million
Required:
A. Compute Dana’s weighted-average cost of capital.
B. Compute Dana’s economic value added.
C. Briefly explain the meaning of economic value added.
LO:
2 Type: RC, A
Answer:
A.
WACC = [(9% x
70%) x $60,000,000) + (12% x $120,000,000)] ÷ ($60,000,000 + $120,000,000)
WACC = ($3,780,000 + $14,400,000) ÷ $180,000,000
WACC = 10.1%
B.
EVA =
($35,000,000 x 70%) - [($150,000,000 - $15,000,000) x 10.1%]
EVA = $24,500,000 - $13,635,000
EVA = $10,865,000
C.
Economic value
added (EVA) measures the amount of shareholder wealth being created from a
company’s activities and operations. To
expand, debt and equity capital are used to fund activities—activities that are
hopefully conducted in a profitable manner.
Profits cover the cost of the related capital, with shareholders
benefiting from the residual (i.e., EVA).
Improving Return on
Investment
67. The following data pertain to Norris Company
for 20x1:
|
Sales revenue
|
$1,000,000
|
|
Cost of goods
sold
|
550,000
|
|
Operating
expenses
|
400,000
|
|
Average
invested capital
|
500,000
|
Required:
A.
Calculate
the company's sales margin, capital turnover, and return on investment for
20x1.
B.
If
the sales and average invested capital remain the same, to what level would
total costs and expenses have to be reduced in 20x2 to achieve a 15% return on
investment?
C.
Assume
that costs and expenses are reduced, as calculated in requirement
"B." Calculate the firm's new
sales margin.
D.
Suggest
two possible actions that will improve the company's capital turnover.
LO: 2,
3 Type: A, N
Answer:
|
A.
|
Sales
revenue
|
|
$1,000,000
|
|||
|
|
Less: Cost
of goods sold
|
$550,000
|
|
|||
|
|
Operating
expenses
|
400,000
|
950,000
|
|||
|
|
Operating
income
|
|
$ 50,000
|
|||
|
|
Sales margin: $50,000 ÷ $1,000,000 = 5%
Capital turnover: $1,000,000 ÷ $500,000
= 2
Return on investment: $50,000 ÷ $500,000
= 10%
|
|||||
|
B.
|
New income level: $500,000 x 15% =
$75,000
|
|||||
|
|
Sales
revenue
|
$1,000,000
|
||||
|
|
Less:
Income
|
75,000
|
||||
|
|
Costs
and expenses
|
$ 925,000
|
||||
|
|
Therefore,
total costs and expenses must be reduced from $950,000 ($550,000 + $400,000)
to $925,000 in order to achieve a 15% ROI.
|
|||||
|
|
|
|||||
|
C.
|
Sales margin: $75,000 ÷ $1,000,000 =
7.5%
|
|||||
|
D.
|
Capital turnover can be improved by increasing sales revenue and
reducing invested capital.
|
|||||
Return on
Investment and Residual Income: Calculation and Analysis
68. The following data pertain to the Oxnard
Division of Kemp Company:
|
Divisional
contribution margin
|
$ 700,000
|
|
Profit margin
controllable by the divisional manager
|
320,000
|
|
Profit margin
traceable to the division
|
294,400
|
|
Average asset
investment
|
1,280,000
|
The company uses responsibility
accounting concepts when evaluating performance, and Oxnard's division manager
is contemplating the following three investments. He can invest up to $400,000.
|
|
No. 1
|
No. 2
|
No. 3
|
|||
|
Cost
|
$250,000
|
$300,000
|
$400,000
|
|||
|
Expected
income
|
50,000
|
54,000
|
96,000
|
|||
Required:
A. Calculate the ROIs of the three investments.
B. What is the division manager's current
ROI, computed by using responsibility accounting concepts?
C. Which of the three investments would be
selected if the manager's focus is on Oxnard's divisional performance? Why?
D. If Kemp has an imputed interest charge of
22%, compute the residual income of investment no. 3. Is this investment attractive from Oxnard's
perspective? From Kemp's
perspective? Why?
