Introduction to Management Accounting, 15e (Horngren)

Chapter 10 Management Control in Decentralized Organizations

10.1 Questions

1) ________ is the process by which organizations concentrate decision making within a particular
location or group.
A) Management by objective
B) Balanced scorecard
C) Decentralization
D) Centralization
Answer: D
Diff: 1 Page Ref: 385
LO: 10-1
AACSB: None

2) Which of the following statements is NOT a benefit of decentralization?

A) Lower-level managers are able to make faster and better decisions on local decisions than higher-level
managers.
B) By delegating decision-making authority to local managers, higher-level managers free up time to deal
with larger issues and fundamental strategy.
C) Local managers who are given more authority often have greater motivation and job satisfaction.
D) Managers in decentralized units may spend time negotiating transfer prices for goods transferred
between units.
Answer: D
Diff: 2 Page Ref: 386
LO: 10-1
AACSB: None

3) The decentralization of organizations has several disadvantages that include ________.

A) lower level managers can make faster decisions than higher level managers.
B) innovative ideas are less likely to be shared in decentralized organizations.
C) local managers are given the opportunity to develop decision making skills so they can move up in the
organization.
D) higher level managers are given more time to pursue strategy issues.
Answer: B
Diff: 2 Page Ref: 386
LO: 10-1
AACSB: None

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4) A firm is a good candidate for decentralization if ________.
A) segments buy from the same suppliers
B) segments sell to the same customers
C) there is frequent transferring of products between segments
D) an organization's segments are relatively independent of each other
Answer: D
Diff: 2 Page Ref: 386
LO: 10-1
AACSB: None

5) ________ is the delegation of decision-making power to segment managers of an organization.

A) Goal congruence
B) Segment autonomy
C) Managerial effort
D) Segment contribution
Answer: B
Diff: 1 Page Ref: 386
LO: 10-1
AACSB: None

6) Decentralization may increase a firm's costs because ________.

A) lower level managers duplicate services that may be less expensive if centralized
B) information costs rise as top management needs additional reports to learn about decentralized units
C) lower level managers may make decisions that are not in the best interests of the firm as a whole
D) all of the above
Answer: D
Diff: 2 Page Ref: 386
LO: 10-1
AACSB: None

7) Decentralization is the delegation of freedom to make decisions.

Answer: TRUE
Diff: 1 Page Ref: 385
LO: 10-1
AACSB: None

8) The lower in the organization that the freedom to make decisions exists, the greater the centralization.
Answer: FALSE
Diff: 2 Page Ref: 385
LO: 10-1
AACSB: None

9) The increasing sophistication of telecommunications facilitates decentralization in organizations.

Answer: TRUE
Diff: 1 Page Ref: 385
LO: 10-1
AACSB: None

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10) Segment autonomy means that the activities of segment managers are directed by top managers.
Answer: FALSE
Diff: 1 Page Ref: 386
LO: 10-1
AACSB: None

11) When compared to a decentralized organization, there are really no advantages to a centralized
organization.
Answer: FALSE
Diff: 1 Page Ref: 386
LO: 10-1
AACSB: None

12) Some level of decentralization in an organizational structure creates benefits for most organizations.
Answer: TRUE
Diff: 1 Page Ref: 386
LO: 10-1
AACSB: None

13) Higher-level managers have the best information concerning local conditions.
Answer: FALSE
Diff: 1 Page Ref: 386
LO: 10-1
AACSB: None

14) Local managers in decentralized organizations tend to duplicate services that may be less expensive if
centralized.
Answer: TRUE
Diff: 1 Page Ref: 386
LO: 10-1
AACSB: None

15) The costs of accumulating and processing information frequently decline under decentralization.
Answer: FALSE
Diff: 2 Page Ref: 386
LO: 10-1
AACSB: None

16) Managers in decentralized units may waste time negotiating with other units about goods or services
one unit transfers to the other.
Answer: TRUE
Diff: 2 Page Ref: 386
LO: 10-1
AACSB: None

17) Decentralization is more popular in nonprofit organizations than profit-seeking organizations.

Answer: FALSE
Diff: 1 Page Ref: 386
LO: 10-1
AACSB: None

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18) Decentralization is most successful when an organization's segments are relatively independent of
one another.
Answer: TRUE
Diff: 2 Page Ref: 386
LO: 10-1
AACSB: None

19) If the segments in a firm buy from the same outside suppliers all the time, they are good candidates
for decentralization.
Answer: FALSE
Diff: 1 Page Ref: 386
LO: 10-1
AACSB: None

20) Define decentralization and identify its expected benefits.

Answer: Decentralization is the delegation of the freedom to make decisions. The lower in the
organization this freedom exists, the greater the degree of decentralization.
Some of the benefits of decentralization are:
(1) Lower-level managers have the best information concerning local conditions and therefore may be
able to make faster and better decisions on local issues than higher-level managers.
(2) By delegating decision making authority to local managers, central managers free up time to deal with
larger issues and fundamental strategy.
(3) Decentralization gives local managers an opportunity to develop their decision-making ability and
other management skills that help them move upward in the firm.
(4) Local managers who are given more authority often have greater motivation and job satisfaction.
Diff: 2 Page Ref: 386
LO: 10-1
AACSB: None

21) Identify the disadvantages of decentralization.

Answer: The disadvantages include:
1) Lower-level managers may make decisions that are not in the organization's best interests.
2) Lower-level managers may duplicate services that may be less expensive if centralized.
3) Costs of accumulating and processing information rise under decentralization because top
management needs additional accounting reports to learn about the decentralized units.
4) Innovative ideas to improve performance are less likely to be shared across units in a decentralized
organization.
5) Managers in decentralized units may waste time negotiating transfer prices for units transferred
between units.
Diff: 2 Page Ref: 386
LO: 10-1
AACSB: None

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10.2 Questions

1) Which of the following statements about management control systems is FALSE?

A) In designing management control systems, top managers must consider the system's impact on the
employee behavior desired by the organization.
B) The management control system should be designed to achieve the best possible alignment between
local manager decisions and the actions central management seeks.
C) The design of a management control system should consider the responsibilities of managers and the
amount of autonomy they have.
D) Profit-center managers always have more decentralized decision-making authority than cost-center
managers.
Answer: D
Diff: 2 Page Ref: 386-387
LO: 10-2
AACSB: None

2) Profit centers can exist only in a decentralized organization.

Answer: FALSE
Diff: 2 Page Ref: 386
LO: 10-2
AACSB: None

3) In designing accounting control systems, top managers should consider the system's impact on the
behavior of employees.
Answer: TRUE
Diff: 1 Page Ref: 387
LO: 10-2
AACSB: None

10.3 Questions

1) Managers' incentives for performance are defined as the ________.

