Suggested Answers Chapters 1819
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Suggested Answer For Chapter 18 and 19...
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Chapter 19 - Strategic Performance Measurement—Investment Centers
18-1
Performance evaluation can be thought of as the process by which managers at all levels in the firm gain information about the performance of tasks within the firm and judge that performance agains againstt pre-es pre-estab tablilishe shed d criter criteria ia as set out in budget budgets, s, plans, plans, and goals. goals. In manage managemen mentt accounting there are two types of performance evaluation -- management control and operational contro control. l. Manag Manageme ement nt contro controll refers refers to the evaluat evaluation ion by upperupper-lev level el manage managers rs of the performanc performance e of mid-level mid-level managers. managers. Operation Operational al control refers to the evaluatio evaluation n of operating level employees by mid-level managers.
18-2
trate trategi gic c perfor performan mance ce measur measureme ement nt is a manage managemen mentt accoun accounti ting ng system system used used by top management management for the evaluation evaluation of business unit managers. managers. It is used when the conditions conditions are such that responsibility can be effectively delegated to business unit managers, and there are ade!uate measures for evaluating the the performance of the managers. It is important for effective effective manage managemen mentt becaus because e it helps helps the decent decentral rali"e i"ed d firm firm evalua evaluate te manage managers rs of decent decentral rali"e i"ed d business units of the f irm.
18-3
#n effective performance evaluation system must consider both the individual and team aspects of work and performance in the firm. In management accounting, we focus on the individual aspects primarily in strategic performance measurement systems. $owever, strategy-focused firms will also develop methods to evaluate teams using techni!ues such as bonuses based on team performance and balanced scorecards based on performance measures that are commonly controlled within the team.
18-4
%he systems for management control are of two types -- formal and informal. &ormal systems are devel develop oped ed from from e'pl e'plic icit it mana manage geme ment nt guid guidan ance ce,, whil while e info inform rmal al syst system ems s aris arise e from from the the unmana unmanaged ged,, and someti sometimes mes uninte unintende nded, d, behavi behavior or of manage managers rs and employ employees ees.. Infor Informal mal systems reflect the managers( and employees( reactions and feelings that arise from the positive and negative aspects of the work environment, for e'ample, the positive feelings of security and acceptance of an employee in a company that has a successful product and generous employee benefits. benefits. &ormal &ormal and informal informal control systems systems can be implemented implemented at both the level of the indivi individua duall manage managerr or that that of a team team of manage managers rs or employ employees ees.. trat trategi egic c perfor performan mance ce measurement is a type of formal control system at the individual level.
18-5
%he two organi"ational designs are centrali"ed centrali"ed and decentrali"ed. # centrali"ed firm reserves reserves much of the decision-making at the top management level. In contrast, a decentrali"ed firm delegates a significant amount of responsibility to lower level managers. )oth the centrali"ed and decentrali decentrali"ed "ed firms are called hierarchical , because responsibility and reporting relationships follow a top to bottom pattern. *esponsibility flows top-down and reporting relationships flow bottom-up.
18-6
# cost center is a production production or support unit within within a firm that that is evaluated on the basis of cost. cost. # revenue center focuses on the selling function and is defined either by product line or by geographical area. # profit profit center generates generates both revenues and incurs incurs the major portion portion of the cost for producing these revenues.
#n investment center center evaluation includes includes assets employed by the center as well as profits in the performance evaluation. %he goal of each type of is center as follows+ ost center+ produce a product or service of given !uality !uality at lowest cost. 19-1 Copyright © 2016 McGraw-Hill Education. All rights rsr!d. "o rproduction or distri#ution without th prior writtn consnt o$ McGraw-Hill Education.
Chapter 19 - Strategic Performance Measurement—Investment Centers
*evenue center+ to meet sales goals within a given e'pense budget. Profit center : achieve desired profit goals. Investment center+ achieve desired profit goals for a given amount of assets. 18-7
hile net income determined using full costing is affected by changes in inventory levels, net income income using using variable variable costing is not affected. affected. %his means that the proper interpreta interpretation tion of net income under full costing, unlike variable variable costing, re!uires an adjustment for changing inventory inventory levels. %his difference is important because users of financial statements prepared under full costing can be misled about the actual performance of the firm if there are significant changes in inventory level for the firm.