LO: 2,
4 Type: A, N
Answer:
|
A.
|
No. 1:
$50,000 ÷ $250,000 = 20%
|
|
|
No. 2:
$54,000 ÷ $300,000 = 18%
|
|
|
No. 3:
$96,000 ÷ $400,000 = 24%
|
|
B.
|
Controllable
profit margin ($320,000) ÷ asset investment ($1,280,000) = 25%
|
|
C.
|
None, as all
will lower the current ROI.
|
|
D.
|
Residual
income: $96,000 - ($400,000 x 22%) = $8,000
|
|
|
This
investment is attractive from both Oxnard and Kemp's perspectives. The positive residual income indicates that
the investment income covers the imputed interest charge.
|
ROI and
Residual Income, Investment Evaluation
69. Jasper Corporation is organized in three
separate divisions. The three divisional
managers are evaluated at year-end, and bonuses are awarded based on ROI. Last year, the overall company produced a 12%
return on its investment.
Managers of Jasper's Iowa Division recently studied an
investment opportunity that would assist in the division's future growth. Relevant data follow.
|
|
Iowa
Division
|
Investment Opportunity
|
|||
|
Income
|
$12,800,000
|
|
$ 4,200,000
|
||
|
Invested capital
|
80,000,000
|
|
30,000,000
|
||
Required:
A.
Compute
the current ROI of the Iowa Division and the division's ROI if the investment
opportunity is pursued.
B.
What
is the likely reaction of divisional management toward the acquisition? Why?
C.
What
is the likely reaction of Jasper's corporate management toward the
investment? Why?
D.
Assume
that Jasper uses residual income to evaluate performance and desires an 11%
minimum return on invested capital.
Compute the current residual income of the Iowa Division and the
division's residual income if the investment is made. Will divisional management likely change its
attitude toward the acquisition? Why?
LO: 2,
4 Type: A, N
Answer:
|
A.
|
ROI = Income
÷ invested capital
Current:
$12,800,000 ÷ $80,000,000 = 16%
If investment is made: ($12,800,000 +
$4,200,000) ÷ ($80,000,000 + $30,000,000) = 15.45%
|
||
|
B.
|
Divisional management will likely be against
the acquisition because ROI will be lowered from 16% to 15.45%. Since bonuses are awarded on the basis of
ROI, the acquisition will result in less compensation. However, before a final decision is made,
additional insights are needed concerning how the investment will assist in
future growth and in what magnitude.
|
||
|
C.
|
An examination of the investment reveals a
14% ROI ($4,200,000 ÷ $30,000,000).
Corporate management would probably favor the acquisition. Jasper has been earning a 12% return, and
the investment will help the organization as a whole.
|
||
|
D.
|
Current residual income of Iowa Division:
|
|
|
|
|
Divisional
income
|
$12,800,000
|
|
|
|
Less:
Imputed interest charge ($80,000,000 x 11%)
|
8,800,000
|
|
|
|
Residual
income
|
$ 4,000,000
|
|
|
|
Residual income if investment is made:
|
|
|
|
|
Divisional income ($12,800,000 + $4,200,000)
|
$17,000,000
|
|
|
|
Less: Imputed interest charge [($80,000,000 +
$30,000,000) x 11%]
|
12,100,000
|
|
|
|
Residual income
|
$ 4,900,000
|
|
|
|
Yes,
divisional managers will likely change their attitude, particularly if they
are team players. Residual income will
increase by $900,000 ($4,900,000 - $4,000,000) from the acquisition. The RI measure focuses on the corporate
perspective, not the divisional perspective, by integrating the firm's
required return on invested capital.
|
||
Using ROI and Residual Income in Operating
Decisions
70. Deborah Lewis, general manager of the
Northwest Division of Berkshire Enterprises, has significant authority over
pricing decisions as well as programs that involve cost reduction/control. The data that follow relate to upcoming
divisional operations:
Average
invested capital: $15,000,000
Annual
fixed costs: $3,900,000
Variable
cost per unit: $80
Number
of units expected to be sold: 120,000
Required:
A.