A) relationship between cost and perceived benefit
B) relationship between goal congruence and managerial effort
C) rewards for managerial effort and actions
D) influence of uncontrollable factors on a manager's performance
Answer: C
Diff: 2 Page Ref: 387
LO: 10-3
AACSB: None

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2) Organizations should choose performance metrics that improve the alignment of managerial incentives
with ________.
A) managerial effort
B) organizational objectives
C) ethical behavior
D) goal congruence
Answer: B
Diff: 1 Page Ref: 388
LO: 10-3
AACSB: None

3) In agency theory, risk to the manager is defined as ________.

A) probability that a desired outcome will not be achieved
B) possibility that performance will be measured inaccurately
C) probability that a desired outcome will be achieved
D) the influence of uncontrollable factors on a manager's performance
Answer: D
Diff: 2 Page Ref: 389
LO: 10-3
AACSB: None

4) An ideal performance metric would measure and reward the manager for ________ factors and neither
reward nor punish the manager for ________ factors.
A) allocated; unallocated
B) controllable; uncontrollable
C) unallocated; allocated
D) uncontrollable; controllable
Answer: B
Diff: 1 Page Ref: 389
LO: 10-3
AACSB: None

5) Which statement is FALSE about performance metrics?

A) The cost benefit criterion leads companies to rely on imperfect performance metrics.
B) The more a manager's reward depends on a performance metric, the more incentives the manager has
to take actions to maximize that measure.
C) Top management should define the performance metric to promote goal congruence and base enough
reward on it to achieve managerial effort.
D) The more uncontrollable factors affect a manager's reward, the less risk the manager bears.
Answer: D
Diff: 2 Page Ref: 389
LO: 10-3
AACSB: None

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6) According to agency theory, employment contracts will balance three factors that include ________.
A) cost-benefit, risk and uncontrollable factors
B) goal congruence, incentive and risk
C) cost of measuring performance, cost-benefit and risk
D) incentive, risk and cost of measuring performance
Answer: D
Diff: 1 Page Ref: 389
LO: 10-3
AACSB: None

7) Incentives do not increase managerial effort toward goal congruence.

Answer: FALSE
Diff: 2 Page Ref: 387
LO: 10-3
AACSB: None

8) Performance-based rewards can be monetary or nonmonetary.

Answer: TRUE
Diff: 1 Page Ref: 388
LO: 10-3
AACSB: None

9) Managers tend to focus their efforts in areas where performance is measured and where their
performance affects rewards.
Answer: TRUE
Diff: 2 Page Ref: 389
LO: 10-3
AACSB: None

10) According to agency theory, employment contracts will balance three factors that include risk,
incentive and the cost of measuring performance.
Answer: TRUE
Diff: 2 Page Ref: 389
LO: 10-3
AACSB: None

11) The greater the influence of noncontrollable factors on responsibility center results, the more
problems there are in using the results to measure and reward a manager's performance.
Answer: TRUE
Diff: 2 Page Ref: 389
LO: 10-3
AACSB: None

12) Companies must pay managers more if the managers bear more risk, assuming the managers are risk
averse.
Answer: TRUE
Diff: 2 Page Ref: 389
LO: 10-3
AACSB: None

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13) Employees have a higher incentive to work when the bonus portion of an employment contract is
larger than the guaranteed portion of the contract.
Answer: TRUE
Diff: 2 Page Ref: 390
LO: 10-3
AACSB: None

10.4 Questions

1) In return on investment calculations, we should measure invested capital ________ because ________.
A) at the end of the period; it is easiest
B) at the end of the period; income is measured at the end of the period
C) at the beginning of the period; it is a lead indicator
D) as an average for the period under review; income is measured over a period of time
Answer: D
Diff: 1 Page Ref: 390
LO: 10-4
AACSB: None

2) Jewel Company's revenues are $300 and invested capital is $240. Expenses are currently 60% of sales.
Jewel Company's current return on investment is ________.
A) 50%
B) 60%
C) 80%
D) 100%
Answer: A
Diff: 1 Page Ref: 390
LO: 10-4
AACSB: Analytic Skills

3) Frazier Company's revenues are $300 on invested capital of $240. Expenses are currently 84% of sales.
If Frazier Company can reduce its expenses to 70% of sales, return on investment will be ________.
A) 20%
B) 37.5%
C) 70%
D) 93.75%
Answer: B
Diff: 1 Page Ref: 390
LO: 10-4
AACSB: Analytic Skills

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4) SS Company's revenues are $300 on invested capital of $240. Expenses are currently 70% of sales. If SS
Company can reduce its invested capital by 25%, return on investment will be ________.
A) 18.75%
B) 50.00%
C) 75.00%
D) 93.75%
Answer: B
Diff: 1 Page Ref: 390
LO: 10-4
AACSB: Analytic Skills

5) The following information is available for the Super Company:

Sales $1,000,000
Invested capital 312,500
Return on investment 20%

What is the operating income?

A) $62,500
B) $100,000
C) $312,500
D) $687,500
Answer: A
Diff: 1 Page Ref: 390
LO: 10-4
AACSB: Analytic Skills

6) The following information is available for the Trompeter Company:

Sales $1,000,000
Invested capital 500,000
Return on investment 10%

What is the capital turnover ratio?

A) 0.10
B) 0.35
C) 0.50
D) 2.00
Answer: D
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: Analytic Skills

9
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
7) The following information is available for the Peter Company:

Sales $150,000
Invested capital 156,250
Return on investment 10%

What is the return on sales?

A) 10.00%
B) 10.42%
C) 62.50%
D) 100.00%
Answer: B
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: Analytic Skills

8) ________ is a measure of income divided by the investment required to obtain that income.
A) Return on sales
B) Capital turnover
C) Return on investment
D) Residual income
Answer: C
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: None

9) Return on investment can be computed as ________ times ________.

A) residual income; capital turnover
B) cost of capital; EVA
C) return on sales; capital turnover
D) net income; cost of capital
Answer: C
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: None

10) An increase in either capital turnover or return on sales, without changing the other, will also
________ the ________.
A) increase; gross book value of long-term assets
B) increase; return on investment
C) increase; cost of capital
D) increase: net book value of long-term assets
Answer: B
Diff: 2 Page Ref: 391
LO: 10-4
AACSB: Analytic Skills

10
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
11) Operating income divided by sales is ________.
A) residual income
B) capital turnover
C) return on investment
D) return on sales
Answer: D
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: None

12) Residual income is defined as ________.

A) sales less operating expenses
B) operating income divided by revenue
C) net operating profit after tax less a capital charge
D) net operating profit after tax
Answer: C
Diff: 2 Page Ref: 391
LO: 10-4
AACSB: None

13) The following information pertains to the Voyager Company:

Total assets $150,000
Total current liabilities 110,000
Total expenses 70,000
Total liabilities 115,000
Total revenues 80,000

Return on sales equals ________.

A) 12.5%
B) 50.0%
C) 75.0%
D) 133.0%
Answer: A
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: Analytic Skills

14) Economic profit is ________ less ________.