18-8
%here are four behavioralimplementation behavioralimplementation issues for )/s+ 0. ost ost shifti shifting, ng, where wherein in a depar departme tment nt replac replaces es its contro controllllabl able e costs costs with with nonnoncontrollable costs. &or e'ample, a manager might attempt to replace variable costs such as manufacturing labor with fi'ed costs such as advanced e!uipment if the manager is evaluated on the basis of contribution margin only 1i.e., fi'ed costs are e'cluded2. 3. hort term focus, where the concern is that strategic performance measurement, done improperly, will motivate managers to focus on short-term profits and neglect long-term strategic issues. 4. )udg )udget et slac slack k whic which h is ofte often n view viewed ed nega negati tive vely ly,, can can have have a posi positi tive ve effe effect ct in management control. lack is sometimes viewed as a dysfunctional aspect of )/s, a result of managers attempting to make their performance goals easier, and therefore an indication of an overall lower than appropriate level of performance. %he positive view of slack is that it addresses effectively the the decision making and fairness objectives of performance evaluation. evaluation. )y limiting managers( e'posure to environmental uncertainty, it reduces the relative risk aversion of the managers.
18-9
# pervasive issue when using cost centers is how the jointly incurred costs of service departments -- such as data processing, engineering, human resources, or maintenance -- are to be allocated to the departments using the service. %he various cost allocation methods are e'plained e'plained in hapter 5. %he choice choice of method method will affect the amount amount of cost allocated allocated to each cost center, and therefore it is critical in effective cost center evaluation.
18-10
trategic performance measurement can be used for both service and not-for-profit firms as well as manufacturing firms. firms. ost centers are particularly particularly appropriate across all organi"ation types, as the organi"ation attempts to identify responsibility for costs and to develop a system for record recording ing,, report reporting ing and evalua evaluatin ting g perfor performan mance ce in managi managing ng costs. costs. #n e'ample e'ample of an application of strategic performance measurement in banking is presented in the chapter.
18-11
ost centers are used when the firm wishes to focus the manager6s attention e'clusively on costs. %his makes sense particularly when for e'ample the manager is producing a product that re!uires little coordination with marketing or design. %here are therefore few times when the manager will need to adjust the functionality of the product or adjust the production schedule to suit the needs of a certain customer. %he manager can then focus her or his a ttention primarily on the cost of manufacture. %he revenue center is used for marketing and sales organi"ations where the principal focus is sales volume. %he profit center is used when the manager has effective control over both revenues a nd costs in the unit, and when there is a need for coordination between the marketing and production areas, as for e'ample, in handling special orders or rush orders. 7valuation on profit provides the incentive incentive for the departments departments to work together. together. #lso, #lso, profit centers are used to set a desirable desirable competitive tone8 all departments have the profit incentive to compete with other providers of the good or service, inside or outside the firm.
18-12
1ee also 09-:2 entrali"ed firms have a strong hierarchical organi"ation in which information flows upward and management flows downward downward in the hierarchy. entrali"ed firms are effective effective 19-2
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Chapter 19 - Strategic Performance Measurement—Investment Centers
in !uickly implementing policy changes and in controlling operations according to the goals of top management management.. ;ower level level managers are given limited limited autonomy, autonomy, and have a limited limited range of decision making. %heir role is to provide information and to implement top management policies. 9, pp. E>-E0.
