CPAR

CPA REVIEW SCHOOL OF THE PHILIPPINES

Manila

MANAGEMENT ADVISORY SERVICES

MAS 9109
DECENTRALIZATION AND PERFORMANCE EVALUATION
RESPONSIBILITY ACCOUNTING

RESPONSIBILITY ACCOUNTING – a system of accounting wherein costs and revenues are

accumulated and reported by levels of responsibility or by responsibility centers within the
organization.

Responsibility center (also called accountability center)

– a clearly identified part or segment of an organization that is accountable for a specified
function or set of activities.
– any part of the organization that a particular manager is responsible for

TYPES OF RESPONSIBILITY CENTERS:

a. Cost Center (or expense center) – a segment of an organization in which managers are
held responsible for the costs or expenses incurred in the segment.
b. Revenue Center – where management is responsible primarily for revenues.
c. Profit Center – a segment of the organization in which the manager is held responsible for
both revenues and costs.
d. Investment Center – a segment of the organization where the manager controls revenues,
costs, and investments. The center’s performance is measured in terms of
the use of the assets as well as the revenues earned and the costs incurred.

CLASSIFICATIONS OF COSTS IN RESPONSIBILITY ACCOUNTING

1. By responsibility center
2. By cost type, as to controllability
3. By specific cost items or cost elements within each classification in (1) and (2).

RESPONSIBILITY vs. ACCOUNTABILITY

Responsibility has two facets, (1) the obligation to secure results, and (2) the obligation to
report back the results achieved to higher authority.

Accountability denotes the obligation to report results achieved to higher authority.

THE CONCEPT OF DECENTRALIZATION

Decentralization refers to the separation or division of the organization into more manageable
units wherein each unit is managed by an individual who is given decision authority and held
accountable for his decisions.
• Goal congruence – all members of an organization have incentives to perform for a common
interest.
• Sub-optimization – occurs when one segment of a company takes action that is in its own best
interests, but is detrimental to the firm as a whole.

BENEFITS OF DECENTRALIZATION
1. Better access to local information
2. Cognitive limitations
3. More timely response
4. Focusing of central management
5. Training and evaluation
6. Motivation
7. Enhanced competition.
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COSTS OF DECENTRALIZATION
1. Some decisions made in one sub-unit may bring about negative effect to the other sub-units
or the organization as a whole.
2. Decentralization necessitates a more elaborate reporting system hence, the costs of
gathering and reporting of data increase.
3. Job duplication or overlapping of functions is usually encountered in a decentralized set-up.

MEASURING THE PERFORMANCE OF INVESTMENT CENTERS

Performance measures for investment centers usually attempt to assess how well managers are
utilizing invested assets of the division to produce profits by relating operating profits to assets.

Return on investment (ROI) is the most common measure of performance for investment centers.
ROI can be defined as follows:

Operating Income
ROI =
Average Operating Assets

Operating income refers to earnings before interest and taxes. Operating assets include all assets
acquired to generate operating income, including cash, receivables, inventories, land, buildings, and
equipment.

The ROI formula can also be broken down into the product of margin and turnover. Margin is the
ratio of operating income to sales. Turnover is defined as sales divided by average operating
assets.
ROI = Margin x Turnover
or
Operating Income Sales
ROI = x
Sales Average Operating Assets

Three advantages of using ROI to evaluate the performance of investment centers:

1. It encourages managers to pay careful attention to the relationships among sales, expenses,
and investment, as should be the case for a manager of an investment center.
2. It encourages cost efficiency.
3. It discourages excessive investment in operating assets.

Two disadvantages of using ROI are:

1. It discourages managers from investing in projects that would decrease the divisional ROI
but would increase the profitability of the company as a whole. (Generally, projects with an
ROI less than a division’s current ROI would be rejected.)
2. It can encourage myopic behavior, in that managers may focus on the short run at the
expense of the long run.