A) net operating profit; capital charge
B) residual income; capital charge
C) income before interest expense and taxes; capital charge
D) income before interest expense but after taxes; capital charge
Answer: D
Diff: 2 Page Ref: 391
LO: 10-4
AACSB: None

11
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
15) Trompeter Company reports the following information:

After-tax operating income $200,000

Before-tax operating income 300,000
Average invested capital 500,000
After-tax cost of capital 10%

What is the residual income for Trompeter Company?

A) $30,000
B) $50,000
C) $150,000
D) $250,000
Answer: C
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: Analytic Skills

16) Pearson Company reports the following information:

After-tax operating income $100,000

Before-tax operating income 300,000
Average invested capital 500,000
After-tax cost of capital 10%

What is the residual income for Pearson Company?

A) $30,000
B) $50,000
C) $250,000
D) $450,000
Answer: B
Diff: 2 Page Ref: 391, 392
LO: 10-4
AACSB: Analytic Skills

12
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
17) Anne Company reports the following information:

Before-tax operating income $500,000

After-tax operating income 300,000
Average invested capital 500,000
After-tax cost of capital 10%

What is the economic profit for Anne Company?

A) $30,000
B) $50,000
C) $250,000
D) $450,000
Answer: C
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: Analytic Skills

18) Yoon Company reports the following information:

Net operating profit after taxes $500,000

Adjusted net operating profit after taxes 670,000
Average invested capital 500,000
Adjusted average invested capital 700,000
After-tax cost of capital 10%

The adjusted figures reflect adjustments used by Stern Stewart & Company.
What is the EVA for Yoon Company?
A) $430,000
B) $450,000
C) $600,000
D) $620,000
Answer: C
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: Analytic Skills

13
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
19) Yun Company reports the following information:

Net operating profit after taxes $400,000

Adjusted net operating profit after taxes 570,000
Average invested capital 600,000
Adjusted average invested capital 700,000
After-tax cost of capital 10%

The adjusted figures reflect adjustments used by Stern Stewart & Company. What is the EVA for Yun
Company?
A) $330,000
B) $340,000
C) $500,000
D) $510,000
Answer: C
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: Analytic Skills

20) Which of the following adjustments to after-tax operating income is used to approximate cash income
for EVA?
A) expensing research and development costs
B) using LIFO inventory method
C) deducting interest payable
D) using taxes paid rather than tax expense
Answer: D
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: None

21) Julio Company's after-tax operating income was $882 million. Total assets were $5,900 million and
total stockholders' equity was $4,050 million. Julio Company's cost of capital was 10%. Julio Company
uses total assets as the measure of invested capital. What is Julio Company's EVA?
A) $187 million
B) $292 million
C) $597 million
D) $667 million
Answer: B
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: Analytic Skills

14
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
22) To calculate economic value added, several adjustments are made to after tax operating profit that
include ________ and ________.
A) the use of LIFO inventory valuation; capitalization of research and development costs
B) taxes paid rather than tax expense; capitalization of research and development costs
C) the use of average cost inventory valuation; current costs of fixed assets
D) the use of LIFO inventory valuation; current costs of fixed assets
Answer: B
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: None

23) Why do some companies prefer the use of economic profit over return on investment in decision-
making?
A) The calculations for economic profit are easier.
B) The data needed to calculate return on investment are not always available.
C) Return on investment can motivate managers to make investment decisions that are not in the best
interests of the company as a whole.
D) The concept behind economic profit is more logical.
Answer: C
Diff: 2 Page Ref: 393
LO: 10-4
AACSB: None

24) From the view of the company as a whole, managers should accept investment projects that earn
more than the ________. ________ should not be used for investment decisions.
A) return on investment; Return on sales
B) return on sales; Capital turnover
C) cost of capital; Return on investment
D) capital turnover; Return on sales
Answer: C
Diff: 2 Page Ref: 393
LO: 10-4
AACSB: None

25) Return on investment equals income divided by investment.

Answer: TRUE
Diff: 1 Page Ref: 390
LO: 10-4
AACSB: None

26) In all return on investment calculations, invested capital should be measured as an average for the
period under review.
Answer: TRUE
Diff: 1 Page Ref: 390
LO: 10-4
AACSB: None

15
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27) Return on sales can be computed by multiplying return on investment by the capital turnover.
Answer: FALSE
Diff: 2 Page Ref: 391
LO: 10-4
AACSB: Analytic Skills

28) Return on investment equals return on sales divided by capital turnover.

Answer: FALSE
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: Analytic Skills

29) Return on sales equals revenue divided by income.

Answer: FALSE
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: None

30) Capital turnover equals revenue divided by invested capital.

Answer: TRUE
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: None

31) Return on sales can be increased by increasing expenses.

Answer: FALSE
Diff: 2 Page Ref: 391
LO: 10-4
AACSB: Analytic Skills

32) Capital turnover can be increased by decreasing investment.

Answer: TRUE
Diff: 2 Page Ref: 391
LO: 10-4
AACSB: Analytic Skills

33) Increasing capital turnover is one of the advantages of implementing the JIT philosophy.
Answer: TRUE
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: None

34) Cost of capital is the company's cost of inventory multiplied by the amount of investment.
Answer: FALSE
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: None

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Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
35) Return on investment tells how much a company's operating income exceeds what it is paying for
capital.
Answer: FALSE
Diff: 1 Page Ref: 391
LO: 10-4
AACSB: Analytic Skills

36) EVA equals adjusted after-tax operating income minus capital turnover.
Answer: FALSE
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: None

37) EVA uses after-tax numbers for operating income.

Answer: TRUE
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: None

38) Companies using EVA consider research and development to be a capital investment.
Answer: TRUE
Diff: 2 Page Ref: 392
LO: 10-4
AACSB: None

39) When a company measures performance using economic profit, managers tend to invest in any
project earning more than the cost of capital and, as a result, increase the firm's total profits.
Answer: TRUE
Diff: 2 Page Ref: 394
LO: 10-4
AACSB: None

40) In general, use of economic profit or EVA will promote goal congruence and lead to better investment
decisions than the use of ROI.
Answer: TRUE
Diff: 2 Page Ref: 394
LO: 10-4
AACSB: None

17
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41) The following information is available for the Jaeger Company:

Sales $2,000,000
Invested capital $500,000
Return on investment 20%

Required:
A) Compute capital turnover.
B) Compute operating income.
C) Compute return on sales.
Answer:
A) 4.0 = $2,000,000/$500,000
B) $100,000
C) 5.0%
Diff: 2 Page Ref: 390-392
LO: 10-4
AACSB: Analytic Skills

42) Nelson Company has two divisions. The following information is available:

North Division South Division

Revenue $300,000 $500,000
After-tax operating income 100,000 90,000
Average invested capital 100,000 200,000
Invested capital at end of period 200,000 300,000
Cost of capital 20% 15%