Top
management will promote Deborah if she can earn a 14% return on investment for
the year. What unit selling price should
she establish to get her promotion?
B.
Independent
of part "A," assume the unit selling price is $132 and that Berkshire
has a 16% imputed interest charge. Top
management will promote Deborah to corporate headquarters if her division can
generate $200,000 of residual income. If
Deborah desires to move to corporate, what must the division do to the amount
of annual fixed costs incurred? Show
your calculations.
LO: 2,
4 Type: A, N
Answer:
A. A
14% return on investment will require the Division to produce income of
$2,100,000 ($15,000,000 x 14%). If X =
selling price, then:
120,000X -
(120,000 x $80) - $3,900,000 = $2,100,000
120,000X -
$9,600,000 - $3,900,000 = $2,100,000
120,000X =
$15,600,000
X = $130
B. If X = fixed cost, then:
[($132 -
$80) x 120,000] - X - ($15,000,000 x 16%) = $200,000
$6,240,000
- X - $2,400,000 = $200,000
X = $3,640,000
To achieve
her promotion, Deborah must reduce fixed costs by $260,000 ($3,900,000 -
$3,640,000).
Basic
Transfer Pricing: General Rule
71. Bronx Corporation's Gauge Division
manufactures and sells product no. 24, which is used in refrigeration
systems. Per-unit variable manufacturing
and selling costs amount to $20 and $5, respectively. The Division can sell this item to external
domestic customers for $36 or, alternatively, transfer the product to the
company's Refrigeration Division. Refrigeration
is currently purchasing a similar unit from Taiwan for $33. Assume use of the general transfer-pricing
rule.
Required:
A.
What
is the most that the Refrigeration Division would be willing to pay the Gauge
Division for one unit?
B.
If
Gauge had excess capacity, what transfer price would the Division's management
set?
C.
If
Gauge had no excess capacity, what transfer price would the Division's
management set?
D.
Repeat
part "C," assuming that Gauge was able to reduce the variable cost of
internal transfers by $4 per unit.
LO: 6 Type: A
Answer:
A.
Refrigeration
would be willing to pay a maximum of $33, its current outside purchase price.
B.
The
general rule holds that the transfer price be set at the sum of outlay cost and
opportunity cost. Thus, ($20 + $5) + $0
= $25.
C.
In
this case, the transfer price would amount to $36: ($20 + $5) + ($36 - $20 -
$5).
D.
The
transfer price would be $32: ($20 + $5 - $4) + ($36 - $20 - $5).
Basic
Transfer Pricing
72. Gamma Division of Vaughn Corporation produces
electric motors, 20% of which are sold to Vaughan's Omega Division and 80% to
outside customers. Vaughn treats its
divisions as profit centers and allows division managers to choose whether to
sell to or buy from internal divisions. Corporate
policy requires that all interdivisional sales and purchases be transferred at
variable cost. Gamma Division's
estimated sales and standard cost data for the year ended December 31, based on
a capacity of 60,000 units, are as follows:
|
|
Omega
|
Outsiders
|
||||
|
Sales
|
$ 660,000
|
|
$5,760,000
|
|||
|
Less:
Variable costs
|
660,000
|
|
2,640,000
|
|||
|
Contribution
margin
|
$ ----
|
|
$3,120,000
|
|||
|
Less: Fixed
costs
|
175,000
|
|
900,000
|
|||
|
Operating
income (loss)
|
$ (175,000)
|
|
$2,220,000
|
|||
|
|
|
|
||||
|
Unit sales
|
12,000
|
48,000
|
||||
Gamma
has an opportunity to sell the 12,000 units shown above to an outside customer
at $80 per unit. Omega can purchase the units it needs from an outside supplier
for $92 each.
Required:
A.
Assuming
that Gamma desires to maximize operating income, should it take on the new
customer and discontinue sales to Omega?
Why? (Note: Answer this question from Gamma's perspective.)
B.
Assume
that Vaughn allows division managers to negotiate transfer prices. The managers agreed on a tentative price of
$80 per unit, to be reduced by an equal sharing of the additional Gamma income
that results from the sale to Omega of 12,000 motors at $80 per unit. On the basis of this information, compute the
company's new transfer price.