Residual income (RI) - the difference between operating income and the minimum peso return
required on a company’s operating assets. The equation for RI can be
expressed as follows:

RI = Operating Income − (Minimum Rate of Return x Operating Assets)

ECONOMIC VALUE ADDED (EVA) – a more specific version of residual income. It represents the
segment’s true economic profit because it measures the benefit obtained by using resources
in a particular way.
After-tax operating income
(EBIT x[1 – Tax Rate]) xx
Less desired income
(After-tax WACC* x [Total assets – Current liabilities]) xx
Economic Value Added (EVA) xx

* WACC = Weighted average cost of capital

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TRANSFER PRICING
TRANSFER PRICE – the monetary value or the price charged by one segment of a firm for the
goods and services it supplies to another segment of the same firm.

OBJECTIVES OF TRANSFER PRICING

1. To facilitate optimal decision-making.
2. To provide a basis in measuring divisional performance.
3. To motivate the different department heads in improving their performance and that of their
departments.

APPROACHES FOR DETERMINING TRANSFER PRICE:

1. Negotiated transfer price
2. Cost-based transfer price
3. Market-based transfer price

General Rules in Choosing a Transfer Price

• The maximum price should be no greater than the lowest market price at which the
buying segment can acquire the goods or services externally.
• The minimum price should be no less than the sum of the selling segment’s incremental
costs associated with the goods or services plus the opportunity cost of the facilities
used.

• A good should be transferred internally whenever the minimum transfer price (set by
the selling division) is less than the maximum transfer price (set by the buying division).
By using this rule, total profits of the firm are not decreased by an internal transfer.

THE BALANCED SCORECARD: STRATEGIC-BASED CONTROL

The Balanced Scorecard is a strategic management system that defines a strategic-based

responsibility accounting system.
Strategy is defined as choosing the market and customer segments the business unit intends
to serve, identifying the critical internal and business processes that the unit must excel at to
deliver the value propositions to customers in the targeted market segments, and selecting the
individual and organizational capabilities required for the internal, customer, and financial
objectives.

The Balanced Scorecard translates an organization’s mission and strategy into operational
objectives and performance measures for four different perspectives: the financial
perspective, the customer perspective, the internal business process perspective, and the
learning and growth (infrastructure) perspective.

Common characteristics of balanced scorecards

a. It should be possible, by examining a company’s balanced scorecard, to infer its strategy and
the assumptions underlying that strategy.
b. The balanced scorecard should emphasize continuous improvement rather than just meeting
present standards or targets.
c. Some of the performance measures on the balanced scorecard should be non-financial.
d. The scorecards for individuals should contain only those performance measures they can
actually influence.
e. The ultimate objectives of the organization are usually financial, but better financial results
cannot be attained without improving customers’ perceptions of the company’s products and
services. In order to improve customers’ perceptions of products and services, it is usually
necessary to improve internal business processes so that the products and services are actually
better. And in order to improve the business processes, it is necessary that employees learn.

The balanced scorecard as a motivation and feedback mechanism. The performance

measures on the balanced scorecard provide motivation and feedback for improving.
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The Financial Perspective

The financial perspective establishes the long- and short-term financial performance
objectives. The financial perspective is concerned with the global financial consequences of
the other three perspectives. Thus, the objectives and measures of the other perspectives
must be linked to the financial objectives. The financial perspective has three strategic
themes: revenue growth, cost reduction, and asset utilization.

Customer Perspective

The customer perspective is the source of the revenue component for the financial
objectives. This perspective defines and selects the customer and market segments in which
the company chooses to compete.

Process Perspective

To provide the framework needed for this perspective, a process value chain is defined. The
process value chain is made up of three processes: the innovation process, the operations
process, and the post sales process.

Cycle time is the time required to produce one unit of product.

Velocity is the number of units that can be produced in a given period of time (e.g.,
units per hour).

Learning/Innovation and Growth Perspective

The learning and growth perspective is the source of the capabilities that enable the
accomplishment of the other three perspectives’ objectives.