Required:
Compute the following for each division:
A) Return on investment
B) Return on sales
C) Capital turnover
D) Residual income
Answer:
A) North Division: $100,000/$100,000 = 100%
South Division: $90,000/$200,000 = 45%
B) North Division: $100,000/$300,000 = 33.3%
South Division: $90,000/$500,000 = 18%
C) North Division: $300,000/$100,000 = 3
South Division: $500,000/$200,000 = 2.5
D) North Division: $100,000 - (20% x $100,000) = $80,000
South Division: $90,000 - (15% x $200,000) = $60,000
Diff: 2 Page Ref: 390-392
LO: 10-4
AACSB: Analytic Skills

18
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43) The following data are available for three divisions of Beck Company:

Division A Division B Division C

Operating income A $45,000 I
Revenue B E $84,000
ROI 15% F 12%
Invested capital $150,000 G $35,000
Return on sales 8% 9% J
Cost of capital 12% H 10%
Capital turnover C 2.5 K
Economic profit D $15,000 L

Required:
Compute the missing data.
Answer:
A) $22,500
B) $281,250
C) 1.875
D) $4,500
E) $500,000
F) 22.5%
G) $200,000
H) 15%
I) $4,200
J) 5%
K) 2.4
L) $700
Diff: 2 Page Ref: 390-392
LO: 10-4
AACSB: Analytic Skills

19
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
10.5 Questions

1) The following information pertains to Jupiter Company:

Total assets $50,000

Total current liabilities 30,000
Total expenses 60,000
Total liabilities 45,000
Total revenues 100,000

Invested capital is defined as total assets. What is the capital turnover?

A) 0.40
B) 0.63
C) 1.79
D) 2.00
Answer: D
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

2) The following information pertains to Alan Company:

Total assets $100,000

Total current liabilities 30,000
Total expenses 60,000
Total liabilities 35,000
Total revenues 80,000

Invested capital is defined as total assets. What is the return on investment?

A) 20%
B) 60%
C) 70%
D) 160%
Answer: A
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

20
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3) The following information pertains to Maria Company:

Total assets $50,000

Total current liabilities 30,000
Total expenses 60,000
Total liabilities 35,000
Total revenues 80,000

Invested capital is defined as total assets. The capital charge is 10%. What is the residual income?
A) $1,600
B) $4,000
C) $15,000
D) $20,000
Answer: C
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

4) The following information pertains to Moore Company:

Total assets $150,000

Total current liabilities 110,000
Total expenses 160,000
Total liabilities 115,000
Total revenues 180,000

Invested capital is defined as total assets. The weighted average cost of capital is 10%. A project earning
a ROI of 12% should be ________.
A) accepted
B) rejected
C) compared to the company's ROI
D) compared to the company's residual income
Answer: A
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

21
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
5) The following information pertains to Robert Company:

Total assets $50,000

Total current liabilities 10,000
Total expenses 60,000
Total liabilities 15,000
Total revenues 80,000

Invested capital is defined as total assets minus current liabilities. The after-tax cost of capital is 20%.
What is the residual income?
A) $2,600
B) $4,000
C) $12,000
D) $20,000
Answer: C
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

6) The following information pertains to Saturn Company:

Total assets $150,000

Total current liabilities 110,000
Total expenses 160,000
Total liabilities 115,000
Total revenues 180,000

Invested capital is defined as total assets minus current liabilities. The after-tax cost of capital is 10%.
What is the economic profit?
A) $16,000
B) $20,000
C) $40,000
D) $50,000
Answer: A
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

7) Invested capital can mean any of the following EXCEPT ________.

A) total assets
B) total assets less current liabilities
C) total assets less long-term liabilities
D) total assets less total liabilities
Answer: C
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: None

22
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
8) When evaluating the performance of division managers, which definition of invested capital should be
used?
A) total assets
B) total assets less current liabilities
C) total assets less total liabilities
D) total assets or total assets less current liabilities
Answer: D
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: None

9) ________ is the original cost of a long-term asset less accumulated depreciation.

A) Net book value
B) Gross book value
C) Net asset
D) Current cost
Answer: A
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: None

10) The asset section of the January 1, 20X9, balance sheet of Big Valley Company includes a machine
which was acquired on January 1, 20X5. The machine's original cost was $500,000, and the estimated life
was 10 years. On January 1, 20X5, the estimated residual value was zero and the straight-line method of
depreciation was used. On January 1, 20X9, the book value of the machine is ________.
A) $250,000
B) $300,000
C) $450,000
D) $500,000
Answer: B
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: None

11) When measuring invested capital, managers in practice predominantly use ________.
A) Net book value at current cost
B) Net book value at historical cost
C) Gross book value at historical cost
D) Gross book value at future cost
Answer: B
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: None

23
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
12) Historical cost is widely used for asset valuation because ________.
A) it reports the replacement cost of long-term assets
B) it is more subjective than other approaches
C) it requires additional data collection
D) the cost of obtaining additional data exceeds the benefit
Answer: D
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: None

13) The following information is available for Bono Company:

Current assets $200,000 Current liabilities $100,000
Property, plant and Long-term liabilities 200,000
Equipment 350,000 Stockholders' equity 350,000
Other assets 100,000 Total liabilities and
Total assets $650,000 stockholders' equity $650,000

Invested capital is defined as total assets less current liabilities. What is invested capital?
A) $350,000
B) $550,000
C) $600,000
D) $650,000
Answer: B
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

14) The following information is available for Timber Company:

Current assets $200,000 Current liabilities $50,000

Property, plant and Long-term liabilities 250,000
Equipment 400,000 Stockholders' equity 350,000
Other assets 50,000 Total liabilities and
Total assets $650,000 stockholders' equity $650,000

Invested capital is defined as total assets less current liabilities. What is invested capital?
A) $350,000
B) $550,000
C) $600,000
D) $650,000
Answer: C
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

24
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
15) The following information is available for Patterson Company:

Current assets $200,000 Current liabilities $100,000

Property, plant and Long-term liabilities 200,000
Equipment 400,000 Stockholders' equity 350,000
Other assets 50,000 Total liabilities and
Total assets $650,000 stockholders' equity $650,000

Invested capital is defined as total stockholders' equity. What is invested capital?

