Chapter 19—Performance Measurement, Balanced Scorecards, and Performance

Rewards

LEARNING OBJECTIVES
LO 1 Why is a mission statement important to an organization?
LO 2 What roles do performance measures serve in organizations?
LO 3 What guidelines or criteria apply to the design of performance measures?
LO 4 What are the common short-term financial performance measures, and how are
they calculated and used?
LO 5 Why should company management focus on long-run performance?
LO 6 What factors should managers consider when selecting nonfinancial performance
measures?
LO 7 Why is it necessary to use multiple measures of performance?
LO 8 How can a balanced scorecard be used to measure performance?
LO 9 What difficulties are encountered in trying to measure performance for multinational
firms?
LO 10 What is compensation strategy, and what factors must be considered in designing the
compensation plan?

QUESTION GRID

True/False
Difficulty Level Learning Objectives
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Completion
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Multiple Choice
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Short Answer
Difficulty Level Learning Objectives
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Problem
Difficulty Level Learning Objectives
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TRUE/FALSE

-
1. An organization’s values statement identifies fundamental beliefs about what is important to the
organization.

ANS: T DIF: Easy OBJ: 19-1

2. An organization typically develops a values statement before developing a mission statement.

ANS: F DIF: Easy OBJ: 19-1

3. The objectives identified in an organization’s values statement must be objective in nature.

ANS: F DIF: Easy OBJ: 19-1

4. In order to assure achievement of an organizational goal, performance measures must be established

for that goal.

ANS: T DIF: Easy OBJ: 19-2

5. Internal performance measures focus on the efficiency and effectiveness of an organization’s

production process.

ANS: T DIF: Easy OBJ: 19-2

6. External performance measures focus on the efficiency and effectiveness of an organization’s

production process.

ANS: F DIF: Easy OBJ: 19-2

7. The most common external performance measure used for all organizations is financial in nature.

ANS: T DIF: Moderate OBJ: 19-2

8. Performance measures need not be correlated with the mission of a subunit.

ANS: F DIF: Moderate OBJ: 19-3

9. Benchmarks for performance measures may be monetary or non-monetary.

ANS: T DIF: Easy OBJ: 19-3

10. The segment margin of a profit or investment center includes allocated common costs.

ANS: F DIF: Moderate OBJ: 19-4

11. The segment margin of a profit or investment center does not include allocated common costs.

ANS: T DIF: Moderate OBJ: 19-4

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12. Manipulation of segment expenses may result in the segment margin not being an accurate
performance measure.

ANS: T DIF: Moderate OBJ: 19-4

13. Profit margin indicates management’s efficiency with regard to sales and expenses.

ANS: T DIF: Moderate OBJ: 19-4

14. Asset turnover measures the effective use of assets relative to revenue production.

ANS: T DIF: Moderate OBJ: 19-4

15. Economic value added (EVA) applies the target rate of return to the market value of the capital
invested in a division.

ANS: T DIF: Moderate OBJ: 19-4

16. Economic value added (EVA) applies the target rate of return to the book value of the assets invested
in a division.

ANS: F DIF: Moderate OBJ: 19-4

17. Economic value added (EVA) is a more appropriate performance measure when there is a large
difference between the market value of invested capital and the book value of assets.

ANS: T DIF: Moderate OBJ: 19-4

18. Economic value added (EVA) is focused on short-term performance measurement.

ANS: T DIF: Moderate OBJ: 19-4

19. Financial measures are lagging indicators.

ANS: T DIF: Easy OBJ: 19-5

20. Speed of delivery is an example of a leading indicator.

ANS: T DIF: Moderate OBJ: 19-5

21. Non-financial measures are generally more indicative of productive activity than are financial
performance measures.

ANS: T DIF: Easy OBJ: 19-6

22. Non-financial measures are generally less timely than are financial performance measures.

ANS: F DIF: Easy OBJ: 19-6

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 23. Non-financial measures are generally more appropriate for gauging teamwork than are financial
performance measures.

ANS: T DIF: Easy OBJ: 19-6

24. The number of good units or quantity of services that are produced and sold by an organization within
a specified time is referred to as process quality yield.

ANS: F DIF: Moderate OBJ: 19-7

25. Total units produced during the period divided by the value-added processing time is referred to as
process productivity.

ANS: T DIF: Moderate OBJ: 19-7

26. The balanced scorecard approach complements measures of past performance with measures of the
drivers of future performance.

ANS: T DIF: Easy OBJ: 19-8

27. Cultural differences between countries may make performance evaluation in multinational settings
more difficult.

ANS: T DIF: Easy OBJ: 19-9

28. Hourly compensation provides a definite link between performance and reward.

ANS: F DIF: Moderate OBJ: 19-10

29. In a pay-for-performance plan, defined performance measures must be highly correlated with an
organization’s operational targets.

ANS: T DIF: Moderate OBJ: 19-10

30. Tax deferral is the most desirable form of tax treatment for employee compensation elements.

ANS: F DIF: Easy OBJ: 19-10

31. Expatriate workers should receive a compensation package that reflects cost of living factors and
currency fluctuations.

ANS: T DIF: Easy OBJ: 19-10

COMPLETION

1. A statement that identifies fundamental beliefs about what is important to an organization is referred to
as a ________________________________.

ANS: values statement

DIF: Easy OBJ: 19-1

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 2. Performance measures that provide a focus on the efficiency and effectiveness of production processes
are referred to as ________________ measures.