SOME INTERNAL BUSINESS PROCESS PERFORMANCE MEASURES.

a. Delivery Cycle Time. This is the total elapsed time between when an order is placed by a
customer and when it is shipped to the customer. Part of this time is wait time that
occurs before the order is placed into production.

b. Throughput (Manufacturing Cycle) Time. This is the total elapsed time between when
an order is initiated into production and when it is shipped to the customer. It consists
of process time, inspection time, move time, and queue time. The only element that
adds value is processing time. Inspection time, move time, queue time, and their
associated activities do not add value and should be minimized.

c. Manufacturing Cycle Efficiency (MCE). MCE is the ratio of value-added time (i.e.,
process time) to total throughput time. It represents the percentage of time an order is
in production in which useful work is being done. The rest of the time represents non-
value-added time (i.e., inspection time, move time, and queue time).

Manufacturing Cycle Efficiency (MCE) can be found as follows:

Processing time
MCE =
Processing time + Move Time + Inspection Time + Wait time

QUALITY COST MEASUREMENT:

Quality-linked activities are those activities performed because poor quality may or does exist.
Costs of quality are costs that exist because poor quality may or does exist.

Control activities are performed by an organization to prevent or detect poor quality. Control
costs are the costs of performing control activities. There are two broad categories of control
costs: prevention costs and appraisal costs. Prevention costs are incurred to prevent poor
quality in the products or services being produced. Appraisal costs are incurred to determine
whether products and services are conforming to their requirements or customer needs.
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Failure activities are performed by an organization or its customers in response to poor quality.
Failure costs are the costs incurred by an organization because failure activities are
performed. There are two broad categories of failure costs: internal failure costs and
external failure costs. Internal failure costs are incurred because products and services do
not conform to specifications or customer needs and the nonconformance is detected prior
to being delivered to outside parties. External failure costs are incurred because products
or services fail to conform to requirements or satisfy customer needs and the
nonconformance is detected after being delivered to outside parties.

PRODUCTIVITY MEASUREMENT

Productivity – measures the relationship between actual inputs used (both quantities and costs)
and actual outputs produced.

Partial productivity – compares the quantity of output produced with the quantity of an individual
input used.

𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑜𝑢𝑡𝑝𝑢𝑡 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑

Partial Productivity =
𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑖𝑛𝑝𝑢𝑡 𝑢𝑠𝑒𝑑

Total Factor Productivity – the ratio of quantity of output produced to the costs of all inputs used
based on current period prices.

𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑜𝑢𝑡𝑝𝑢𝑡 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑

Total factor productivity =
𝐶𝑜𝑠𝑡𝑠 𝑜𝑓 𝑎𝑙𝑙 𝑖𝑛𝑝𝑢𝑡𝑠 𝑢𝑠𝑒𝑑

EXERCISES:

1. Best Workplace (BW), a division of Modular Office Corporation, buys and installs modular
office components. For the most recent year, the division had the following performance
targets:

Asset turnover 2.5

Profit margin 6%
Target rate of return on investments for RI 13%
Cost of capital 10%
Income tax rate 40%

Actual information concerning the company’s performance for last year follows:

Total assets at beginning of year P3,600,000

Total assets at end of year 5,300,000
Total invested capital (annual average) 8,000,000
Sales 9,000,000
Variable operating costs 3,650,000
Direct fixed costs 4,770,000
Allocated fixed costs 675,000

REQUIRED:

a. For BW, compute the segment margin and the average assets for the year.
b. Based on segment margin and average assets, compute the profit margin, asset
turnover and ROI.
c. Evaluate the ROI performance of BW.
d. Using your answers from part b., compute the residual income of BW.

2. The Sporty Company produces a wide variety of sports equipment. Its newest division,
Golf Pro, manufactures and sells a single product— AccuClub, a golf club that uses
global positioning satellite technology to improve the accuracy of golfers’ shots. The
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demand for AccuClub is relatively insensitive to price changes. The following data are
available for Golf Pro, which is an investment center for Sporty:

Total annual fixed costs P30,000,000

Variable cost per AccuClub P 500
Number of AccuClubs sold each year 150,000
Average operating assets invested in the division P48,000,000

REQUIRED:

1. Compute Golf Pro’s ROI if the selling price of AccuClubs is P720 per club. 6.25%
2. If management requires an ROI of at least 25% from the division, what is the
minimum selling price that the Golf Pro Division should charge per AccuClub?
P780
3. Assume that Sporty judges the performance of its investment centers on the
basis of RI rather than ROI. What is the minimum selling price that Golf Pro
should charge per AccuClub if the company’s required rate of return is 20%?
P764

3. “I know Headquarters wants us to add that new product line,” said John Erick, manager
of Fabula Company’s Office Products Division. “But I want to see the numbers before I
make any move. Our division’s return on investment (ROI) has led the company for
three years, and I don’t want any letdown.”