A) $350,000
B) $550,000
C) $600,000
D) $650,000
Answer: A
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

16) The following information is available for Gable Company:

Current assets $100,000 Current liabilities $75,000

Property, plant and Long-term liabilities 100,000
Equipment 150,000 Stockholders' equity 125,000
Other assets 50,000 Total liabilities and
Total assets $300,000 stockholders' equity $300,000

Invested capital is defined as total assets. Net operating income is $60,000. What is ROI?
A) 20%
B) 30%
C) 50%
D) 120%
Answer: A
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

25
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
17) The following information is available for Rory Company:

Current assets $100,000 Current liabilities $75,000

Property, plant and Long-term liabilities 100,000
Equipment 50,000 Stockholders' equity 125,000
Other assets 150,000 Total liabilities and
Total assets $300,000 stockholders' equity $300,000

Invested capital is defined as total assets. Before-tax operating profit is $175,000. After-tax operating
profit is $125,000. The after-tax cost of capital is 10%. What is economic profit?
A) $95,000
B) $125,000
C) $145,000
D) $175,000
Answer: A
Diff: 2 Page Ref: 391, 392, 396
LO: 10-5
AACSB: Analytic Skills

18) The following information is available for Des Plaines Company:

Current assets $100,000 Current liabilities $175,000

Property, plant and Long-term liabilities 100,000
Equipment 150,000 Stockholders' equity 25,000
Other assets 50,000 Total liabilities and
Total assets $300,000 stockholders' equity $300,000

Invested capital is defined as total assets less current liabilities. The after-tax operating income is
$150,000. The after-tax cost of capital is 20%. The before-tax operating income is $200,000. What is the
residual income?
A) $90,000
B) $120,000
C) $125,000
D) $175,000
Answer: C
Diff: 2 Page Ref: 391, 392, 396
LO: 10-5
AACSB: Analytic Skills

26
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
19) The following information is available for West Allis Company:

Current assets $100,000 Current liabilities $75,000

Property, plant and Long-term liabilities 100,000
Equipment 150,000 Stockholders' equity 125,000
Other assets 50,000 Total liabilities and
Total assets $300,000 stockholders' equity $300,000

Invested capital is defined as total stockholders' equity. What is invested capital?

A) $125,000
B) $225,000
C) $250,000
D) $300,000
Answer: A
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

20) In measuring the performance of a division manager, stockholders' equity should not be used as the
amount of invested capital.
Answer: TRUE
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: None

21) Possible definitions of invested capital include total assets and total stockholders' equity.
Answer: TRUE
Diff: 1 Page Ref: 396
LO: 10-5
AACSB: None

22) The proponents of gross book value maintain that it facilitates comparisons between years and
between plants or divisions.
Answer: TRUE
Diff: 2 Page Ref: 397
LO: 10-5
AACSB: None

23) The rate of return on net book value decreases as equipment ages.
Answer: FALSE
Diff: 2 Page Ref: 397
LO: 10-5
AACSB: Analytic Skills

24) The rate of return on gross book value will not change if operating income remains constant.
Answer: TRUE
Diff: 2 Page Ref: 397
LO: 10-5
AACSB: Analytic Skills

27
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
25) Managers evaluated using net book value will tend to replace assets sooner than managers evaluated
using gross book value.
Answer: FALSE
Diff: 2 Page Ref: 397
LO: 10-5
AACSB: None

26) The use of net book value promotes a more conservative approach to asset replacement when
compared to gross book value.
Answer: TRUE
Diff: 2 Page Ref: 397
LO: 10-5
AACSB: Analytic Skills

27) The Johnsen Company has gathered the following data:

Total assets $4,000,000

Total current liabilities 600,000
Total liabilities 800,000
Revenue 1,500,000
Expenses 900,000

Required:
A) Compute ROI assuming invested capital is equal to total assets.
B) Compute ROI assuming invested capital is equal to total assets minus current liabilities.
C) Compute ROI assuming invested capital is equal to stockholders' equity.
Answer:
A) 15%
B) 17.65%
C) 18.75%
Diff: 2 Page Ref: 396
LO: 10-5
AACSB: Analytic Skills

10.6 Questions

1) Which of the following is NOT a goal of transfer pricing systems?

A) preserve segment autonomy
B) eliminate segment autonomy
C) increase performance of company as a whole
D) guide managers to make best possible decisions regarding whether to buy or sell products inside or
outside the organization
Answer: B
Diff: 2 Page Ref: 398
LO: 10-6
AACSB: None

28
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
2) Transfer prices are ________.
A) revenues of the segment producing the transferred product
B) costs of the segment acquiring the transferred product
C) costs of the segment producing the transferred product
D) revenues of the segment producing the transferred product and costs of the segment acquiring the
transferred product
Answer: D
Diff: 2 Page Ref: 398
LO: 10-6
AACSB: Analytic Skills

3) A transfer price exists when two segments of the same organization sell ________.
A) a product to the same customer
B) a product to each other
C) a product in a foreign country
D) the same service to customers
Answer: B
Diff: 1 Page Ref: 398
LO: 10-6
AACSB: None

4) Transfer prices are the amounts charged by one segment of an organization for a product that it
supplies to an outside firm.
Answer: FALSE
Diff: 1 Page Ref: 398
LO: 10-6
AACSB: None

5) The transfer price is revenue to the acquiring segment, and it is a cost to the segment producing the
product.
Answer: FALSE
Diff: 1 Page Ref: 398
LO: 10-6
AACSB: None

10.7 Questions

1) What is the general benchmark for transfer prices? The transfer price equals ________ plus ________.
A) fixed costs; opportunity costs
B) outlay cost; sunk cost
C) outlay cost; variable cost
D) outlay cost; opportunity cost
Answer: D
Diff: 2 Page Ref: 398
LO: 10-7
AACSB: None

29
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
2) North Division sells a part internally to South Division. South Division uses the part to produce
inexpensive products sold at discount stores. North Division incurs costs of $1.50 per part, while South
Division incurs additional costs of $4.80 per product. North Division sells the part to South Division for
$2.00 per part. The final product is sold to external customers for $8.00 each. Which of the following
formulas correctly reflects the company's operating income?
A) $8.00 - $1.50 - $4.80 - $2.00 = $(0.30)
B) $8.00 - $1.50 - $4.80 = $1.70
C) $8.00 - $4.80 -$2.00 = $1.20
D) $8.00 - $1.50 = $6.50
Answer: B
Diff: 2 Page Ref: 399
LO: 10-7
AACSB: Analytic Skills

3) Highpointe Division sells a part internally to Low Division. Low Division uses the part to produce
inexpensive products sold at discount stores. Highpointe Division incurs costs of $1.50 per part, while
Low Division incurs additional costs of $4.80 per product. Highpointe Division sells the part to Low
Division for $2.00 per part.
Low Division can purchase the part from an outside supplier for $1.00 per part, but does not accept the
offer. The final product is sold to external customers for $8.00 each. Which of the following formulas
correctly reflects the company's operating income?
A) $8.00 - $1.50 - $4.80 - $2.00 - $1.00 = $(1.30)
B) $8.00 - $1.50 - $4.80 = $1.70
C) $8.00 - $4.80 - $2.00 = $1.20
D) $8.00 - $1.50 = $6.50
Answer: B
Diff: 2 Page Ref: 399
LO: 10-7
AACSB: Analytic Skills