ANS: internal

DIF: Moderate OBJ: 19-2

3. Performance measures that reflect an organization’s ability to satisfy customers better than rival firms
do are referred to as ________________ measures.

ANS: external

DIF: Moderate OBJ: 19-2

4. The ratio of income to assets invested is referred to as ______________________________.

ANS: return on investment (ROI)

DIF: Easy OBJ: 19-4

5. The ratio of income to sales is referred to as ______________________________.

ANS: profit margin

DIF: Easy OBJ: 19-4

6. The ratio of sales to assets is referred to as ______________________________.

ANS: asset turnover

DIF: Easy OBJ: 19-4

7. Profit margin x Asset Turnover is often referred to as the _____________________

ANS: DuPont Model

DIF: Moderate OBJ: 19-4

8. Profit earned in excess of an amount charged for funds committed to a profit center is referred to as
______________________________________.

ANS: residual income

DIF: Easy OBJ: 19-4

9. A measure of profit produced above the cost of capital is referred to as

_____________________________________.

ANS: economic value added (EVA)

DIF: Moderate OBJ: 19-4

PMY At =
pot 655

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044%4*4*1=-01 1 0
 10. An indicator that reflects the results of past decisions is referred to as a(n)
________________________________.

ANS: lagging indicator

DIF: Easy OBJ: 19-5

11. Statistical data about the steps that will create the results desired as referred to as
__________________________________________.

ANS: leading indicators

DIF: Easy OBJ: 19-5

12. The number of good units or quantity of services that are produced and sold by an organization within
a specified time is referred to as _________________________.

ANS: throughput

DIF: Moderate OBJ: 19-7

13. Total units produced during the period divided by the value-added processing time is referred to as
_________________________________________.

ANS: process productivity

DIF: Medium OBJ: 19-7

14. The proportion of good units resulting from activities is referred to as

____________________________________.

ANS: process quality yield

DIF: Moderate OBJ: 19-4

15. The three components of throughput are _____________________________________,

_______________________________, and ________________________________.

ANS: manufacturing cycle efficiency, process productivity, process quality yield

DIF: Moderate OBJ: 19-7

MULTIPLE CHOICE

1. Variance analysis would be appropriate to measure performance in

a. profit centers.
b. investment centers.
c. cost centers.
d. all of the above.
ANS: D DIF: Easy OBJ: 19-4

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2. Which of the following responsibility centers may be evaluated on the basis of residual income?
a. investment center
b. revenue center
c. profit center
d. cost center
ANS: A DIF: Easy OBJ: 19-4

3. Net cash flow could be used to measure performance in

a. cost centers and investment centers.
b. revenue centers and profit centers.
c. revenue centers and investment centers.
d. profit and investment centers.
ANS: D DIF: Easy OBJ: 19-4

4. Using a single performance evaluation criterion for an investment center

a. is most effective because a manager can concentrate on a single goal.
b. can result in manipulation of the performance measure.
c. allows multinational investment centers' performances to be equitably compared.
d. is only appropriate if the criterion is non-monetary.
ANS: B DIF: Easy OBJ: 19-3,19-7

5. A company has set a target rate of return of 16% for its investment center. An investment center
manager in this company would
a. acquire assets that would increase divisional income by more than 16%.
b. sell all assets that do not generate divisional income of more than 16%.
c. acquire assets that would increase sales by more than 16%.
d. acquire any technologically advanced assets that would cause costs to be reduced by 16%
or more.
ANS: A DIF: Easy OBJ: 19-4

6. In evaluating the performance of a profit center manager, the manager

a. and the sub-unit should be evaluated on the basis of the same costs and revenues.
b. should only be evaluated on the basis of variable costs and revenues of the sub-unit.
c. should be evaluated on all costs and revenues that are controllable by the manager
d. should be evaluated on all costs and revenues that can be directly traced to the sub-unit.
ANS: C DIF: Easy OBJ: 19-4

7. The Statement of Cash Flows may be superior to the cash budget as a performance evaluation measure
because
a. cash flows are shown on the accrual basis on the cash budget.
b. the cash budget does not include capital investments.
c. cash flows are arranged by activity.
d. of all the above reasons.
ANS: C DIF: Moderate OBJ: 19-4

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 8. The Statement of Cash Flows indicates the cash inflows and outflows from
a. investing, financing, and borrowing activities.
b. operating, investing, and sending activities.
c. merchandising, financing, and investing activities.
d. operating, investing, and financing activities.
ANS: D DIF: Easy OBJ: 19-4

9. Division A's investment in a new project will raise the overall organization's return on investment if
a. the return on investment on the new project exceeds the target return of the overall
organization.
b. the return on investment on the new project exceeds the return on investment of Division
A.
c. the return on investment on the new project exceeds the overall organization's return on
investment.
d. Division A's return on investment exceeds the return on investment of the overall
organization.
ANS: C DIF: Easy OBJ: 19-4

10. If sales and expenses both rise by $100,000

a. residual income will increase.
b. return on investment will increase.
c. return on investment will be unchanged.
d. asset turnover will decrease
ANS: C DIF: Easy OBJ: 19-4

11. ABC Corp. is composed of three operating divisions. Overall, the ABC Corp. has a return on
investment of 20%. A Division has a return on investment of 25%. If ABC Corp. evaluates its
managers on the basis of return on investment, how would the A Division manager and the ABC Corp.
president react to a new investment that has an estimated return on investment of 23%?