Fabula Company is a decentralized wholesaler with five autonomous divisions. The

divisions are evaluated on the basis of ROI, with year-end bonuses given to the
divisional managers who have the highest ROI. Operating results for the company’s
Office Products Division for the most recent year are given below:

Sales P10,000,000
Variable expenses 6,000,000
Contribution margin P 4,000,000
Fixed expenses 3,200,000
Operating income P 800,000

Divisional operating assets P 4,000,000

The company had an overall return on investment (ROI) of 15% last year (considering
all divisions). The Office Products Division has an opportunity to add a new product line
that would require an additional investment in operating assets of P1,000,000. The
costs and revenue characteristics of the new product line per year would be:

Sales P2,000,000
Variable expenses 60% of sales
Fixed expenses P 640,000

Required:
1. Compute the Office Product Division’s ROI for the most recent year, also
compute the ROI as it would appear if the new product line is added.
2. If you were in John Erick's position, would you accept or reject the new product
line? Explain.
3. Why do you suppose Headquarters is anxious for the Office Products Division
to add the new product line?
4. Suppose that the company’s minimum required rate of return on operating
assets is 12% and that performance is evaluated using residual income.
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a. Compute the Office Products Division’s residual income for the most
recent year. Compute also the residual income as it would appear if the
new product line is added.
b. Under these circumstances, if you were in John Erick’s position, would
you accept or reject the new product line? Explain.

4. Adan, Inc. reported these data at year-end:

Operating income before tax P 7,500,000
Total assets 45,000,000
Total liabilities 12,000,000
Current liabilities 4,500,000
Weighted average cost of capital 12%
Income tax rate 25%

REQUIRED: Calculate the Economic Value Added (EVA).

TRANSFER PRICING

5. Xander Appliance Company’s Audio Division produces a speaker that is used by

manufacturers of various audio products. Sales and cost data on the speaker follow:

Selling price per unit on the intermediate market P60

Variable costs per unit P42
Fixed costs per unit (based on capacity) P8
Capacity in units 25,000

Xander Appliance Company has a TV Division that could use this speaker in one of its
products. The TV Division will need 5,000 speakers per year. It has received a quote of
P57 per speaker from another manufacturer. Xander Appliance Company evaluates
division managers on the basis of divisional profits.

Required:
1. Assume that the Audio Division is now selling only 20,000 speakers per year to
outside customers.
a. From the standpoint of the Audio Division, what is the lowest acceptable
transfer price for speakers sold to the TV Division?
b. From the standpoint of the TV Division, what is the highest acceptable transfer
price for speakers acquired from the Audio Division?
c. If left free to negotiate without interference, would you expect the division
managers to voluntarily agree to the transfer of 5,000 speakers from the Audio
Division to the TV Division? Why or why not?
d. From the standpoint of the entire company, should the transfer take place?
Why or why not?

2. Assume that the Audio Division is selling all of the speakers that in can produce to
outside customers.
a. From the standpoint of the Audio Division, what is the lowest acceptable
transfer price for speakers sold to the TV Division?
b. From the standpoint of the TV Division, what is the highest acceptable transfer
price for speakers acquired from the Audio Division?
c. If left free to negotiate without interference, would you expect the division
managers to voluntarily agree to the transfer of 5,000 speakers from the Audio
Division to the TV Division? Why or why not?
d. From the standpoint of the entire company, should the transfer take place?
Why or why not?
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6. GreenThumb, Inc., is a nursery products firm. It has three divisions that grow and sell
plants: the Western Division, the Southern Division, and the Central Division.