4) Division Y sells a food product internally to Division Z. Division Z uses the food product to produce
vegetarian burgers that sell for $5 per pound. Division Y incurs costs of $0.75 per pound to produce the
food product and sells the food product to Division Z for $1.00 per pound. Division Z incurs additional
costs of $2.50 per pound to produce the final product of vegetarian burgers. Division Z can purchase the
food product needed from outside suppliers for $0.75 per pound, but does not do so. Which formula
should be used to determine the company's operating income?
A) $5.00 - $0.75 - $1.00 - $0.75 - $2.50 = 0
B) $5.00 - $0.75 - $1.00 - $2.50 = $0.75
C) $5.00 - $0.75 - $2.50 = $1.75
D) $5.00 - $0.75 - $1.00 + $0.75 = $4.00
Answer: C
Diff: 2 Page Ref: 399
LO: 10-7
AACSB: Analytic Skills

30
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
5) There is(are) ________ goal(s) of transfer pricing systems. There is no universally ________ transfer
price.
A) multiple; maximum
B) one; maximum
C) multiple; optimal
D) one; optimal
Answer: C
Diff: 2 Page Ref: 400
LO: 10-7
AACSB: None

6) The West and East Divisions are part of the same company. Currently the East Division buys a part
from West Division for $384 per unit. The West Division wants to increase the price of the part it sells to
East Division by $96 to $480. The manager of the East Division has stated that he cannot pay that much
insofar as the division's profit goes below zero. The manager of the East Division can buy the part from
an outside supplier for $448 per unit. The cost data pertaining to the part is supplied by the West
Division:

Direct materials $136

Direct labor 200
Variable overhead 40
Fixed overhead 42

If West Division does not produce the parts for the East Division, it will be able to avoid one-third of the
fixed manufacturing overhead costs. The West Division has excess capacity but no alternative uses for
the facilities. From the standpoint of the company as a whole, should the East Division buy the part from
the West Division or the outside supplier?
A) East Division should buy the part from the West Division because the Company's profit will be $14.00
per unit larger.
B) East Division should buy the part from the West Division because the company's profit will be $32.00
per unit larger.
C) East Division should buy the part from the West Division because the company's profit will be $58.00
per unit larger.
D) East Division should buy from an outside supplier.
Answer: C
Diff: 2 Page Ref: 400
LO: 10-7
AACSB: Analytic Skills

31
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
7) The West and East Divisions are part of the same company. Currently the East Division buys a part
from West Division for $384 per unit. The West Division wants to increase the price of the part it sells to
East Division by $96 to $480. The manager of the East Division has stated that he cannot pay that much
insofar as the division's profit goes below zero. The manager of the East Division can buy the part from
an outside supplier for $448 per unit. The cost data pertaining to the part is supplied by the West
Division:

Direct materials $136.00

Direct labor 200.00
Variable overhead 40.00
Fixed overhead 38.40

If West Division does not produce the parts for the East Division, it will be able to avoid one-third of the
fixed manufacturing overhead costs. The West Division has excess capacity but no alternative uses for
the facilities. What is the maximum transfer price per unit that East Division should pay for the part?
A) $388.80
B) $414.40
C) $448.00
D) $480.00
Answer: C
Diff: 2 Page Ref: 400
LO: 10-7
AACSB: Analytic Skills

8) The West and East Divisions are part of the same company. Currently the East Division buys a part
from West Division for $384 per unit. The West Division wants to increase the price of the part it sells to
East Division by $96 to $480. The manager of the East Division has stated that he cannot pay that much
insofar as the division's profit goes below zero. The manager of the East Division can buy the part from
an outside supplier for $448 per unit. The cost data pertaining to the part is supplied by the West
Division:

Direct materials $136

Direct labor 200
Variable overhead 40
Fixed overhead 42

If West Division does not produce the parts for the East Division, it will be able to avoid one-third of the
fixed manufacturing overhead costs. The West Division has excess capacity but no alternative uses for
the facilities. What is the minimum transfer price per unit that West Division should charge East
Division?
A) $376
B) $390
C) $448
D) $480
Answer: B
Diff: 2 Page Ref: 400
LO: 10-7
AACSB: Analytic Skills

32
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
9) If there is a competitive market for the product being transferred internally, using the ________ as the
transfer price will lead to ________.
A) full cost; managerial effort
B) variable cost; performance rewards
C) full cost plus profit; goal congruence
D) market price; goal congruence
Answer: D
Diff: 2 Page Ref: 400
LO: 10-7
AACSB: None

10) Assuming a company uses a cost-based pricing system for transfer pricing, which of the following
items would NOT be used?
A) variable-costing
B) full-costing plus profit
C) full-costing
D) fixed-costing
Answer: D
Diff: 2 Page Ref: 400
LO: 10-7
AACSB: None

11) The most popular systems for transfer pricing in practice are ________.
A) market-based transfer prices
B) cost-based transfer prices based on variable costs
C) cost-based transfer prices based on full costs
D) all of the above
Answer: D
Diff: 1 Page Ref: 400
LO: 10-7
AACSB: None

33
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
12) Lou Company's records reveal the following:
Division X
Market price of finished component to outsiders $32
Variable costs per component $24
Contribution margin per component $8

Division Y
Sale price of finished product $42
Variable costs:
Division X(1 component) 24
Division Y Assembly 9
Division Y Packaging 4
Contribution margin per unit $5

The variable costs of Division Y will be incurred whether it buys from Division X or from an outside
supplier. Division X wants to transfer the components to Division Y for $34 each. Division Y can buy the
component for $32 per unit from an outside supplier. Division X has no excess capacity. The manager of
Division Y should ________.
A) buy the components from the outside supplier for $32 each
B) buy the components from Division X at $34 each
C) buy the components from an outside supplier for $33 each
D) none of the above
Answer: A
Diff: 2 Page Ref: 400-401
LO: 10-7
AACSB: Analytic Skills

34
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
13) Captain Company's records reveal the following:
Division X
Market price of finished component to outsiders $32
Variable costs per component $24
Contribution margin per component $8

Division Y
Sale price of finished product $42
Variable costs:
Division X(1 component) 24
Division Y Assembly 9
Division Y Packaging 4
Contribution margin per unit $5

The variable costs of Division Y will be incurred whether it buys from Division X or from an outside
supplier. Division Y can buy the component for $32 per unit from an outside supplier. Division X has no
excess capacity. What is the highest price per unit that Division Y should pay to Division X for the
components?
A) $8 per unit
B) $22 per unit
C) $24 per unit
D) $32 per unit
Answer: D
Diff: 2 Page Ref: 400-401
LO: 10-7
AACSB: Analytic Skills

35
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
14) Martin Company's records reveal the following:
Division X
Market price of finished component to outsiders $32
Variable costs per component $24
Contribution margin per component $8

Division Y
Sale price of finished product $42
Variable costs:
Division X(1 component) 24
Division Y Assembly 9
Division Y Packaging 4
Contribution margin per unit $5