LO: 6,
7 Type: A
Answer:
A.
Yes. Gamma is currently selling motors to Omega at
a transfer price of $55 per unit ($660,000 ÷ 12,000 units). A price of $80 to the new customer will
increase Gamma Division's operating income by $300,000 [($80 - $55) x 12,000
units].
B. The additional operating income to Gamma
is $300,000 [($80 - $55) x 12,000 units].
Splitting this amount equally results in a new transfer price of $67.50,
calculated as follows:
|
Transfer price before reduction
|
$80.00
|
|
Less: Omega's per-unit share of additional income [($300,000 x 50%)
÷ 12,000 units]
|
12.50
|
|
New transfer price
|
$67.50
|
Transfer Pricing: Selling
Internally or Externally
73. Sonoma Corporation is a multi-divisional
company whose managers have been delegated full profit responsibility and
complete autonomy to accept or reject transfers from other divisions. Division X produces 2,000 units of a
subassembly that has a ready market. One
of these subassemblies is currently used by Division Y for each final product
manufactured, the latter of which is sold to outsiders for $1,600. Y's sales during the current period amounted
to 2,000 completed units. Division X
charges Division Y the $1,100 market price for the subassembly; variable costs
are $850 and $600 for Divisions X and Y, respectively.
The
manager of Division Y feels that X should transfer the subassembly at a lower
price because Y is currently unable to make a profit.
Required:
A.
Calculate
the contribution margins (total dollars and per unit) of Divisions X and Y, as
well as the company as a whole, if transfers are made at market price.
B.
Assume
that conditions have changed and X can sell only 1,000 units in the market at $900
per unit. From the company's
perspective, should X transfer all 2,000 units to Y or sell 1,000 in the market
and transfer the remainder? Note: Y's
sales would decrease to 1,000 units if the latter alternative is pursued.
LO: 6,
7 Type: A
Answer:
|
A.
|
|
Division X
|
Division Y
|
Company
|
||||||
|
|
Sales at $1,600
|
|
|
$ 3,200,000
|
$ 3,200,000
|
|||||
|
|
Transfers at
$1,100
|
$ 2,200,000
|
|
(2,200,000)
|
|
|||||
|
|
Less:
Variable costs
|
|
|
|
|
|||||
|
|
at $850
|
(1,700,000)
|
|
|
|
|||||
|
|
at $600
|
|
|
(1,200,000)
|
(2,900,000)
|
|||||
|
|
Contribution
margin
|
$ 500,000
|
|
$ (200,000)
|
$ 300,000
|
|||||
|
|
|
|
|
|
|
|||||
|
|
Unit
contribution margin
|
$ 250
|
|
$ (100)
|
$ 150
|
|||||
|
B.
|
Alternative
no. 1: Transfer 2,000 units to Division Y:
|
|||||||||
|
|
Company
sales (2,000 x $1,600)
|
$3,200,000
|
||||||||
|
|
Less:
Variable costs [2,000 x $850) + (2,000 x $600)]
|
2,900,000
|
||||||||
|
|
Contribution
margin
|
$ 300,000
|
||||||||
|
|
Alternative
no. 2: Sell 1,000 units in the open market and transfer 1,000 units to Y:
|
|||||||||
|
|
Company
sales [(1,000 x $900) + (1,000 x $1,600)]
|
$2,500,000
|
||||||||
|
|
Less:
Variable costs [(2,000 x $850) + (1,000 x $600)]
|
2,300,000
|
||||||||
|
|
Contribution
margin
|
$ 200,000
|
||||||||
|
|
Division X
should transfer all 2,000 units to Division Y to produce an additional $100,000
($300,000 - $200,000) of contribution margin.
|
|||||||||
Transfer
Pricing; Negotiation
74. Kendall Corporation has two divisions:
Phoenix and Tucson. Phoenix currently
sells a condenser to manufacturers of cooling systems for $520 per unit. Variable costs amount to $380, and demand for
this product currently exceeds the division's ability to supply the
marketplace.