Recently, the Southern Division of GreenThumb acquired a plastics factory that

manufactures green plastic pots. These pots can be sold both externally and internally.
Company policy permits each manager to decide whether to buy or sell internally. Each
divisional manager is evaluated on the basis of return on investment and EVA.

The Western Division had bought its plastic pots in lots of 100 from a variety of vendors.
The average price paid was P75 per box of 100 pots. However, the acquisition made Nay
Sy, manager of the Western Division, wonder whether a more favorable price could be
arranged. She decided to approach Flint, manager of the Southern Division, to see if he
wanted to offer a better price for an internal transfer. She suggested a transfer of 3,500
boxes at P70 per box.

Flint gathered the following information regarding the cost of a box of 100 pots:
Direct materials P35
Direct labor 8
Variable overhead 10
Fixed overhead* 10
Total unit cost P63

Selling price P75

Production capacity 20,000 boxes

*Fixed overhead is based on P200,000/20,000 boxes.

REQUIRED:
1. Suppose that the plastics factory is producing at capacity and can sell all that it
produces to outside customers. How should Flint respond to Nay’s request for a lower
transfer price?
2. Now assume that the plastics factory is currently selling 16,000 boxes. What are the
minimum and maximum transfer prices? Should Flint consider the transfer at P70 per
box?
3. Suppose that GreenWorld’s policy is that all transfer prices be set at full cost plus 20
percent. Would the transfer take place? Why or why not?
1. Flint should not reduce the price charged to Nay if he can sell all he produces. It does not matter whether the
two divisions trade internally or not.
2. The minimum price is P53, and the maximum is P75. Yes, Flint should consider the transfer, since his income
will increase by P59,500 [3,500(P70 – P53)].
3. The transfer price would be P75.60 (P63 × 1.2). No, the transfer would not occur, since the transfer price is
higher than the outside price that Nay could get.

7. Balanced scorecards contain a number of factors that are important to the success of a
business. These factors are often divided into four categories: financial, customer, learning
and growth, and internal operations.

Consider the factors that follow.

a. Number of customer complaints

b. On-time deliveries as a percentage of all deliveries
c. Suggestions per employee
d. Number of new customers
e. Defect-free units as a percentage of completed units
f. Employee turnover
g. Unfavorable standard cost variances
h. Market share
i. Time from call by customer to repair of product
j. Cash flow from operations
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l. Hours of in-house training per employee

m. Gross margin
n. Percentage of customers retained from last period
o. Product returns as a percentage of sales

REQUIRED:
Determine the proper classification (financial, customer, learning and growth, or
internal business process) for each of the factors listed.

8. The following information for a recent project was taken from the records of
Gatwick Company:

Processing time 15.0 days

Inspection time 0.5 days
Waiting time:
From order receipt until start of production 6.0 days
From start of production through project completion 3.0 days
Move time 1.5 days

REQUIRED:
a. How long did it take to complete the project once production commenced?
b. Compute the manufacturing cycle efficiency.
c. As judged by the cycle efficiency, what percentage of the overall production time
was spent on (1) value-adding activities and (2) non-value adding activities?

9. Pinto Company manufactures high-quality wooden doors used in home construction. Pinto
produces doors in batches of 70 units. The following information pertains to operations
during February.
Processing time (average per batch) 20 hours
Inspection time (average per batch) 4 hour
Waiting time (average per batch) 5 hours
Move time (average per batch) 6 hours

REQUIRED:
Compute the following operational measures:
1. average value-added time per batch
2. average nonvalue- added time per batch
3. manufacturing cycle efficiency
4. manufacturing cycle time
5. velocity.