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Chapter 19 - Strategic Performance Measurement—Investment Centers
18-39 +inan!ia% Re&orting an# S, 'erorman!e (20 min
0. %he business unit information prepared for public 1e'ternal2 financial reporting purposes may not be appropriate for the evaluation of business unit management performance because+ an allocation of common costs incurred for the benefit of more than one business unit must be included for public reporting purposes, in e'ternal financial reports, common costs are often allocated on an arbitrary 1non-causal2 basis . the business units identified for public reporting purposes may not coincide with actual managerial responsibilities. # business unit may have different operating responsibilities in practice than that described in the financial report. &or e'ample, for simplicity the annual report may group operations into geographical-based categories 1foreign versus domestic8 western states versus Midwest, etc. 2, when instead unit managers are given responsibility for product lines including all areas in which the product is sold. If business unit leaders6 performance is evaluated on the basis of the information in the annual financial report, unit managers may become frustrated and dissatisfied because they would be held responsible for an earnings figure that includes the arbitrary allocation of common costs and costs traceable to but not controllable by them. %his type of performance evaluation is unfair to managers and does little to motivate them. #s a result of this dissatisfaction, the best managers may seek employment elsewhere. •
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Chapter 19 - Strategic Performance Measurement—Investment Centers
18-39 (!ontin*e# -1
3. %he company should consider establishing profit centers for its business units. %he contribution income statement should be used to evaluate amentech Inc.6s business unit managers. %he contribution income statement is the best measure of performance because it distinguishes both+ a2 traceable and nontraceable costs, and b2 controllable and uncontrollable costs 1some costs might be traceable to a unit, but not controllable in the short term, as for e'ample the cost of facilities.2 %he determination of whether noncontrollable costs should be charged to division is a comple' issue. &or e'ample, the managers in this case are choosing a higher cost insurance coverage in order to maintain some local fle'ibility. If insurance costs are not charged to the unit managers, there is no incentive for them to choose a cost-saving insurance plan. In this case, the desired incentive might be achieved by allocating the cost of insurance 1for e'ample, on the basis of headcount, number of claims, or some measure that is related to the use of insurance2, thereby providing the incentive for the managers to get together and choose a cost-saving join policy. Many times it can be advantageous to compare the managers6 performance to a budget, where the budget is determined with an e'plicit consideration of conditions in the industry for that unit. %his way managers are not rewarded or penali"ed for favorable or unfavorable conditions within the market place that are beyond their control. #lso, the company should consider using the balanced scorecard, in order to include in the performance measurement all of the critical success factors that managers should attend to in order to align their performance with the company6s strategic goals. 4. /sing the ) and the contribution income statement should help amentech Inc. bring its managers6 decision making more in line with overall corporate strategy. It will specifically help control the lack of motivation and cooperation that is commonplace in amentech Inc.6s current operations. 19-9 Copyright © 2016 McGraw-Hill Education. All rights rsr!d. "o rproduction or distri#ution without th prior writtn consnt o$ McGraw-Hill Education.
Chapter 19 - Strategic Performance Measurement—Investment Centers
18-54 /entra%iation vs $e!entra%iation; ,anking (30 min
0. %he following advantages are attributed to a decentrali"ed organi"ational structure+ •
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%he manager making the decisions is closer to the situation and can make better and faster decisions. %op management has more time for strategic decisions and longrange planning because operational decisions are made at lower levels. Hreater freedom and responsibility provide greater opportunity for individual development, innovation, and creative decisions. 7'cellent training in decision-making is provided for lower level managers resulting in a pool of trained managerial talent.
3. %he following disadvantages of a decentrali"ed structure and their effect on *D) are as follows. •
%here is an increased risk of loss of control. *D) does not have sufficient control over its individual banks as evidenced by the uni!ue BpackagedC accounts, inter-bank competition, and conflicting advertising.
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Chapter 19 - Strategic Performance Measurement—Investment Centers
18-54 (!ontin*e# -1 •
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%here is less information flow to top levels. %he individual banks sometimes failed to notify the e'ecutive office of their plans and programs. min2
0. %he new 7O made the correct decision because the increased contribution of sales from lighting fi'tures upscale and electronic timing devices more than made up for the increased selling costs and the lost sales in the mid-range unit. %his is due largely to the fact that the mid-range units had relatively low margins in comparison to those in the upscale unit and the timing devices unit. 3. a. %he benefits that an organi"ation reali"es from business unit reporting include the following+ •
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Improved evaluation of profit contributions of divisions, plants, product lines, and sales territories because of the separation of traceable and nontraceable costs and the separation of controllable and non-controllable costs. )etter consideration of decisions such as eliminating unprofitable business units, providing special attention to problem business units, and allocating capital to the most promising business units.