A Division manager ABC Corp. president

a. accept accept
b. accept reject
c. reject accept
d. reject reject
ANS: C DIF: Easy OBJ: 19-4

12. A company's return on investment is affected by a change in

Profit Margin
Asset Turnover on Sales

a. Yes Yes
b. Yes No
c. No No
d. No Yes

ANS: A DIF: Easy OBJ: 19-4

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13. The return on investment (ROI) ratio measures
a. only asset turnover.
b. only earnings as a percent of sales.
c. both asset turnover and earnings as a percent of sales.
d. asset turnover and earnings as a percent of sales, correcting for the effects of differing
depreciation methods.
ANS: C DIF: Easy OBJ: 19-4

14. Return on investment (ROI) is a term most often used to express income earned on assets
invested in a business unit. A company's return on investment would increase if sales
a. increased by the same dollar amount as expenses and total assets increased.
b. remained the same and expenses were reduced by the same dollar amount that total assets
increased.
c. decreased by the same dollar amount that expenses increased.
d. and expenses increased by the same percentage that total assets increased.
ANS: B DIF: Moderate OBJ: 19-4

15. A sub-unit of an organization is evaluated on the basis of its ROI. If this sub-unit's sales and expenses
both increase by $30,000, how will the following measures be affected?

ROI Assert turnover Profit margin

a. increase increase increase

b. indeterminate increase decrease
c. no change increase decrease
d. no change decrease no change
ANS: C DIF: Moderate OBJ: 19-4

16. Which of the following would be an appropriate alternative to the use of ROI in evaluating the
performance of an investment center?

Residual Net cash Cost and revenue

income flow variance analysis

a. yes yes yes

b. no yes no
c. yes no no
d. yes no yes

ANS: C DIF: Easy OBJ: 19-4

17. Return on investment is computed by dividing income by

a. contribution margin.
b. inventory turnover.
c. assets invested.
d. average assets employed.
ANS: C DIF: Easy OBJ: 19-4

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18. Presently, the Classic Book Division of Griffin Publishing Corporation has a profit margin of 30%. If
total sales rise by $100,000, the net result will be
a. an increase in the profit margin ratio to above 30%.
b. a decrease in the profit margin ratio to below 30%.
c. no change in the profit margin ratio.
d. a change in the profit margin ratio that cannot be determined from this information.
ANS: C DIF: Moderate OBJ: 19-4

19. Profit margin indicates the portion of sales that

a. covers fixed expenses.
b. is not used to cover expenses.
c. equals contribution margin.
d. equals product contribution margin.
ANS: B DIF: Easy OBJ: 19-4

20. Profit margin equals

a. income divided by sales.
b. incomes divided by average inventory.
c. income divided by average assets.
d. income divided by average stockholder's equity.
ANS: A DIF: Easy OBJ: 19-4

21. The Du Pont model measures

a. residual income.
b. return on investment.
c. throughput.
d. profit.
ANS: B DIF: Easy OBJ: 19-4

22. In the Du Pont model, profit margin is a ratio of

a. income to sales.
b. income to assets.
c. sales to income.
d. sales to assets.
ANS: A DIF: Easy OBJ: 19-4

23. The Du Pont model measures ROI as it is affected by

a. contribution margin and asset turnover.
b. profit margin and asset turnover.
c. asset turnover.
d. profit margin.
ANS: B DIF: Easy OBJ: 19-4

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24. Residual income is used as a performance measure in
a. profit centers.
b. cost centers.
c. investment centers.
d. revenue centers.
ANS: C DIF: Easy OBJ: 19-4

25. If a new project generates a positive residual income, the

a. project's return on investment is less than the target rate.
b. project's return on investment is greater than the target rate.
c. project's return on investment is equal to the target rate.
d. relationship between the project's return on investment and the target rate cannot
necessarily be determined.
ANS: B DIF: Easy OBJ: 19-4

26. A prospective project under consideration by the Telephone Division of Communications Corporation.
has an estimated residual income of $(20,000). If the project requires an investment of $400,000, the
a. project generates a negative return on investment.
b. project's return on investment is zero.
c. project's return on investment is 5% less than the company's target rate.
d. company's target rate is 15%
ANS: C DIF: Moderate OBJ: 19-4

27. Residual income is the

a. contribution margin of an investment center, less the imputed interest on the invested
capital used by the center.
b. contribution margin of an investment center, plus the imputed interest on the invested
capital used by the center.
c. income of an investment center, less the imputed interest on the invested capital used by
the center.
d. income of an investment center, plus the imputed interest on the invested capital used by
the center.
ANS: C DIF: Easy OBJ: 19-4

28. Residual income is an example of a ____________ performance measurement.

a. long-term
b. short-term
c. qualitative
d. profit center
ANS: B DIF: Easy OBJ: 19-4

29. If a division generates a positive residual income then the division's

a. asset turnover was very high.
b. profitability was greater than that of other divisions in the company.
c. performance was above expectations.
d. actual return on investment exceeds the division's target return.
ANS: D DIF: Easy OBJ: 19-4

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30. Residual income is determined as
a. income times the asset turnover rate.
b. income times the inventory turnover rate.
c. income minus (asset base times target rate of return).
d. sales minus (asset base times target rate of return).
ANS: C DIF: Easy OBJ: 19-4

31. Residual income is used as a performance measure in which of the following types of centers?

Revenue Investment Profit

a. yes no yes
b. yes yes yes
c. no yes yes
d. no yes no

ANS: D DIF: Easy OBJ: 19-4

32. An increase in a corporation's target rate would result in a(n)

a. increase in residual income.
b. decrease in return on investment.
c. decrease in residual income.
d. decrease in both residual income and return on investment.
ANS: C DIF: Easy OBJ: 19-4