10. Box Co. manufactures hand-made pine storage boxes for a variety of clients. As production
manager, you have developed the following value chart:

Operation Average Number of Days

Receiving materials 1
Storing materials 2
Handling materials 3
Cutting/measuring materials 6
Assembling materials 4
Building boxes 7
Attaching hinges 2
Inspection 1

REQUIRED:
a. Determine the value-added activities and their total time.
b. Determine the non-value-added activities and their total time.
c. Calculate the manufacturing cycle efficiency.
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a. Value-added activities Time

Cutting/measuring materials 6
Assembling materials 4
Building boxes 7
Attaching hinges 2
Total production time (days) 19

b. Non-value-added activities Time

Receiving 1
Storing 2
Handling 3
Inspection 1
Total nonproduction time (days) 7

c. Total lead time = 19 + 7 = 26 days

MCE = 19/26 = 73.1%

11. Laudencio, Inc. automated its plant at the start of the current year and installed a flexible
manufacturing system. The company is also evaluating its suppliers and moving toward
Lean Production. Many adjustment problems have been encountered, including problems
relating to performance measurement. After much study, the company has decided to
use the performance measures below, and it has gathered data relating to these measures
for the first four months of operations.

January February March April

Throughput time (days) ? ? ? ?
Delivery cycle time (days) ? ? ? ?
Manufacturing cycle efficiency (MCE) ? ? ? ?

Percentage of on-time deliveries 91% 86% 83% 79%

Total sales (units) 3,210 3,072 2,915 2,806

Management has asked for your help in computing throughput time, delivery cycle time,
and MCE. The following average times have been gathered:

Average Per Month (in days)

January February March April
Move time per unit 0.4 0.3 0.4 0.4
Process time per unit 2.1 2.0 1.9 1.8
Wait time per order before start
of production 16.0 17.5 19.0 20.5
Queue time per unit 4.3 5.0 5.8 6.7
Inspection time per unit 0.6 0.7 0.7 0.6

REQUIRED:
1. For each month, compute the following:
a. The throughput time 7.4; 8.0; 8.8; 9.5
b. The manufacturing cycle efficiency (MCE) 28.4%; 25.0%; 21.6%; 18.9%
c. The delivery cycle time 23.4; 25.5; 27.8; 30.0

2. Evaluate the company’s performance over the given four months (January to April).

All of the performance measures display unfavorable trends. Throughput time per unit is
increasing—largely because of an increase in queue time. Manufacturing cycle efficiency is
declining and delivery cycle time is increasing. In addition, the percentage of on-time deliveries
has dropped.

3. Refer to the move time, process time, and so forth given for the month of April.
a. Assume that in May, the move time, process time, and so forth are the same as
in April, except that through the use of Lean Production, the company is able to
completely eliminate the queue time during production. Compute the new
throughput time and MCE. 2.8; 64.3%
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b. Assume that in June, the move time, process time, and so forth, are again the
same as in April, except that the company is able to completely eliminate both
the queue time during production and the inspection time. Compute the new
throughput time and MCE. 2.2; 81.8%

As a company reduces non-value-added activities, the manufacturing cycle efficiency

increases rapidly. The goal, of course, is to have an efficiency of 100%. This will be achieved
when all non-value-added activities have been eliminated and process time is equal to
throughput time.

12. Salido Enterprises has identified the following as having an impact on the company's
quality costs:
a. Inspection of manufactured goods on assembly line
b. Warranty repairs
c. Employee training
d. Quality engineering/design
e. Units repaired at customers' site
g. Customer complaints
h. Product liability
i. Rework of defective goods before transfer to finished goods
j. Preventive maintenance for equipment
k Evaluation of suppliers

REQUIRED:
Classify the eleven costs as prevention, appraisal, internal failure, or external failure.

11. Kalidad Company's quality cost report is to be based on the following data:
Supervision of testing and inspection activities P29,000
Warranty repairs and replacements P12,000
Net cost of scrap P53,000
Test and inspection of materials P23,000
Technical support provided to suppliers P71,000
Disposal of defective products P94,000
Quality data gathering, analysis, and reporting P47,000
Liability arising from defective products P75,000
Depreciation of test equipment P22,000

REQUIRED:
Compute the total amount of (a) prevention costs, P118,000 (b) appraisal costs, P74,000(c)
internal failure costs, P147,000 and (d) external failure costs. P87,000

WINDING UP

RESPONSIBILITY ACCOUNTING & TRANSFER PRICING

1. Belle, Inc. uses an accounting system that charges costs to the manager who has been
delegated the authority to make decisions incurring the costs. For example, if the sales
manager accepts a rush order that will result in higher-than-normal manufacturing costs,
these additional costs are charged to the sales manager because the authority to accept
or decline the rush order was given to the sales manager. This type of accounting system
is known as
a. responsibility accounting. c. reciprocal allocation.
b. functional accounting. d. transfer price accounting.

