Responsibility Accounting and Performance Measures Paper 5

Answer (C) is correct. Using the budgeted rate times actual hours of usage would reward those departments who budgeted their computer usage carefully while appropriately charging those who exceeded their budgets.

Answer (B) is correct. A contribution income statement emphasizes the distinction between fixed and variable costs. Thus, fixed manufacturing costs and other fixed costs are separated from variable manufacturing costs and other variable costs. The basic categories in the contribution income statement are variable costs, contribution margin, fixed costs, and operating income.

Answer (C) is correct. Residual income is the excess of the return on an investment over a targeted amount equal to an imputed interest charge on invested capital. The rate used is ordinarily set as a target return by management but is often equal to the weighted average cost of capital. Some enterprises prefer to measure managerial performance in terms of the amount of residual income rather than the percentage ROI because the firm will benefit from expansion as long as residual income is earned.

Answer (D) is correct. ROI equals income divided by invested capital. If a company is already profitable, increasing sales and expenses by the same percentage will increase ROI. For example, if a company has sales of $100 and expenses of $80, its net income is $20. Given invested capital of $100, ROI is 20% ($20 ÷ $100). If sales and expenses both increase 10% to $110 and $88, respectively, net income increases to $22. ROI will then be 22% ($22 ÷ $100).

Answer (B) is correct. Return on investment is the key performance measure in an investment center. ROI is a rate computed by dividing a segment’s income by the invested capital. ROI is therefore subject to the numerous possible manipulations of the income and investment amounts. For example, a manager may choose not to invest in a project that will yield less than the desired rate of return, or (s)he may defer necessary expenses.

Answer (D) is correct. An investment center is responsible for revenues, expenses, and invested capital. Given average plant and equipment of $1,775 and average working capital of $625, the net investment is $2,400. Before-tax profit is $400 ($4,000 sales – $3,525 cost of goods sold – $75 general expenses). If before-tax ROI equals before-tax profit divided by net investment, the answer is 16.67% ($400 ÷ $2,400).

Answer (D) is correct. ROI is calculated by dividing income by invested capital. It is a key performance measure of an investment center. Invested capital may be defined in various ways, such as shareholders’ equity, total assets available, or total assets employed (which excludes assets that are idle). Total assets available is the measure that assumes the manager will use all assets without regard to financing.

Answer (D) is correct. An increase in revenue and a decrease in costs will increase the ROI numerator. A decrease in investment will decrease the denominator. The ROI must increase in this situation.

Answer (D) is correct. Each investment center of a business should be evaluated based upon return on investment to judge operating performance. ROI is comparable to calculations made both within and without a particular organization. Management may review the investment opportunities available within or without the firm. In essence, net income is stated as a proportion of investment capital (resources required).

Answer (D) is correct. ROI equals net income divided by investment. Increasing net income (e.g., by decreasing expenses or by increasing prices or sales volume) or decreasing the investment base improves ROI. Hence, any of the actions listed increases the return on investment. Management and the accounting profession are very concerned with classification of expenses and assets and other decisions involving the accounting for these items to achieve a proper calculation of return on investment.