33. All other things being equal, an increase in sales price would increase
a. asset turnover.
b. profit margin.
c. residual income.
d. all of the above.
ANS: D DIF: Easy OBJ: 19-4

34. If sales and expenses both rise by $100,000, profit margin will
a. decrease and asset turnover will decrease.
b. increase and asset turnover will decrease.
c. decrease and asset turnover will increase.
d. increase and asset turnover will increase.
ANS: C DIF: Moderate OBJ: 19-4

35. Asset turnover equals

a. income divided by average assets.
b. sales divided by assets.
c. sales divided by average assets.
d. assets divided by sales.
ANS: C DIF: Easy OBJ: 19-4

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36. The information below relates to costs, revenues, and assets anticipated in the Boot Division of BVD
Footwear Corporation:

Sales $ 4,000,000
Variable costs 75% of sales
Average assets employed
Fixed costs
$12,000,000
0
ait
How would each of the following measures be affected if sales rise by $5,000 in the Boot Division?

ROI /
-01 Asset -544A" 't
Asset turnover Profit margin
01
/
sun,
J

a. increase increase increase

b. increase no change increase
c.
d.
increase
no change
increase
no change
no change
increase 1201=01 / Asset
ANS: C DIF: Easy OBJ: 19-4
Anish / Asset
37. A division of Lachman Corporation reported a return on investment of 20% for a recent period. If the
e-
division's asset turnover was 5, its profit margin must have been
a. 100%
b. 4% pm = /
01 sales
c. 25%
d. 2%

✗ AN
PM
ANS: B Ro / =

ROI = Profit Margin x Asset Turnover

.20 = PM x 5

:#
PM = ROI/Asset Turnover =P
PM = .04 or 4%

DIF: Easy OBJ: 19-4

38. Which measure is limited by the fact that it uses accounting income?
a. ROI
b. RI
c. EVA
d. All of the above
ANS: D DIF: Easy OBJ: 19-4

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39. The Cake Division of Bakery Corporation has the following segment information:
= 01 -

AOA ✗ rn
Assets available for use $1,800,000 Rt
Target rate of return 10%
01 18m ✗ 10%
-

Residual income $ 270,000 270k =

c-
What was Cake Division's return on investment?
270k = 01 -
1810k
a. 15%
b. 10%
c. 25%
d. 20%
270kt -1801<=01
ANS: C
ROI = Income / Assets Invested

Income = Residual Income + (Target Rate * Assets)

= $270,000 + (.10 * $1,800,000)
4804 1800k
= $450,000
=
ROI = $(450,000/1,800,000)
= 25%

DIF: Moderate OBJ: 19-4

United Toy Company

The Doll Division of United Toy Company had the following financial data for the year:

Assets available for use $1,000,000 Book Value

/sales
$1,500,000 Market Value
Residual income $100,000
01
Return on investment 15%

e-
40. Refer to United Toy Company. What was the Doll Division’s segment income?

Acht
a. $150,000

Yasht
b. $100,000
① ✗
c. $250,000
d. $ 50,000
ROK

lit
/ Im HE
ANS: A
Segment Income = ROI * BV of Total Assets =

= 0.15 * $1,000,000
= $150,000

DIF: Moderate OBJ: 19-4

RI = 01 -
AOAXIPR

664 look =
took Im
-
✗ IRK

/ .
80k in =

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 :
41. Refer to United Toy Company. What was the target rate of return for United Toy Company?
a. 10%
b. 15%
c. 25%
d. 5%
ANS: D
Net Income - (Target Rate x Asset Base) = Residual Income
$150,000 - (Target Rate x $1,000,000) = $100,000
(Target Rate x $1,000,000) = $50,000
Target Rate = 5.0%

DIF: Moderate OBJ: 19-4

42. Refer to United Toy Company. If the manager of the Doll Division is evaluated based on return on
investment, how much would she be willing to pay for an investment that promises to increase net
segment income by $50,000?
a. $ 50,000

01
/ Assets
b. $ 333,333
c. $1,000,000
d. $ 500,000 po|=
ANS: B
$50,000 / 0.15 = $333,333 501<1154 .

/*
If 't -_
tot
3333%3
.

DIF: Moderate OBJ: 19-4 et =

43. Refer to United Toy Company. If expenses increased by $20,000 in Apple Division,
a. return on investment would decrease.
b. residual income would increase.
c. the target rate of return would decrease.
d. asset turnover would decrease.
ANS: A DIF: Easy OBJ: 19-4

Houston Company

Texas Division of the Houston Company has the following statistics for its most recent operations:

Assets available for use (Market Value) $3,600,000

Assets available for use (Book Value) $2,000,000
Texas Division's return on investment 25%
Texas Division's residual income 200,000
Return on investment (entire Houston Company) 20%

IWPAT
- Aretxklltc
10%
✗
IMY2-H.b.am
401=01 / feet toot-401 .

665
300k
-
Merk
251.042m

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=t
 -
equity

b. $ 150,000
c. $0
⑥ Era
=
0 .
¥+4
44. Refer to Houston Company. Compute EVA assuming the cost of capital is 10% and the tax rate is 40%.
a. $ 90,000
Asset
d. $ (60,000) 3. any 101 .

