BKAM3023 MA11 T4 PERFORMANCE MEASURE A221

QUESTION 1

MSport Sdn Bhd (MSSB) has two divisions that report on a decentralized basis. Their results for
2020 were as follows:
Racket Ball
Sales RM150,000 RM300,000
Cost of goods sold RM70,000 RM120,000
Advertising expenses RM32,000 RM75,000
Administrative expenses RM30,000 RM55,000
Average operating asset RM 75,000 RM150,000
Weighted average cost of
12% 12%
capital
Tax 15% 15%

REQUIRED:
(a) Compute the following amounts for each division (show all workings):
i. Return on investment (ROI) if the desired rate of return is 12 percent.
ii. Residual income (RI) if the desired rate of return is 20 percent.
iii. Economic Value Added (EVA).
iv. Operating Asset Turnover if the desired rate of return is 25 percent.

(b) Based on the financial performance measures of the two divisions, justify the best
division among them.

(c) Since it was launched, the performance measurement system in MSSB has focused only
on financial measures that are the ROI, RI and EVA. Discuss ONE (1) inefficiency of
financial performance measures for MSSB.

(d) Recommend TWO (2) possible strategies how to help helmet division to improve its RI
and EVA.

(e) Discuss ONE (1) reason why do you think Helmet and Ball division have the same
operating asset turnover despite of their differences in ROI, RI and EVA performance.

QUESTION 2
Alu-Glass Sdn Bhd (AGSB) has been acknowledged as the leading glass and aluminium
manufacturer in Malaysia. In manufacturing the window panes, AGSB operates three divisions,
namely: transparent, translucent and opaque divisions. Given that the required rate of return is
15% and the budgeted operating results for the year 2021 are as follows:

Transparent Translucent Opaque Division

Division Division
Operating income RM30,000,000 RM50,000,000 RM22,000,000
Investment RM200,000,000 RM250,000,000 RM100,000,000

During the board meeting this morning, the management planned to expand the company
business
for the next year, 2022. This expansion will require each division to increase its investments by
RM50,000,000 and its income by RM9,000,000.

REQUIRED:

(a) Calculate the following amounts for each division for the year 2021 (show all workings):
(i) Return on investment (ROI).
(ii) Residual income (RI).

(b) Determine the effects after adding the new project to each division’s ROI and RI. Show all
workings.

(c) If the division managers are evaluated based on ROI or RI, explain a reason on which
division manager(s) is/are pleased with the expansion.

(d) In manufacturing the window panes, the Transparent Division makes the window glass and
transfers it to either the Translucent or Opaque Division where the glass is framed for
finishing process. None internal prices negotiation made by Transparent Division in this
procedure. The finished window pane is then sold by the company to the customers. The top
management of AGSB sets the production schedules for these three divisions and evaluates
them on the cost variances and output (quantity and quality).

(i) Identify whether Transparent, Translucent and Opaque divisions are operated
as the centralized or decentralized divisions. Justify your answer.

(ii) Explain TWO (2) reasons either the Transparent, Translucent and Opaque
divisions functioned as the cost centers, revenue centers or profit centers.

(iii) Suppose the top management of AGSB decides to let Transparent, Translucent
and Opaque divisions to set their own production schedules, buy and sell
products in the external market, and have the Translucent and Opaque divisions
negotiate with the Transparent division for the glass windows using a transfer
price.

Determine either this new procedure will change your answers in d (i) and d
(ii) above or not. Explain a reason for each of your answer for d (i) and d (ii).

QUESTION 3
BKAM3023 MA11 T4 PERFORMANCE MEASURE A221

A. The following data related to the Alpha division of Beka Bhd:

RM
Division contribution margin 500,000
Profit margin controllable by the division manager 200,000
Profit margin traceable to the division 180,000
Average asset investment 600,000

Management bonuses are based on Return On Investment (ROI) and the company uses
responsibility accounting concepts when evaluating performance. Alpha division manager
is contemplating the following THREE (3) investments. He can invest up to RM300,000.
Investment 1 Investment 2 Investment 3
RM RM RM
Cost 160,000 200,000 300,000
Expected income 40,000 34,000 84,000

Beka Berhad has a cost of capital of 20 percent.

REQUIRED:
(a) Calculate ROI for the THREE (3) investments.

(b) Calculate the division manager’s current ROI.

(c) Which of the three investments would be selected if the manager’s focus is on
divisional performance.

(d) Calculate the residual income of Investment 3 if Beka Bhd required a cost of
capital of 20%. Justify your answer from the division perspective.