Kendall
is considering another use for the condenser, namely, integration into an
enhanced refrigeration system that would be made by Tucson. Related information about the refrigeration
system follows.
Selling
price of refrigeration system: $1,285
Additional
variable manufacturing costs required: $820
Transfer
price of condenser: $490
Top management is anxious to introduce the
refrigeration system; however, unless the transfer is made, an introduction
will not be possible because of the difficulty of obtaining condensers in the
quality and quantity desired. The
company uses responsibility accounting and ROI in measuring divisional
performance, and awards bonuses to divisional management.
Required:
A.
How
would Phoenix's divisional manager likely react to the decision to transfer
condensers to Tucson? Show computations
to support your answer.
B.
How
would Tucson's divisional management likely react to the $490 transfer
price? Show computations to support your
answer.
C.
Assume
that a lower transfer price is desired.
What parties should be involved in setting the new price?
D.
From
a contribution margin perspective, does Kendall benefit more if it sells the
condensers externally or transfers the condensers to Tucson? By how much?
LO: 6,
7 Type: A, N
Answer:
|
A.
|
The Phoenix
divisional manager will likely be opposed to the transfer. Currently, the division is selling all the
units it produces at $520 each. With
transfers taking place at $490, Phoenix will suffer a $30 drop in sales
revenue and profit on each unit that is sent to Tucson.
|
|
B.
|
Although
Tucson is receiving a $30 "price break" on each unit purchased from
Phoenix, the $490 transfer price would probably be deemed too high. The reason: Tucson will lose $25 on each
refrigeration system produced and sold.
|
|
|
Sales
revenue
|
|
$1,285
|
|
|
Less: Variable manufacturing costs
|
$820
|
|
|
|
Transfer price paid to Phoenix
|
490
|
1,310
|
|
|
Income
(loss)
|
|
$ (25)
|
|
C.
|
Kendall uses
a responsibility accounting system, awarding bonuses based on divisional
performance. The two divisional
managers (or their representatives) should negotiate a mutually agreeable
price.
|
|
D.
|
Kendall would
benefit more if it sells the condenser externally. Observe that the transfer price is ignored
in this evaluation—one that looks at the firm as a whole.
|
|
|
|
Produce Condenser; Sell Externally
|
Produce Condenser; Transfer; Sell Refrigeration System
|
||
|
|
Sales revenue
|
$520
|
|
$1,285
|
|
|
|
Less: Variable cost
$380; $380 + $820
|
380
|
|
1,200
|
|
|
|
Contribution margin
|
$140
|
|
$ 85
|
|
Basic
Transfer Pricing: Domestic and International Implications
75. Walker, Inc., has a Pennsylvania-based division that
produces electronic components, with a very strong domestic market for circuit
no. 222. The variable production cost is
$140, and the division can sell its entire output for $190. Walker is subject to a 30% income tax rate.
Alternatively, the Pennsylvania division can ship the
circuit to a division that is located in Mississippi, to be used in the
manufacture of a global positioning system (GPS). Information about the global positioning
system and Mississippi's costs follow.
Selling
price: $380
Circuit shipping and handling fees to
Mississippi: $10
Labor,
overhead, and additional material costs of GPS: $120
Required:
A.
Assume that the
transfer price for the circuit was $160.
How would Pennsylvania's divisional manager likely react to a corporate
decision to transfer the circuits to Mississippi? Why?
B.
Calculate
Pennsylvania income, Mississippi income, and income for the company as a whole
if the transfer took place at $160 per circuit.
C.
Assuming that
transfers took place at a price higher than $160, would the revised price
increase, decrease, or have no effect on Walker's income? Briefly explain.
D.
Assume that
Walker moved its GPS production facility to a division located in Germany,
which is subject to a 45% tax rate. The
transfer took place at $180. Shipping
fees (absorbed by the overseas division) doubled to $20; the German division
paid an import duty equal to 10% of the transfer price; and labor, overhead,
and additional material costs were $150 per GPS. If the German selling price of the GPS
amounted to $450, calculate Pennsylvania income, German income, and income for
Walker as a whole.