ANS: D
EVA = After Tax Net Income - (Cost of Capital x Market Value of Assets)
EVA = (($2,000,000 * .25) x .60) - (.10 x $3,600,000)
EVA = $(300,000 - 360,000)
EVA = $(60,000)

DIF: Moderate OBJ: 19-4

45. Refer to Houston Company. What is the target rate of return in Houston Company?
a. 25%
b. 20% Asset ✗ MR
RI 01
= -

c. 15%
d. 10%
took -2M 4 MR
ANS: C 200k =

2M IRR

#
Net Income - (Target Rate of Return x Total assets) = Residual Income
$500,000 - (Target Rate of Return * $2,000,000) = $200,000 =
Target Rate of Return * $2,000,000 = $300,000 hook
Target Rate of Return = 15%
-2M
DIF: Moderate OBJ: 19-4

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46. Refer to Houston Company. If Houston Company evaluates its managers on the basis of return on
investment, the manager of Texas Division would invest in a project costing $100,000 only if it
increased net segment income by at least
a. $10,000.

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b. $15,000. .

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c. $20,000.
d. $25,000.
ANS: D
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$100,000 * .25 = $25,000

DIF: Moderate OBJ: 19-4

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47. Andersen Corporation has a target return of 15%. If a prospective investment has an estimated return
on investment of 20%, and a residual income of $10,000, what is the estimated cost of the investment?

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a. $200,000
b. $ 66,667 Ant -112k
c. $ 50,000
d. The answer can't be determined from this information.
10k = 2k
15%
ANS: A

0.20 - 0.15 = 0.05 residual income

$10,000 / 0.05 = $200,000 RI
DIF: Moderate OBJ: 19-4

48. The Steelrod Division of Metal Products Company is considering an investment in a new project. The
project has an estimated cost of $1,000,000. If Metal Products Company has a target rate of return of
12%, how large does the return on investment on this project need to be to generate $150,000 of
residual income?
a. 15%
b. 12%
c. 25%
d. 27%
ANS: D
(ROI x Total Assets) - (Target Rate x Total Assets) = Residual Income
(ROI x $1,000,000) - (0.12 x $1,000,000) = $150,000
(ROI x $1,000,000) = $270,000
ROI = 27%

DIF: Moderate OBJ: 19-4

49. In the South Division of Occident Company, segment income for the most recent year exceeded
residual income by $15,000. Also, return on investment exceeded the target rate of return by 10%.
What was the level of investment in the X Division for the most recent year?
a. $ 15,000
b. $100,000
c. $150,000
d. An answer can't be determined from this information.
ANS: C
$15,000/0.10 = $150,000

DIF: Difficult OBJ: 19-4

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18. Presently, the Classic Book Division of Griffin Publishing Corporation has a profit margin of 30%. If
total sales rise by $100,000, the net result will be
a. an increase in the profit margin ratio to above 30%.
b. a decrease in the profit margin ratio to below 30%.
c. no change in the profit margin ratio.
d. a change in the profit margin ratio that cannot be determined from this information.
ANS: C DIF: Moderate OBJ: 19-4

19. Profit margin indicates the portion of sales that

a. covers fixed expenses.
b. is not used to cover expenses.
c. equals contribution margin.
d. equals product contribution margin.
ANS: B DIF: Easy OBJ: 19-4

20. Profit margin equals

a. income divided by sales.
b. incomes divided by average inventory.
c. income divided by average assets.
d. income divided by average stockholder's equity.
ANS: A DIF: Easy OBJ: 19-4

21. The Du Pont model measures

a. residual income. 1 0
b. return on investment.
c. throughput.
d. profit.
 d. profit.
ANS: B DIF: Easy OBJ: 19-4

22. In the Du Pont model, profit margin is a ratio of

a. income to sales.
b. income to assets.
c. sales to income.
d. sales to assets.
ANS: A DIF: Easy OBJ: 19-4

23. The Du Pont model measures ROI as it is affected by

a. contribution margin and asset turnover.
b. profit margin and asset turnover.
c. asset turnover.
d. profit margin.
ANS: B DIF: Easy OBJ: 19-4

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24. Residual income is used as a performance measure in
a. profit centers.
b. cost centers.
c. investment centers.
d. revenue centers.
ANS: C DIF: Easy OBJ: 19-4

25. If a new project generates a positive residual income, the

a. project's return on investment is less than the target rate.
b. project's return on investment is greater than the target rate.
c. project's return on investment is equal to the target rate.
d. relationship between the project's return on investment and the target rate cannot
necessarily be determined.
ANS: B DIF: Easy OBJ: 19-4

26. A prospective project under consideration by the Telephone Division of Communications Corporation.
has an estimated residual income of $(20,000). If the project requires an investment of $400,000, the
a. project generates a negative return on investment.
b. project's return on investment is zero.
c. project's return on investment is 5% less than the company's target rate.
d. company's target rate is 15%
ANS: C DIF: Moderate OBJ: 19-4

27. Residual income is the

a. contribution margin of an investment center, less the imputed interest on the invested
capital used by the center.
b. contribution margin of an investment center, plus the imputed interest on the invested
capital used by the center.
c. income of an investment center, less the imputed interest on the invested capital used by
the center.
d. income of an investment center, plus the imputed interest on the invested capital used by
the center.
ANS: C DIF: Easy OBJ: 19-4

28. Residual income is an example of a ____________ performance measurement.

a. long-term
b. short-term
c. qualitative
d. profit center
ANS: B DIF: Easy OBJ: 19-4
1 0
29. If a division generates a positive residual income then the division's
a. asset turnover was very high.
b. profitability was greater than that of other divisions in the company.
 c. performance was above expectations.
d. actual return on investment exceeds the division's target return.
ANS: D DIF: Easy OBJ: 19-4