2. In responsibility accounting, a center’s performance is measured by controllable costs.

Controllable costs are best described as including
a. direct material and direct labor only.
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b. only those costs that the manager can influence in the current time period.
c. only discretionary costs.
d. those costs about which the manager is knowledgeable and informed.

3. A segment of an organization is referred to as a service center if it has

a. responsibility for developing markets and selling the output of the organization.
b. responsibility for combining the raw materials, direct labor, and other factors of
production into a final output.
c. authority to make decisions affecting the major determinants of profit including the
power to choose its markets and sources of supply.
d. authority to provide specialized support to other units within the organization.

4. The basic purpose of a responsibility accounting system is

a. budgeting c. authority.
b. motivation. d. variance analysis.

5. A successful responsibility accounting reporting system is dependent upon

a. the correct allocation of controllable variable costs.
b. identification of the management level at which all costs are controllable.
c. the proper delegation of responsibility and authority.
d. a reasonable separation of costs into their fixed and variable components since fixed
costs are not controllable and must be eliminated from the responsibility report.

6. Which one of the following statements pertaining to the return on investment (ROI) as a
performance measurement is incorrect?
a. When the average age of assets differs substantially across segments of a business,
the use of ROI may not be appropriate.
b. ROI relies on financial measures that are capable of being independently verified,
while other forms of performance measures are subject to manipulation.
c. The use of ROI may lead managers to reject capital investment projects that can
be justified by using discounted cash flow models.
d. The use of ROI can make it undesirable for a skillful manager to take on trouble-
shooting assignments such as those involving turning around unprofitable divisions.

7. Yuri’s Service Co. is a service center. For the month of June, Yuri had the following
operating statistics:
Sales P750,000
Operating income 25,000
Net profit after taxes 8,000
Total assets available 500,000
Shareholders’ equity 200,000
Cost of capital 6%
Yuri has a
a. return on investment of 3.33%. c. return on investment of 6%.
b. residual income of P(5,000). d. residual income of P(20,000).

8. Listed below is selected financial information for the Northern Division of Hanziel Company
for last year:
Account Amount (in thousands)
Average working capital P 625
General and administrative expenses 75
Net sales 4,000
Average plant and equipment 1,775
Cost of goods sold 3,525

If Hanziel treats the Northern Division as an Investment Center for performance

measurement purposes, what is the before-tax return on investment (ROI) for last year?
a. 34.78% c. 19.79%
b. 22.54% d. 16.67%
MAS 9109 DECENTRALIZATION AND PERFORMANCE EVALUATION
Page 13 of 15

9. Apple is the general manager of the Industrial Product Division, and his performance is
measured using the residual income method. Apple is reviewing the following forecasted
information for his division for next year:
Category Amount (in thousands)
Working capital P 1,800
Revenue 30,000
Plant and equipment 17,200

If the imputed interest charge is 15% and Apple wants to achieve a residual income target
of P2,000,000, what will costs have to be in order to achieve the target?
a. P 9,000,000 c. P25,150,000
b. P10,800,000 d. P25,690,000

10. Vicky Co. is a computer service center. For the month of May, Vicky had the following
operating statistics:
Sales P450,000
Operating income 25,000
Net profit after taxes 8,000
Total assets 500,000
Shareholders’ equity 200,000
Cost of capital 6%

Based on the above information, which one of the following statements is correct? Vicky

has a
a. return on investment of 4%. c. return on investment of 1.6%.
b. residual income of P(5,000). d. residual income of P(22,000).

11. The price that one division of a company charges another division for goods or services
provided is called the
a. market price. c. outlay price.
b. transfer price. d. distress price.

12. The most fundamental responsibility center affected by the use of market-based transfer
prices is a(n)
a. production center. c. cost center.
b. investment center. d. profit center.