(e) Does the company’s bonus plan encourage the most effective investment practice
for Beka Bhd? Suggest how the plan can be improved.

B. Beta division of Sayarrat Bhd produces electric motors. The division sold 20 percent of
them to Sigma division and 80 percent are sold to external customers. Sayarrat Bhd treats
its divisions as profit centres and allows division managers to choose whether to sell or buy
from internal divisions. Corporate policy requires that all interdivisional sales and
purchases be transferred at variable cost. Beta division estimated sales and standard costs
for the year ended 31 December based on a capacity of 50,000 units are as follows:

Sigma Division External

RM Customers
RM
Sales 450,000 4,000,000
Less: variable costs 450,000 1,800,000
Contribution margin - 2,200,000
Less: fixed costs 150,000 450,000
Operating income/(loss) (150,000) 1,750,000
Units sales 10,000 40,000

Beta division has an opportunity to sell the 10,000 units to an external customer for RM75
per unit. Sigma division is allowed to purchase the units it needs from an external supplier
for RM85 each.

(a) Assuming that Beta division desires to maximise operating income, should it take
on the new customer and discontinue sales to Sigma division? Why?

(b) Assume that Sayarrat Bhd allows division managers to negotiate transfer prices.
The managers agreed on a tentative price of RM75 per unit, to be reduced by an
equal sharing of the additional operating income that results from the sale to
Sigma of 10,000 motors at RM75 per unit. Calculate the company’s new transfer
price.

(c) Assume that Beta division could sell all units to outsiders for RM100 per unit.
Should Beta takes this opportunity?

QUESTION 4
Deria Corporation presented two years of data for its Sporting Goods Division and its Camping
Division.

Sporting Good Division Camping Division

REQUIRED:

a) Compute the ROI and the margin and turnover ratios for each year for the Sporting
Goods Division.
BKAM3023 MA11 T4 PERFORMANCE MEASURE A221

b) Compute the ROI and the margin and turnover ratios for each year for the Camping
Goods Division.

c) Explain the change in ROI from Year 1 to Year 2 for each division.

d) Explain the terms below:

i) Market based transfer pricing

ii) Negotiated transfer pricing

QUESTION 5
BKAM3023 MA11 T4 PERFORMANCE MEASURE A221

QUESTION 6
PSI Technology Sdn. Bhd. is a manufacturing firm. The company has a number of divisions that
produce digital camera, video camera, MP3 player, battery and camera bag. The Battery Division
manufactures a variety of battery that can be sold externally to an open market or internally to PSI’s
Camera Division. Sales and cost data per unit for battery is as follows:

RM
Unit selling price 22.40
Unit variable cost
Unit product fixed cost* 5.60
Practical capacity (units) 500,000

*RM2,800,000/500,000

For the next year, the Battery Division expects to sell 390,000 units battery. The Camera Division
currently plans to buy 100,000 batteries on the outside market for RM22.40 per unit. Mr. Raymond,
manager of the Battery Division, approached Mr. Ayman, manager of the Camera Division, and
offered to sell 100,000 batteries for RM22.00 per unit. Mr. Raymond explained to Mr. Ayman that he
can avoid selling costs of RM0.80 per battery by selling internally and that he would split the savings
by offering a RM0.40 discount on the usual price.

REQUIRED:

(a) Determine the minimum price that the Battery Division would be willing to accept and the
maximum price that the Camera Division would be willing to pay.

(b) Based on your answer in (a), determine whether an internal transfer would take place and
calculate the benefit (or loss) to the company as a whole if the internal transfer occurs.

(c) Suppose Mr. Ayman knows that the Battery Division has idle capacity. Do you think that he
would agree to the transfer price of RM22.00? If he counters with an offer to pay RM19.20 per
unit, would Mr. Raymond, be interested in this price? Explain your answer with supporting
computations.

(d) Suppose that PSI Technology’s policy is that all internal transfers take place at full manufacturing
cost. Determine the transfer price and whether the internal transfer would take place.

(e) “Under the general transfer-pricing guideline, the minimum transfer price will vary depending on
whether the supplying division has idle capacity or not”. Do you agree? Explain.