661

30. Residual income is determined as 1 0

a. income times the asset turnover rate.
b. income times the inventory turnover rate.
 c. income minus (asset base times target rate of return).
d. sales minus (asset base times target rate of return).
ANS: C DIF: Easy OBJ: 19-4

31. Residual income is used as a performance measure in which of the following types of centers?

Revenue Investment Profit

a. yes no yes
b. yes yes yes
c. no yes yes
d. no yes no

ANS: D DIF: Easy OBJ: 19-4

32. An increase in a corporation's target rate would result in a(n)

a. increase in residual income.
b. decrease in return on investment.
c. decrease in residual income.
d. decrease in both residual income and return on investment.
ANS: C DIF: Easy OBJ: 19-4

33. All other things being equal, an increase in sales price would increase
a. asset turnover.
b. profit margin.
c. residual income.
d. all of the above.
ANS: D DIF: Easy OBJ: 19-4

34. If sales and expenses both rise by $100,000, profit margin will
a. decrease and asset turnover will decrease.
b. increase and asset turnover will decrease.
c. decrease and asset turnover will increase.
d. increase and asset turnover will increase.
ANS: C DIF: Moderate OBJ: 19-4

35. Asset turnover equals

a. income divided by average assets.
b. sales divided by assets.
c. sales divided by average assets.
d. assets divided by sales.
ANS: C DIF: Easy OBJ: 19-4

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36. The information below relates to costs, revenues, and assets anticipated in the Boot Division of BVD
Footwear Corporation:

Sales $ 4,000,000
Variable costs 75% of sales
Average assets employed $12,000,000
Fixed costs 0

How would each of the following measures be affected if sales rise by $5,000 in the Boot Division?

ROI Asset turnover Profit margin

a. increase increase increase

b. increase no change increase
c. increase increase no change
d. no change no change increase
ANS: C DIF: Easy OBJ: 19-4
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37. A division of Lachman Corporation reported a return on investment of 20% for a recent period. If the
division's asset turnover was 5, its profit margin must have been
 a. 100%
b. 4%
c. 25%
d. 2%
ANS: B
ROI = Profit Margin x Asset Turnover
.20 = PM x 5
PM = ROI/Asset Turnover
PM = .04 or 4%

DIF: Easy OBJ: 19-4

38. Which measure is limited by the fact that it uses accounting income?
a. ROI
b. RI
c. EVA
d. All of the above
ANS: D DIF: Easy OBJ: 19-4

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39. The Cake Division of Bakery Corporation has the following segment information:

Assets available for use $1,800,000

Target rate of return 10%
Residual income $ 270,000

What was Cake Division's return on investment?

a. 15%
b. 10%
c. 25%
d. 20%
ANS: C
ROI = Income / Assets Invested

Income = Residual Income + (Target Rate * Assets)

= $270,000 + (.10 * $1,800,000)
= $450,000

ROI = $(450,000/1,800,000)
= 25%

DIF: Moderate OBJ: 19-4

United Toy Company

The Doll Division of United Toy Company had the following financial data for the year:

Assets available for use $1,000,000 Book Value

$1,500,000 Market Value
Residual income $100,000
Return on investment 15%

40. Refer to United Toy Company. What was the Doll Division’s segment income?
a. $150,000
b. $100,000
c. $250,000 1 0
d. $ 50,000
ANS: A
Segment Income = ROI * BV of Total Assets
= 0.15 * $1,000,000
= $150,000

DIF: Moderate OBJ: 19-4

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41. Refer to United Toy Company. What was the target rate of return for United Toy Company?
a. 10%
b. 15%
c. 25%
d. 5%
ANS: D
Net Income - (Target Rate x Asset Base) = Residual Income
$150,000 - (Target Rate x $1,000,000) = $100,000
(Target Rate x $1,000,000) = $50,000
Target Rate = 5.0%

DIF: Moderate OBJ: 19-4

42. Refer to United Toy Company. If the manager of the Doll Division is evaluated based on return on
investment, how much would she be willing to pay for an investment that promises to increase net
segment income by $50,000?
a. $ 50,000
b. $ 333,333
c. $1,000,000
d. $ 500,000
ANS: B
$50,000 / 0.15 = $333,333

DIF: Moderate OBJ: 19-4

43. Refer to United Toy Company. If expenses increased by $20,000 in Apple Division,
a. return on investment would decrease.
b. residual income would increase.
c. the target rate of return would decrease.
d. asset turnover would decrease.
ANS: A DIF: Easy OBJ: 19-4

Houston Company

Texas Division of the Houston Company has the following statistics for its most recent operations:

Assets available for use (Market Value) $3,600,000

Assets available for use (Book Value) $2,000,000
Texas Division's return on investment 25%
Texas Division's residual income 200,000
Return on investment (entire Houston Company) 20%

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44. Refer to Houston Company. Compute EVA assuming the cost of capital is 10% and the tax rate is 40%.
a. $ 90,000
b. $ 150,000
c. $0
d. $ (60,000)
ANS: D
EVA = After Tax Net Income - (Cost of Capital x Market Value of Assets)
EVA = (($2,000,000 * .25) x .60) - (.10 x $3,600,000)
EVA = $(300,000 - 360,000)
EVA = $(60,000)
1 0
DIF: Moderate OBJ: 19-4
45. Refer to Houston Company. What is the target rate of return in Houston Company?
a. 25%
b. 20%
c. 15%
d. 10%
ANS: C
Net Income - (Target Rate of Return x Total assets) = Residual Income
$500,000 - (Target Rate of Return * $2,000,000) = $200,000
Target Rate of Return * $2,000,000 = $300,000
Target Rate of Return = 15%