The variable costs of Division Y will be incurred whether it buys from Division X or from an outside
supplier. Assume Division X is working at full capacity; there is no excess capacity. Division Y can buy
the component from an outside supplier for $32 per unit. What is the lowest transfer price per unit
Division X should accept from Division Y for the component?
A) $8 per unit
B) $22 per unit
C) $24 per unit
D) $32 per unit
Answer: D
Diff: 2 Page Ref: 400-401
LO: 10-7
AACSB: Analytic Skills

36
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
15) Frances Company's records reveal the following:
Division X
Market price of finished component to outsiders $32
Variable costs per component $24
Contribution margin per component $8

Division Y
Sale price of finished product $42
Variable costs:
Division X(1 component) 24
Division Y Assembly 9
Division Y Packaging 4
Contribution margin per unit $5

The variable costs of Division Y will be incurred whether it buys from Division X or from an outside
supplier. Assume Division X has excess capacity. Division Y can buy the component from an outside
supplier for $32 per unit. What is the lowest transfer price per unit at which Division X would be willing
to sell to Division Y?
A) $8
B) $22
C) $24
D) $32
Answer: C
Diff: 2 Page Ref: 400-401
LO: 10-7
AACSB: Analytic Skills

37
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
16) Steven Company's records reveal the following:
Division A
Market price of finished part to outsiders $75
Variable costs per part $51
Contribution margin per part $24

Division B
Sale price of finished product per unit $105
Variable costs:
Division A(1 part) 51
Division B Processing 27
Division B Selling 12
Contribution margin per unit $15

The variable costs of Division B will be incurred whether it buys from Division A or from an outside
supplier. Division A wants to transfer the parts to Division B for $81 each. Division B can buy the parts
for $75 per unit from an outside supplier. Division A has no excess capacity. The manager of Division B
should ________.
A) buy the parts from the outside supplier for $75 each
B) buy the parts from Division A at $81 each
C) buy the parts from an outside supplier for $76 each
D) none of the above
Answer: A
Diff: 2 Page Ref: 400-401
LO: 10-7
AACSB: Analytic Skills

38
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
17) Anne Company's records reveal the following:
Division A
Market price of finished part to outsiders $75
Variable costs per part $51
Contribution margin per part $24

Division B
Sale price of finished product per unit $105
Variable costs:
Division A(1 part) 51
Division B Processing 27
Division B Selling 12
Contribution margin per unit $15

The variable costs of Division B will be incurred whether it buys from Division A or from an outside
supplier. Division B can buy the parts from an outside supplier at $75 per unit. Division A has no excess
capacity. What is the highest price that Division B should pay to Division A for the parts per unit?
A) $24
B) $51
C) $66
D) $75
Answer: D
Diff: 2 Page Ref: 400-401
LO: 10-7
AACSB: Analytic Skills

39
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
18) Campos Company's records reveal the following:
Division A
Market price of finished part to outsiders $75
Variable costs per part $51
Contribution margin per part $24

Division B
Sale price of finished product per unit $105
Variable costs:
Division A(1 part) 51
Division B Processing 27
Division B Selling 12
Contribution margin per unit $15

The variable costs of Division B will be incurred whether it buys from Division A or from an outside
supplier. Assume Division A is working at full capacity. Division B can buy the parts from an outside
supplier at $75 per unit. What is the lowest transfer price per unit Division A should accept from
Division B?
A) $24
B) $51
C) $66
D) $75
Answer: D
Diff: 2 Page Ref: 400-401
LO: 10-7
AACSB: Analytic Skills

40
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
19) Dusty Company's records reveal the following:
Division A
Market price of finished part to outsiders $75
Variable costs per part $51
Contribution margin per part $24

Division B
Sale price of finished product per unit $105
Variable costs:
Division A(1 part) 51
Division B Processing 27
Division B Selling 12
Contribution margin per unit $15

The variable costs of Division B will be incurred whether it buys from Division A or from an outside
supplier. Division A has excess capacity. Division B can buy the parts for $75 per unit from an outside
supplier. What is the lowest transfer price per unit Division A will accept from Division B?
A) $24
B) $51
C) $66
D) $75
Answer: B
Diff: 2 Page Ref: 400-401
LO: 10-7
AACSB: Analytic Skills

20) ________ is an approach for establishing a market-based transfer price.

A) Full cost plus a normal profit markup
B) External market price less selling and delivery costs
C) External market price plus a profit markup
D) Variable cost plus unavoidable fixed cost
Answer: B
Diff: 1 Page Ref: 401
LO: 10-7
AACSB: None

21) ________ is any decision in conflict with organizational goals.

A) Congruent behavior
B) Managerial effort
C) Dysfunctional decision
D) Negotiating
Answer: C
Diff: 1 Page Ref: 401
LO: 10-7
AACSB: None

41
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
22) If market prices are not available for transfer prices, most companies use ________ transfer prices.
A) negotiated
B) calculated
C) cost-based
D) estimated
Answer: C
Diff: 2 Page Ref: 401
LO: 10-7
AACSB: None

23) Cost-based transfer prices are easy to implement but can lead to ________ decisions.
A) questionable
B) negotiated
C) dysfunctional
D) autonomous
Answer: C
Diff: 1 Page Ref: 403
LO: 10-7
AACSB: None

24) A general rule for transfer pricing is that the transfer price should equal the sum of outlay cost and
opportunity cost.
Answer: TRUE
Diff: 2 Page Ref: 398
LO: 10-7
AACSB: None

25) When determining a transfer price, outlay cost is often the variable cost for producing the item
transferred.
Answer: TRUE
Diff: 2 Page Ref: 398
LO: 10-7
AACSB: None

26) The opportunity cost of transferring an item internally is the contribution to profit that the selling
segment foregoes by transferring the item internally.
Answer: TRUE
Diff: 2 Page Ref: 398
LO: 10-7
AACSB: None

27) In cases of constrained capacity, the opportunity cost of transferring a product internally is zero.
Answer: FALSE
Diff: 2 Page Ref: 398
LO: 10-7
AACSB: None

42
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
28) When a division has idle production capacity, the transfer price that leads to optimal decision making
is variable cost.
Answer: TRUE
Diff: 2 Page Ref: 401
LO: 10-7
AACSB: None

29) Dysfunctional decisions are decisions that conflict with organizational goals and objectives.
Answer: TRUE
Diff: 2 Page Ref: 401
LO: 10-7
AACSB: None

30) It is recommended that standard costs be used instead of actual costs for cost-based transfer prices.
Answer: TRUE
Diff: 2 Page Ref: 402
LO: 10-7
AACSB: None

31) If actual costs are used for transfer pricing by a selling division, the division has little incentive to
control costs.
Answer: TRUE
Diff: 2 Page Ref: 402
LO: 10-7
AACSB: None

32) A full-cost or full-cost plus profit transfer price can potentially create dysfunctional decisions.
Answer: TRUE
Diff: 2 Page Ref: 402
LO: 10-7
AACSB: None

33) The time and effort spent negotiating a transfer price between a company's divisions adds nothing
directly to the profits of a company.
Answer: TRUE
Diff: 2 Page Ref: 403
LO: 10-7
AACSB: None

34) Top managers who wish to encourage decentralization will often make sure that both buying and
selling division managers understand all the facts and then allow the managers to negotiate a transfer
price.
Answer: TRUE
Diff: 2 Page Ref: 404
LO: 10-7
AACSB: None

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Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
35) The Nicholson and Cage Divisions are in the same company. Currently the Cage Division buys a part
from the Nicholson Division for $82 per unit. The Nicholson Division wants to increase the price of the
part to $100 per unit. Cage Division can buy the part for $94 from an outside supplier. The cost data for
the part obtained from the Nicholson Division is below:

Direct materials $25.50

Direct labor 32.50
Variable indirect production 22.50
Fixed indirect production 9.60

If Nicholson does not provide the parts to Cage, it will save one-fourth of the fixed indirect production
costs. The Nicholson Division has excess capacity but no alternative uses of the facilities.