E.
Suppose that U.S.
and German tax authorities allowed some discretion in how transfer prices were
set. Given the difference in tax rates,
should Walker attempt to generate the majority of its income in Pennsylvania or
Germany? Why?
LO:
6, 7 Type: RC, A
Answer:
A.
The manager would
be unhappy, as the division is being forced to take a "hit" of $30
per circuit ($190 vs. $160).
B.
Pennsylvania:
$160 - $140 = $20; $20 - ($20 x 30%) = $14
Mississippi: $380 - $10 - $120 - $160 = $90; $90 -
($90 x 30%) = $63
Walker, Inc.: $14 + $63 = $77
C.
Walker's income
is unaffected, as the transfer price is a wash between the divisions. In other words, Pennsylvania's revenue is
offset by Mississippi's cost.
D.
Pennsylvania:
$180 - $140 = $40; $40 - ($40 x 30%) = $28
Germany: $450 - $20 - $150 - $180 - ($180 x 10%) =
$82; $82 - ($82 x 45%) = $45.10
Walker, Inc.: $28.00 + $45.10 = $73.10
E. Tax rates are
lower in the U.S. than in Germany (30% vs. 45%). Thus, Walker would benefit if it generated
the majority of its income in Pennsylvania.
Basic
Transfer Pricing: International
76. Cheney Corporation produces goods in the
United States, to be sold by a separate division located in Italy. More specifically, the Italian division
imports units of product X34 from the U.S. and sells them for $950 each. (Imports of similar goods sell for $850.) The Italian division is subject to a 40% tax
rate whereas the U.S. tax rate is only 30%. The manufacturing cost of product X34 in the
United States is $720. Furthermore, there is a 10% import duty, computed on the
transfer price, that will be paid by the Italian division and is deductible
when computing Italian income.
Tax
laws of the two countries allow transfer prices to be set at U.S. manufacturing
cost or the selling prices of comparable imports in Italy.
Required:
Analyze
the profitability of the U.S. division and the Italian division to determine
whether Cheney as a whole would be better off if transfers took place at (1)
U.S. manufacturing cost or (2) the selling price of comparable imports.
LO: 6,
7 Type: A
Answer:
Alternative no. 1: Transfer at U.S. manufacturing cost
United States: $720 - $720 = $0
Italy: $950 - $720 - ($720 x 10%) = $158;
$158 - ($158 x 40%) = $94.80
Cheney Corporation: $0 + $94.80 = $94.80
Alternative no. 2: Transfer at
selling price of comparable imports
United States: $850 - $720 = $130; $130 - ($130 x 30%) =
$91
Italy: $950 - $850 - ($850 x 10%) = $15; $15 - ($15 x 40%)
= $9
Cheney Corporation: $91 + $9 = $100
Alternative no. 2 would be more profitable: $100.00 vs.
$94.80.
International Transfer
Pricing; Analysis of Operations
77. Cunningham, Inc., which produces electronic
parts in the United States, has a very strong local market for part no.
54. The variable production cost is $40,
and the company can sell its entire supply domestically for $110. The U.S. tax rate is 30%.
Alternatively,
Cunningham can ship the part to a division that is located in Switzerland, to
be used in a product that the Swiss division will distribute throughout
Europe. Information about the Swiss
product and the division's operating environment follows.
Selling
price of final product: $400
Shipping
fees to import part no. 54: $20
Labor,
overhead, and additional material costs of final product: $230
Import duties levied on part no. 54 (to be paid by the
Swiss division): 10% of transfer price
Swiss tax
rate: 40%
Based
on U.S. and Swiss tax laws, the company has established a transfer price for
part no. 54 equal to the U.S. market price.
Assume that the Swiss division can obtain part no. 54 in Switzerland for
$125.
Required:
A. If you were the head of the Swiss
division, would you be better off to conduct business with your U.S. division
or buy part no. 54 locally? Why? Show computations.