DIF: Moderate OBJ: 19-4

46. Refer to Houston Company. If Houston Company evaluates its managers on the basis of return on
investment, the manager of Texas Division would invest in a project costing $100,000 only if it
increased net segment income by at least
a. $10,000.
b. $15,000.
c. $20,000.
d. $25,000.
ANS: D
$100,000 * .25 = $25,000

DIF: Moderate OBJ: 19-4

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47. Andersen Corporation has a target return of 15%. If a prospective investment has an estimated return
on investment of 20%, and a residual income of $10,000, what is the estimated cost of the investment?
a. $200,000
b. $ 66,667
c. $ 50,000
d. The answer can't be determined from this information.
ANS: A

0.20 - 0.15 = 0.05 residual income

$10,000 / 0.05 = $200,000

DIF: Moderate OBJ: 19-4

48. The Steelrod Division of Metal Products Company is considering an investment in a new project. The
project has an estimated cost of $1,000,000. If Metal Products Company has a target rate of return of
12%, how large does the return on investment on this project need to be to generate $150,000 of
residual income?
a. 15%
b. 12%
c. 25%
d. 27%
ANS: D
(ROI x Total Assets) - (Target Rate x Total Assets) = Residual Income
(ROI x $1,000,000) - (0.12 x $1,000,000) = $150,000
(ROI x $1,000,000) = $270,000
ROI = 27%

DIF: Moderate OBJ: 19-4 1 0

49. In the South Division of Occident Company, segment income for the most recent year exceeded
residual income by $15,000. Also, return on investment exceeded the target rate of return by 10%.
What was the level of investment in the X Division for the most recent year?
a. $ 15,000
b. $100,000
c. $150,000
d. An answer can't be determined from this information.
ANS: C
$15,000/0.10 = $150,000

DIF: Difficult OBJ: 19-4

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 RAD Company

RAD Co. has established a target rate of return of 16% for all divisions. For the most recent year,
Division D generated sales of $10,000,000 and expenses of $7,500,000. Total assets at the beginning
of the year were $5,000,000 and total assets at the end of the year were $7,000,000.

50. Refer to RAD Company. In the most recent year, what was Division D's residual income?
a. $ 960,000
b. $1,380,000
c. $1.540,000
d. $1,700,000
ANS: C
Residual Income = $(10,000,000 - 7,500,000) - ((.16) * $6,000,000)
= $(2,500,000 - 960,000)
=$1,540,000

DIF: Moderate OBJ: 19-4

51. Refer to RAD Company. For the most recent year, what was Division D's return on investment ?
a. 20.83 %
b. 35.71 %
c. 41.67 %
d. 50.00 %
ANS: C
ROI = Net Income/Average Total Assets
= $(2,500,000/6,000,000)
= 41.67%

DIF: Moderate OBJ: 19-4

52. The Card Division of Party Company reported the following results for a recent year

Sales $8,000,000
Expenses 6,250,000
Total assets (1/1) 5,000,000
Total assets (12/31) 5,400,000

What was the profit margin for the Card Division?

a. 68%
b. 35%
c. 32%
d. 22%
ANS: D
Profit Margin = Gross Margin/Sales
=$(1,750,000/8,000,000)
1 0
=22%

DIF: Moderate OBJ: 19-4

 DIF: Moderate OBJ: 19 4

668

53. The Card Division of Party Company reported the following results for a recent year

Sales $8,000,000
Expenses 1 0 6,250,000
Total assets (1/1) 5,000,000
Total assets (12/31) 5,400,000
 What was the asset turnover ratio of the Card Division?
a. 1.538
b. 2.97
c. 0.650
d. 1.20
ANS: A
$8,000,000/($((5,000,000 + 5,400,000)/2) = 1.538

DIF: Moderate OBJ: 19-4

54. Empire Division of New York Delights, is evaluated based on residual income generated. In the most
recent year, the Empire Division generated a residual income of $2,000,000 and net income of
$5,000,000. The target rate of return for all divisions of New York Delights is 20%. What was the
return on investment for the Empire Division?
a. 40%
b. 13%
c. 20%
d. 33%
ANS: D
(Net Income) - (Target Rate x Total Assets) = Residual Income
($5,000,000) - (0.20 x Total Assets) = $2,000,000
(0.20 x Total Assets) = $3,000,000
Total Assets = $15,000,000
ROI = (5,000,000/15,000,000)
ROI = 33%

DIF: Moderate OBJ: 19-4

55. Qualitative non-financial performance measures

a. are usually the most well-received by managers.
b. often reflect long-term organizational goals better than financial performance measures.
c. can only be developed in the production area of an organization.
d. is limited by the number of critical success factors defined by the organization.
ANS: B DIF: Easy OBJ: 19-6

56. Relative to qualitative performance measures, quantitative performance measures are less
a. subject to manipulation.
b. dependent on accounting information.
c. effective in the pursuit of organizational goals.
d. subjective.
ANS: D DIF: Easy OBJ: 19-6

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57. Improved effectiveness and efficiency of a product is considered a ______ performance measurement?
a. non-financial
b. financial
c. quantitative
d. qualitative
ANS: D DIF: Easy OBJ: 19-6