13. Transfer price should encourage goal congruence and managerial effort. In a
decentralized organization, it should also encourage autonomous decision-making.
Managerial effort is
a. the desire and the commitment to achieve a specific goal.
b. the sharing of goals by supervisors and subordinates.
c. the extent to which individuals have the authority to make decisions.
d. the extent of the attempt to accomplish a specific goal.

14. Goal congruence is

a. the desire and the commitment to achieve a specific goal.
b. the sharing of goals by supervisors and subordinates.
c. the extent to which individuals have the authority to make decisions.
d. the extent of the attempt to accomplish a specific goal.

15. Motivation is
a. the desire and the commitment to achieve a specific goal.
b. the sharing of goals by supervisors and subordinates.
c. the extent to which individuals have the authority to make decisions.
d. the extent of the attempt to accomplish a specific goal.
MAS 9109 DECENTRALIZATION AND PERFORMANCE EVALUATION
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16. In theory, the optimal method for establishing a transfer price is

a. flexible budget cost. c. budgeted cost with or without
mark-up.
b. incremental cost. d. market price.

17. An appropriate transfer price between two divisions of GMA Company can be determined
from the following data:
Fabricating Division
Market price of sub-assembly P50
Variable cost of sub-assembly P20
Excess capacity (in units) 1,000

Assembling Division
Number of units needed 900

What is the natural bargaining range for the two divisions?

a. Between P20 and P50 c. Any amount less than P50.
b. Between P50 and P70 d. P50 is the only acceptable price.

Items 18 to 20 are based on the following information:

River Park, Inc. has several divisions that operate as decentralized profit centers. River
Park’s Entertainment Division manufactures video arcade equipment using the products
of two of River Park’s other divisions. The Plastics Division manufactures plastic
components, one type that is made exclusively for the Entertainment Division, while other
less complex components are sold to outside markets. The products of the Video Cards
Division are sold in a competitive market; however, one video card model is also used by
the Entertainment Division.

The actual costs per unit used by the Entertainment Division are presented below:
Plastic Components Video Cards
Direct materials P1.25 P2.40
Direct labor 2.35 3.00
Variable overhead 1.00 1.50
Fixed overhead 0.40 2.25
Total cost P5.00 P9.15

The Plastics Division sells its commercial products at full cost plus a 25% markup and
believes the proprietary plastic component made for the Entertainment Division would sell
for P6.25 per unit on the open market. The market price of the video card used by the
Entertainment Division is P10.98 per unit.

18. A per-unit transfer price from the Video Cards Division to the Entertainment Division at
full cost, P9.15, would
a. allow evaluation of both divisions on a competitive basis.
b. satisfy the Video Cards Division’s profit desire by allowing recovery of opportunity
costs.
c. provide no profit incentive for the Video Cards Division to control or reduce costs.
d. encourage the Entertainment Division to purchase video cards from an outside
source.

19. Assume that the Entertainment Division is able to purchase a large quantity of video cards
from an outside source at P8.70 per unit. The Video Cards Division, having excess
capacity, agrees to lower its transfer price to P8.70 per unit. This action would
a. optimize the profit goals of the Entertainment Division while subverting the profit
goals of River Park, Inc.
b. allow evaluation of both divisions on the same basis.
MAS 9109 DECENTRALIZATION AND PERFORMANCE EVALUATION
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c. subvert the profit goals of the Video Cards Division while optimizing the profit goals
of the Entertainment Division.
d. optimize the overall profit goals of River Park, Inc.

20. Assume that the Plastics Division has excess capacity and it has negotiated a transfer
price of P5.60 per plastic component with the Entertainment Division. This price will
a. cause the Plastics Division to reduce the number of commercial plastic components
it manufactures.
b. motivate both divisions as estimated profits are shared.
c. encourage the Entertainment Division to seek an outside source for plastic
components.
d. demotivate the Plastics Division causing mediocre performance.

1. A 11. B
2. B 12. D
3. D 13. D
4. B 14. B
5. C 15. A
6. B 16. D
7. B 17. A
8. D 18. C
9. C 19. D
10. B 20. B

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