B. Cunningham's accounting department has
figured that the firm will make $66.40 for each unit transferred and used in
the Swiss division's product. Rather
than proceed with the transfer, would Cunningham be better off to sell its
goods domestically and allow the Swiss division to acquire part no. 54 in
Switzerland? Show computations for both
U.S. and Swiss operations to support your answer.
C. Generally speaking, when tax rates differ
between countries, what income strategy should a company use in setting its
transfer prices? If the seller is in a
low tax-rate country, what type of price should it set? Why?
LO: 6,
7 Type: A, N
Answer:
A.
Courtesy
of the shipping fee and import duty, both of which can be avoided, it is
cheaper to purchase in Switzerland at $125.
The shipping fee and import duty raise the cost to acquire parts from
the U.S. operation to $141 ($110 + $20 + $11).
B.
Yes. Cunningham will make $76 ($49 + $27) if no
transfer takes place and part no. 54 is sold in the U.S.
U.S. operation: $110 - $40 = $70; $70 -
($70 x 30%) = $49
Swiss
operation: $400 - $125 - $230 = $45; $45 - ($45 x 40%) = $27
C.
When
tax rates differ, companies should strive to generate more income in low
tax-rate countries, and vice versa.
Thus, if the seller is in a low tax-rate country, it should set a high
transfer price (within allowed limits) to increase that country's income.
DISCUSSION
QUESTIONS
Disadvantages
of Return on Investment and Residual Income
78. Return on investment (ROI) and residual
income (RI) are popular measures of divisional performance. Like any measure, there are disadvantages or
weaknesses that are an inherent part of these tools. Briefly discuss a major weakness associated
with each tool.
LO: 4 Type: RC
Answer:
Divisions
with high ROIs apparently are very successful. Top management would therefore like these
managers to aggressively seek additional investment opportunities. However, the
managers will often reject opportunities that are attractive to the company as
a whole but that have a lower ROI than a division's current return.
Residual
income (RI) does not have the same weakness as described above for ROI.
However, it is difficult to compare divisions of different sizes since RI is
not a percentage.
Return on
Investment: Asset Valuation
79. Return on investment (ROI) is a very popular
tool to evaluate performance. The
measurement of ROI is dependent, in part, on whether fixed assets are valued at
acquisition cost or net book value.
List
several advantages of acquisition cost and net book value as ways to value
long-lived assets.
LO: 5 Type: RC
Answer:
Acquisition cost:
·
The
investment base is not affected by the choice of an arbitrary depreciation
method.
·
The
investment base does not shrink over time because of accumulated depreciation. This avoids misleading increases in ROI or
residual income.
Net book value:
·
Consistency
with the balance sheet is maintained.
·
Consistency
with the definition of income is maintained, as both the numerator and
denominator will reflect depreciation amounts.
General Transfer-Pricing Rule
80. One element of the general transfer-pricing
rule is opportunity cost. Briefly define
the term "opportunity cost" and then explain how it is computed for
(1) companies that have excess capacity and (2) companies that have no excess
capacity.
LO: 6 Type: RC
Answer:
Opportunity
cost is the benefit forgone by taking a particular action. Technically, companies that have excess
capacity are not forgoing profits from business that has been rejected; thus,
the opportunity cost is zero. In
contrast, if a transfer is made in a firm that has no excess capacity, the firm
will have to give up profits on selected outside transactions. These profits are measured by computing the
contribution margin on lost sales in external marketplaces.
Negotiated
Transfer Prices
81. Although the general rule for transfer prices
is the outlay cost plus opportunity cost, many companies instead use negotiated
prices to price their goods and services. When are negotiated transfer prices used? Are such prices consistent or inconsistent
with responsibility accounting? Explain.
LO: 7 Type: RC, N
Answer:
Negotiated transfer prices can be used when no market price exists
for the transferred product or when a buying division can obtain a cheaper
price outside of the organization.
Negotiated prices are typically consistent with responsibility
accounting; they generally do not require intervention by top management and
thus help to preserve divisional autonomy. This is important since the divisional
structure is predicated on the advantage of giving managers a high degree of
responsibility for their unit operations.
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