b. )usiness unit reporting on a variable cost basis not only focuses on costs that vary with production and sales but also re!uires the segregation of fi'ed costs between traceable fi'ed costs 1i.e., those directly assignable to the business unit2 and common fi'ed costs. %raceable fi'ed costs can also be further distinguished as controllable or not. ontrollable fi'ed costs could be discontinued if the business unit were to be discontinued. %hus, variable costing allows management to focus on the profit contribution of decisions or actions. /nder full costing the allocation of fi'ed manufacturing costs to inventory and cost of goods sold can introduce a bias into the calculation of profit, since profit under full costing is affected by changes in inventory levels.
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Chapter 19 - Strategic Performance Measurement—Investment Centers
18-55 (!ontin*e# -1
4. %he current approach of allocating common fi'ed e'penses on the basis of units produced is unfavorable to the 7lectronic %iming :,C by #ndra Humbus, )ridget ;yons, and >3, pp. E-:>.
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Chapter 19 - Strategic Performance Measurement—Investment Centers
19-1 Investment centers are commonly used when there are a number of business units
to be compared, andor when top management intends to evaluate the economic performance of the business unit relative to alternative investments. )y definition, managers of these business units e'ercise control over revenues, costs, and the level of investment in the business unit. %he profit per dollar invested 1usually called the BreturnC2 can be compared to the rate of return for alternative investments other types of business units or other investment possibilities. ommonly, the rate of return is determined by taking the ratio of the amount of profit divided by the amount invested in the business unit
19-2
*eturn on investment 1*OI2 is the ratio of some measure of BprofitC to some measure of Binvested capitalC for the business unit.
19-3
%he primary measurement issues for *OI are+ 0. %he effect of accounting policies, which affect the determination of Bincome.C 3. Other measurement issues for income, which include the handling of nonrecurring items in the income statement, differences in the effect of income ta'es across units, differential effect of foreign currency e'change, and the effect of cost allocation when two or more units share a facility or cost. 4. Measuring investment+ which assets to includeF . Measuring investment+ whether and how to allocate the cost of shared assets.
19-4
%he primary advantages of using return on investment 1*OI2 as a performance indicator are+ 0. It is intuitive and easily understood. 3. It provides a useful basis for comparison among )/s. 4. It is widely used. %he primary limitations of return on investment 1*OI2 as a performance indicator are+ 0. It has an e'cessive short-term focus. 3. Investment planning uses discounted cash flow 1. calculated as follows+ *OI N Income from operations before ta'es average operating assets N =0>,E3:,>>> =9>,5:>,>>> N 1316> b. %he calculation of residual income 1*I2 on the basis of average operating assets employed is as follows+ *I N income from operations before ta'es R minimum re!uired return on average assets N =0>,E3:,>>> R 1=9>,5:>,>>> >.>G2 N =0>,E3:,>>> R =5,3E5,:>> N =3.357.500
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Chapter 19 - Strategic Performance Measurement—Investment Centers
19-41 1continued2
4. %he management of *eigis teel would be more likely to accept the contemplated capital ac!uisition if residual income 1*I2 were used as the performance measure because the investment would increase both the division6s residual income and management bonuses. /sing residual income 1*I2, management would accept all investments with a return higher than GS as these investments would all increase the dollar value of *I. hen using *OI as a performance measure, *egis6 management is likely to reject any investment that would lower the current overall *OI 104.0ES for 3>0E2, even though the return is higher than the re!uired minimum, as this would lower bonus rewards. . *eigis must be able to control all items related to profits and investment if it is to be evaluated fairly as an investment center using either *OI or residual income 1*I2 as a performance measure. *eigis must control all elements of the business e'cept the cost of invested capital, that being controlled by onsolidated Industries.