58. Non-financial performance measures (NFPMs) are better than financial measures in that NFPMs
a. provide a better indication of customer satisfaction.
b. may better predict the direction of future cash flows.
c. directly measure how well an organization does those things that create shareholder value.
d. all of the above
ANS: D DIF: Easy OBJ: 19-6

59. In selecting non-financial performance measures managers should choose measures that reflect
a. qualitative characteristics that point out sub-optimization activities and throughput
bottlenecks.
b. both short-term and long-term measures related to critical success factors.
c. long-term supplier satisfaction levels.
d. short-term financial viability.
1 0
ANS: B DIF: Easy OBJ: 19-6
60. Which of the following would be considered a non financial performance measurement?
a. increase in market share
b. variances from standards
c. number of customer complaints
d. cost of engineering changes
ANS: C DIF: Easy OBJ: 19-6

61. Which type of financial measure better predicts the direction of future cash flows?

Non-financial Measures Financial Measures

a. yes yes
b. yes no
c. no no
d. no yes

ANS: D DIF: Easy OBJ: 19-6

62. Which of the following would be classified as a non-financial critical success factor?

Technical Manufacturing Manufacturing

Quality Excellence Efficiency Effectiveness

a. no no no yes
b. yes no no no
c. yes yes yes yes
d. yes yes no yes

ANS: C DIF: Easy OBJ: 19-5

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63. Which of the following is necessary for any valid performance measurement?
a. It must be part of the financial accounting system in use.
b. It must be quantifiable.
c. Goal congruence must be promoted by its use.
d. It must be financial in nature.
ANS: C DIF: Easy OBJ: 19-3

64. Process quality yield is used in the measurement of

a. throughput.
b. cash flows.
c. asset turnover.
d. profit margin.
ANS: A DIF: Easy OBJ: 19-7

65. An increase in productive processing time will increase

a. throughput.
b. process yield.
c. return on investment.
d. productive capacity.
ANS: A DIF: Easy OBJ: 19-7

66. Which of the following is the throughput measure?

a. Processing time/Total time
b. Good units/Total time
c. Good units/Processing time
d. Total units/Total time
ANS: B DIF: Easy OBJ: 19-7

67. Productive capacity is a measure used in computing

a. residual income.
b. net cash flow.
c. return on investment.
d. throughput.
ANS: D DIF: Easy OBJ: 19-7

68. Process quality yield reflects the proportion of

a. good units to bad units. 1 0
b. time required to produce a good unit.
c. total units manufactured that are good.
8. Innovative Furnishing Solutions (IFS), a division of Steelman 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:

$3,600,000

:
Total assets at beginning of year
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 IFS, 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 IFS.
d. Using your answers from part b., compute the residual income of IFS.
e. Compute the EVA of IFS. Why are the EVA and RI levels different?
f. Based on the data given in the problem, discuss why ROI, EVA and RI may be inappropriate
measures of performance for IFS.

ANS:

a. Sales $9,000,000
Variable costs (3,650,000)
Direct fixed costs (4,770,000)
Segment margin $ 580,000

Average assets = ($3,600,000 + $5,300,000) / 2 = $4,450,000

b. Profit margin = $580,000 / $9,000,000 = 6.44%

Asset turnover = $9,000,000 / $4,450,000 = 2.02
ROI = $580,000 / $4,450,000 = 13%

c. The target ROI for the division was 2.5 x 6 = 15%. The division generated an ROI of only
13%. Thus the division did not achieve its target rate of return. The poor performance resulted
from the divisions failure to achieve its targeted asset turnover.

d. RI = $580,000 - (13% x $4,450,000)

= $580,000 - $578,500 = $1500

688
 e. After-tax profits = pretax income - taxes

= $580,000 - ($580,000 x 40%) = $348,000

EVA = $348,000 - ($8,000,000 x 10%) = $(452,000)

EVA and RI differ for three reasons. First, RI is based on pre-tax rather than after-tax income. Second,
RI is based on the book value of investment, whereas EVA is based on the market value of investment.
Third, the target rates of return differ between the methods.

f. ROI, RI and EVA are measures of short-term performance. These measures may be particularly
inappropriate for divisions that have long-term missions (such as high growth). In this case, the
relatively large growth and assets of IFS from the beginning of the period to the end of the
period may indicate this division is oriented to growth. If so, the ROI, RI and EVA measures
will provide an incentive contrary to the growth mission.

DIF: Difficult OBJ: 19-4

9. The Cuddly Creations Company produces small plastic dolls in its Georgia manufacturing plant. The
company is currently evaluating ways to improve productivity. The accountant of the firm's parent
organization suggested that management implement a new compensation plan based on throughput
performance measure as an incentive to increase productivity. To demonstrate how such a measure
might work, the accountant gathered the following production data for a recent month:

Total units attempted 6,000,000

Good units manufactured 4,800,000
Processing time (total hours) 800
Value-added processing time 600

a. How many defective units were produced?

b. Compute manufacturing cycle efficiency.
c. Compute process productivity.
d. Compute process quality yield.
e. Compute hourly throughput.

ANS:

a. Defective units = 6,000,000 - 4,800,000 = 1,200,000

b. MCE = 600 ( 800 = 75%
c. Process productivity = 6,000,000 ( 600 = 10,000 units per hour
d. Process quality yield = 4,800,000 ( 6,000,000 = 80%
e. Throughput = 10,000 x .75 x .8 = 6,000 dolls per hour

DIF: Moderate OBJ: 19-7

689