QUESTION 7
BumiMegah Sdn. Bhd. (BMSB) is a diversified manufacturer with several divisions,
including Trendy Division. BMSB monitors its divisions on the basis of both unit
contribution and return on investment (ROI), with investment defined as average operating
assets employed. All investments in operating assets are expected to earn a minimum return
of 9% before income taxes.
BKAM3023 MA11 T4 PERFORMANCE MEASURE A221

Trendy’s cost of good sold is considered to be entirely variable; however, its administrative
expenses do not depend on volume. Selling expenses are a mixed cost with 40% attributed to
sales volume. The operating income for Trendy is as follows:

Items RM RM
Sales revenue 7,000,000
Less: Expenses
Cost of good sold 3,700,000
Administrative expenses 791,000
Selling expenses 540,000 5,031,000
Operating income before tax 1,969,000

The division’s assets and liabilities as at 31st December 2012 are as follows:

Items RM
Current assets* 6,460,000
Long-term assets* 9,690,000
Current liabilities 2,500,000
Long-term debt 5,000,000

*Note: For the 2011 year-end balance, total assets are RM16,000,000.

REQUIRED:

(a) Calculate Trendy Division’s unit contribution margin if it produced and sold 300,000
units for the year ended 31st December 2012.

(b) Calculate the following performance measures for 2012 for Trendy Division:
(i) ROI, based on average operating assets employed.

(ii) Residual income (RI), calculated on the basis of average operating assets employed.

(c) Trendy management is presented with the opportunity to invest in a project that would
earn an ROI of 10%. Determine whether Trendy is likely to accept or not the new project.
Explain your decision.

(d) Identify TWO (2) items that Trendy should control if it is to be fairly evaluated as a
separate investment center within BMSB. using either ROI or RI as performance
measures.

(e) Explain TWO (2) disadvantages of ROI.

(f) Explain ONE (1) difference between profit center and investment center.
BKAM3023 MA11 T4 PERFORMANCE MEASURE A221

QUESTION 8
Integrated Auto Sdn. Bhd. specialises in manufacturing the compact car and family car. It
operates in two (2) divisions. The following are the division’s financial measures for year ended
2011:
Compact Car Division Family Car
Division
Total assets RM43,000,000 RM38,500,000
Current liabilities RM16,600,000 RM18,400,000
Operating income RM 3,217,500 RM3,334,500
Required rate of return 12 percent 12 percent

REQUIRED :
(a) Calculate Return on Investment (ROI) for each division using total assets as a measure of
investment.
(b) Calculate Residual Income (RI) for each divison.
(c) The compact car division’s manager, argues that the family car division has loaded up on
a lot of short-term debt to boost its RI. Calculate an alternative RI for each division that is
not sensitive to the amount of short-term debt. Comment on the result.
(d) Intergrated Auto Sdn. Bhd., which tax rate is 35 percent has two sources of funds: long-
term debt with a market value of RM28,000,000 at an interest rate of 10 percent, and
equity capital with a market value of RM22,000,000 and a cost of equity of 15 percent.
(i) Calculate the Weighted-Average Cost of Capital (WACC) to each division.
(ii) Using the WACC in (i) above, calculate the Economic Value Added (EVA) for each
division.
(e) Use your preceding calculations in (a), (b), (c) and (d) above to comment on the relative
performance of each division.
(f) Give THREE (3) definitions of investment that can be used in calculating ROI.
(g) Define assets based on current cost and historical cost.
BKAM3023 MA11 T4 PERFORMANCE MEASURE A221

QUESTION 9

RI, EVA, measurement alternatives, goal congruence. Refresh Resorts, Inc., operates health
spas in Key West, Florida; Phoenix, Arizona; and Carmel, California. The Key West spa was the
company’s first and opened in 1991. The Phoenix spa opened in 2004, and the Carmel spa
opened in 2013. Refresh Resorts has previously evaluated divisions based on RI, but the
company is considering changing to an EVA approach. All spas are assumed to face similar
risks. Data for 2017 are:

Required:
1. Calculate RI for each of the spas based on operating income and using total assets as the
measure of investment. Suppose that the Key West spa is considering adding a new group of
saunas from Finland that will cost $225,000. The saunas are expected to bring in operating
income of $22,000. What effect would this project have on the RI of the Key West spa?
Based on RI, would the Key West manager accept or reject this project? Without resorting to
calculations, would the other managers accept or reject the project? Why?
2. Why might Refresh Resorts want to use EVA instead of RI for evaluating the performance of
the three spas?
BKAM3023 MA11 T4 PERFORMANCE MEASURE A221

3. Refer back to the original data. Calculate the WACC for Refresh Resorts.
4. Refer back to the original data. Calculate EVA for each of the spas, using net book value of
long-term assets. Calculate EVA again, this time using gross book value of long-term assets.
Comment on the differences between the two methods.
5. How does the selection of asset measurement method affect goal congruence?