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Chapter 19 - Strategic Performance Measurement—Investment Centers
19-42 /a%!*%ating Ret*rn on nvestment (R an# Resi#*a% n!ome (R; /omå Res*%ts 13: minutes2
0. a. *OI N Operating Income #verage #ssets N =3,>,>>> TU=0E,>>>,>>> V 1=0E,>>>,>>> 0.>E2W 3X N =3,>,>>> 11=0E,>>>,>>> V =0:,>G,4>2 32 N =3,>,>>> =0:,:5,05> N 1569> b. *I N Operating Income * 1#vg. #ssets Min. pre-ta' rate of return2 N =3,>,>>> * 1=0:,:5,05> >.0>2 N =3,>,>>> R =0,::,505 N =885.283 3. In this case residual income 1*I2 provides the desired incentive for local managers to make investments desired by top management. > of total demand2 to outside consumers. %he remaining capacity 13>S, or 03,:>> units2 should be used to provide should be determined for these internal sales. %he important point from the firm6s view is that these 03,:>> parts should be purchased internally, since the internal cost of =E> is less than the e'ternal cost of =9>. It is up to the two divisions to determine the right price, but to fail to transfer the units would not be acceptable from the overall firm6s view.
P=$80
+,
/(' 5what di!ision A wants /60
+, 3s Capacity / 624'00
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Chapter 19 - Strategic Performance Measurement—Investment Centers
19-50 ranser 'ri!ing; Strategy 1: minutes2
0. %here are three options for the commercial division+ buy from the internal supplier 1the industrial division2, buy from #dmiral 7lectric, or buy from #dvanced Micro. %he analysis follows, from the perspective of &MI+ )uy inside from the industrial division+ ost to &MI 1assuming the Industrial > =55:,>>> Plus+ lost contribution on Industrial : * =0::2 :,>>> 3:>,>>> =0,>3:,>>> =0,>3:,>>> :,>>> N =205 per unit )uy from #dmiral 7lectric+ ost to &MI is =30>. %he contribution on sales to #dmiral by the industrial division is ignored because these sales are not contingent on the commercial division6s decision. )uy from #dvanced Micro+ ost to &MI+ =3>> )est decision for &MI+ have the commercial division buy from #dvanced Micro, presuming the parts sold by #dvanced Micro and #dmiral 7lectric are of e!uivalent !uality and service. %he cost is the lowest, at =3>>. %he best transfer price, which would cause the buying division to autonomously make the correct decision, would be to use the selling division6s market price of =3>:. 3.
If the sales to #dmiral 7lectric by the industrial division were contingent on the commercial division6s decision, the relevant cost to &MI would be the price of =30> :,>>> units 1amount needed over the capacity of the industrial division2. %he net cost would then be the cost of =30> :,>>> N =0,>:>,>>> less the contribution from the sales to #dmiral 7lectric, E:> 1=G: * =E:2 N =0G,:>>, or =0,>4>,:>>, or =20610 &er *nit . %he correct transfer price would not change but would still be =205. as in part 0. 19-%&
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Chapter 19 - Strategic Performance Measurement—Investment Centers
19-50 1continued2
4. %he decision to have the commercial division buy outside to reduce overall costs is also consistent with a strategy of decreasing the reliance of the commercial division on products from the industrial division. If top management is unsure about the growth potential of the industrial division and has declined any new investments there, perhaps the future holds capacity reduction or divestment of the industrial division. On the other hand, it appears that the outside sales of the industrial division are currently !uite strong. %here is a good margin of =:> on its sales of part 34-E500 outside the company. Moreover, it appears that #dmiral 7lectric intends to continue to buy part 99-E0 from the industrial division, irrespective of the commercial division6s decision. %his is a positive statement about the !uality of the industrial division6s product and the !uality of its relationship with #dmiral. Perhaps top management should rethink its long-term strategy for the industrial division.
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Chapter 19 - Strategic Performance Measurement—Investment Centers
19-51 Strategy; Strategi! 'erorman!e )eas*rement; ranser 'ri!ing 1:> minutes2
0. %ransfer prices based on cost are not appropriate as a divisional performance measure, and among the reasons are because they+
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provide little incentive for the selling division to control manufacturing costs as all costs incurred will be recovered often lead to suboptimal decisions for the company as a whole
3. /sing the market price as the transfer price the contribution margin for both the Mining
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