Required:
A) From the standpoint of the company as a whole, should Cage Division continue to buy the part from
Nicholson Division?
B) From the standpoint of Cage Division only, should Cage Division continue to buy the part from
Nicholson Division?
Answer:
A) It costs $82.90 per unit to make the part in house and $94 per unit to buy the part from an outside
supplier. Cage Division should buy the part from Nicholson Division.
B) The purchase options available to Cage Division are $94 per unit from the outside supplier and $100
per unit from the Nicholson Division. Cage Division should buy the part from the outside supplier.
Diff: 2 Page Ref: 398-400
LO: 10-7
AACSB: Analytic Skills

44
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
36) Sweater Division manufactures sweaters. The buttons used in production are purchased from an
outside supplier at a cost of $4.50 per sweater. The buttons can also be purchased in house from Supply
Division for $4.00 per sweater. The cost data for the buttons produced by Supply Division are as follows:

Direct material $1.30

Direct labor 0.90
Variable indirect production 0.35
Fixed indirect production 0.30
Variable selling expenses 0.50
Fixed selling expenses 0.45

Variable selling expenses are not incurred on inside transfers. Assume Supply Division has excess
capacity.

Required:
A) What is the minimum transfer price that Supply Division should charge Sweater Division for the
transferred buttons?
B) What is the maximum transfer price that Sweater Division should pay Supply Division for the
transferred buttons?
Answer:
A) $2.55
B) $4.50
Diff: 2 Page Ref: 399-400
LO: 10-7
AACSB: Analytic Skills

10.8 Questions

1) Multinational companies use transfer prices to minimize worldwide income taxes, ________ and
________.
A) tariffs; financial restrictions imposed by U.S. government
B) tariffs; import duties
C) financial restrictions imposed by U.S. government; import duties
D) foreign bribes; import duties
Answer: B
Diff: 2 Page Ref: 404
LO: 10-8
AACSB: None

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Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
2) A division of Saskowski Company is located in Bulgaria. The country places restrictions on the
amount of funds that may be paid as dividends to foreign owners. If Saskowski Company wants to
maximize the amount of cash received from the foreign division, Saskowski Company should set a
________.
A) high transfer price for goods transferred out of Bulgaria
B) high transfer price for goods transferred into Bulgaria
C) low transfer price for goods transferred out of Bulgaria
D) low transfer price for goods transferred into Bulgaria
Answer: B
Diff: 2 Page Ref: 405
LO: 10-8
AACSB: None

3) The variable cost of Part X is $50 per unit and the full cost of the part is $80 per unit. The part is
produced in Country Z and transferred to a plant in Country B. Country Z has a 30% income tax rate.
Country B has a 50% income tax rate and an import duty equal to 10% of the price of the item. Part X can
be transferred at full cost or variable cost. Assume Part X is transferred at full cost. By using full cost
instead of variable cost for the transfer price, the income tax effect per unit in Country Z is ________.
A) a decrease in tax by $9 per unit
B) an increase in tax by $9 per unit
C) a decrease in tax by $24 per unit
D) an increase in tax by $24 per unit
Answer: B
Diff: 2 Page Ref: 405
LO: 10-8
AACSB: Analytic Skills

4) The variable cost of Part X is $50 per unit and the full cost of the part is $80 per unit. The part is
produced in Country Z and transferred to a plant in Country B. Country Z has a 30% income tax rate.
Country B has a 50% income tax rate and an import duty equal to 10% of the price of the item. Part X can
be transferred at full cost or variable cost. Assume Part X is transferred at full cost. By using full cost
instead of variable cost for the transfer price, the income tax effect per unit in Country B is ________.
A) a decrease in tax by $9 per unit
B) an increase in tax by $9 per unit
C) a decrease in tax by $15 per unit
D) an increase in tax by $15 per unit
Answer: C
Diff: 2 Page Ref: 405
LO: 10-8
AACSB: Analytic Skills

46
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
5) The variable cost of Part X is $50 per unit and the full cost of the part is $80 per unit. The part is
produced in Country Z and transferred to a plant in Country B. Country Z has a 30% income tax rate.
Country B has a 50% income tax rate and an import duty equal to 10% of the price of the item. Part X can
be transferred at full cost or variable cost. Assume Part X is transferred at full cost. By using full cost
instead of variable cost for the transfer price, the net savings is ________.
A) $3 per unit
B) $6 per unit
C) $9 per unit
D) $15 per unit
Answer: A
Diff: 2 Page Ref: 405
LO: 10-8
AACSB: Analytic Skills

6) Multinational companies use transfer pricing to minimize their worldwide income taxes, duties and
tariffs.
Answer: TRUE
Diff: 2 Page Ref: 404
LO: 10-8
AACSB: None

7) For multinational companies, worldwide income taxes do not influence the setting of transfer prices.
Answer: FALSE
Diff: 2 Page Ref: 404
LO: 10-8
AACSB: None

8) In a multinational setting, low transfer prices generally lead to low import duties.
Answer: TRUE
Diff: 2 Page Ref: 404
LO: 10-8
AACSB: None

9) U.S. multinational companies must follow the Internal Revenue Code when setting transfer prices.
Answer: TRUE
Diff: 2 Page Ref: 404
LO: 10-8
AACSB: None

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Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall
10.9 Questions

1) The joint formulation by a manager and his or her superior of a set of goals and plans for achieving the
goals for a forthcoming period is known as ________.
A) capital budgeting
B) managerial effort
C) management control system
D) management by objectives
Answer: D
Diff: 1 Page Ref: 406
LO: 10-9
AACSB: None

2) A management by objectives approach stresses budgeted results.

Answer: TRUE
Diff: 2 Page Ref: 406
LO: 10-9
AACSB: None

3) Companies will not suffer negative consequences if they overemphasize meeting a budget when
evaluating managers.
Answer: FALSE
Diff: 2 Page Ref: 407
LO: 10-9
AACSB: None

48
Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall