Cost Management

CHAPTER 19
MEASURING AND REWARDING ORGANIZATIONAL PERFORMANCE

MULTIPLE CHOICE
1.
Variance analysis would be appropriate to measure performance in

a.
b.
c.
d.
profit centers.
investment centers.
cost centers.
all of the above.
ANSWER:
2.
investment center
revenue center
profit center
cost center
ANSWER:
EASY
cost centers and investment centers.

revenue centers and profit centers.
revenue centers and investment centers.
profit and investment centers.
ANSWER:
EASY
Using a single performance evaluation criterion for an investment center

a.
b.
c.
d.
is most effective because a manager can concentrate on a single goal.

can result in manipulation of the performance measure.
allows multinational investment centers' performances to be equitably compared.
is only appropriate if the criterion is non-monetary.
ANSWER:
5.
Net cash flow could be used to measure performance in

a.
b.
c.
d.
4.
EASY
Which of the following responsibility centers may be evaluated on the basis of residual
income?
a.
b.
c.
d.
3.
EASY
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%.
19-1
19-2
Performance
b.
c.
d.
Chapter 19
sell all assets that do not generate divisional income of more than 16%.
acquire assets that would increase sales by more than 16%.
acquire any technologically advanced assets that would cause costs to be reduced
by 16% or more.
ANSWER:
6.
c.
d.
EASY
The Statement of Cash Flows may be superior to the cash budget as a performance
evaluation measure because
a.
b.
c.
d.
cash flows are shown on the accrual basis on the cash budget.
the cash budget does not include capital investments.
cash flows are arranged by activity.
of all the above reasons.
ANSWER:
MEDIUM
The Statement of Cash Flows indicates the cash inflows and outflows from
a.
b.
c.
d.
investing, financing, and borrowing activities.

operating, investing, and sending activities.
merchandising, financing, and investing activities.
operating, investing, and financing activities.
ANSWER:
9.
EASY
and the sub-unit should be evaluated on the basis of the same costs and revenues.
should only be evaluated on the basis of variable costs and revenues of the subunit.
should be evaluated on all costs and revenues that are controllable by the manager
should be evaluated on all costs and revenues that can be directly traced to the
sub-unit.
ANSWER:
8.
In evaluating the performance of a profit center manager, the manager

a.
b.
7.
Measuring and Rewarding Organizational
EASY
Division A's investment in a new project will raise the overall organization's return on
investment if
a.
b.
the return on investment on the new project exceeds the target return of the overall
organization.
the return on investment on the new project exceeds the return on investment of
Division A.
Chapter 19
c.
d.
Measuring and Rewarding Organizational Performance
the return on investment on the new project exceeds the overall organization's
return on investment.
Division A's return on investment exceeds the return on investment of the overall
organization.
ANSWER:
10.
EASY
If sales and expenses both rise by $100,000

a.
b.
c.
d.
residual income will increase.

return on investment will increase.
return on investment will be unchanged.
asset turnover will decrease
ANSWER:
11.
EASY
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.
b.
c.
d.
A Division manager
accept
accept
reject
reject
ANSWER:
12.
19-3
ABC Corp. president

accept
reject
accept
reject
EASY
A company's return on investment is affected by a change in
a.
b.
c.
d.
Asset Turnover
Yes
Yes
No
No
ANSWER:
Profit Margin
on Sales
Yes
No
No
Yes
EASY
19-4
Performance
13.
Chapter 19
The return on investment (ROI) ratio measures

a.
b.
c.
d.
only asset turnover.

only earnings as a percent of sales.
both asset turnover and earnings as a percent of sales.
asset turnover and earnings as a percent of sales, correcting for the effects of
differing depreciation methods.
ANSWER:
14.
c.
d.
MEDIUM
A sub-unit of an organization is evaluated on the basis of its ROI. If this sub-units sales
and expenses both increase by $30,000, how will the following measures be affected?
a.
b.
c.
d.
ROI
increase
indeterminate
no change
no change
ANSWER:
Assert turnover
increase
increase
increase
decrease
Profit margin
increase
decrease
decrease
no change
MEDIUM
Which of the following would be an appropriate alternative to the use of ROI in

evaluating the performance of an investment center?
a.
b.
c.
d.
Residual
income
yes
no
yes
yes
ANSWER:
17.
EASY
increased by the same dollar amount as expenses and total assets increased.
remained the same and expenses were reduced by the same dollar amount that
total assets increased.
decreased by the same dollar amount that expenses increased.
and expenses increased by the same percentage that total assets increased.
ANSWER:
16.
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.
b.
15.
Net cash
flow
yes
yes
no
no
c
Cost and revenue

variance analysis
yes
no
no
yes
EASY
Return on investment is computed by dividing income by
Chapter 19
a.
b.
c.
d.
contribution margin.
inventory turnover.
assets invested.
average assets employed.
ANSWER:
18.
MEDIUM
Profit margin indicates the portion of sales that

a.
b.
c.
d.
covers fixed expenses.

is not used to cover expenses.
equals contribution margin.
equals product contribution margin.
ANSWER:
EASY
Profit margin equals

a.
b.
c.
d.
income divided by sales.

incomes divided by average inventory.
income divided by average assets.
income divided by average stockholders equity.
ANSWER:
21.
EASY
an increase in the profit margin ratio to above 30%.

a decrease in the profit margin ratio to below 30%.
no change in the profit margin ratio.
a change in the profit margin ratio that cannot be determined from this information.
ANSWER:
20.
Presently, the Alligator Division of Animal Crackers Co. has a profit margin of 30%. If
total sales rise by $100,000, both the numerator and the denominator of the profit margin
will increase. The net result will be
a.
b.
c.
e.
19.
19-5
EASY
The Du Pont model measures

a.
b.
c.
d.
residual income.
throughput.
profit.
ANSWER:
EASY
19-6
Performance
22.
Chapter 19
In the Du Pont model, profit margin is a ratio of

a.
b.
c.
d.
income to sales.
income to assets.
sales to income.
sales to assets.
ANSWER:
23.
EASY
Residual income is used as a performance measure in

a.
b.
c.
d.
profit centers.
cost centers.
investment centers.
revenue centers.
ANSWER:
EASY
If a new project generates a positive residual income, the

a.
b.
c.
d.
project's return on investment is less than the target rate.

project's return on investment is greater than the target rate.
project's return on investment is equal to the target rate.
relationship between the project's return on investment and the target rate cannot
necessarily be determined.
ANSWER:
26.
EASY
contribution margin and asset turnover.

profit margin and asset turnover.
asset turnover.
profit margin.
ANSWER:
25.
The Du Pont model measures ROI as it is affected by

a.
b.
c.
d.
24.
EASY
A prospective project under consideration by P Division of C Co. has an estimated

residual income of a negative $20,000. If the project requires an investment of $400,000,
the
a.
b.
c.
d.
project generates a negative return on investment.

project's return on investment is zero.
project's return on investment is 5% less than the company's target rate.
company's target rate is 15%
ANSWER:
MEDIUM
Chapter 19
27.
Residual income is the

a.
b.
c.
d.
contribution margin of an investment center, less the imputed interest on the

invested capital used by the center.
contribution margin of an investment center, plus the imputed interest on the
invested capital used by the center.
income of an investment center, less the imputed interest on the invested capital
used by the center.
income of an investment center, plus the imputed interest on the invested capital
used by the center.
ANSWER:
28.
EASY
If a division generates a positive residual income then the divisions

a.
b.
c.
d.
asset turnover was very high.

profitability was greater than that of other divisions in the company.
performance was above expectations.
actual return on investment exceeds the divisions target return.
ANSWER:
EASY
Residual income is determined as

a.
b.
c.
d.
income times the asset turnover rate.

income times the inventory turnover rate.
income minus (asset base times target rate of return).
sales minus (asset base times target rate of return).
ANSWER:
31.
EASY
long-term
short-term
qualitative
profit center
ANSWER:
30.
Residual income is an example of a ____________ performance measurement.

a.
b.
c.
d.
29.
19-7
EASY
Residual income is used as a performance measure in which of the following types of

centers?
a.
b.
Revenue
yes
yes
Investment
no
yes
Profit
yes
yes
19-8
Performance
c.
d.
Chapter 19
no
no
ANSWER:
32.
EASY
All other things being equal, an increase in sales price would increase
a.
b.
c.
d.
asset turnover.
profit margin.
residual income.
all of the above.
ANSWER:
EASY
If sales and expenses both rise by $100,000, profit margin will

a.
b.
c.
d.
decrease and asset turnover will decrease.

increase and asset turnover will decrease.
decrease and asset turnover will increase.
increase and asset turnover will increase.
ANSWER:
35.
EASY
increase in residual income.

decrease in return on investment.
decrease in residual income.
decrease in both residual income and return on investment.
ANSWER:
34.
yes
no
An increase in a corporation's target rate would result in a(n)

a.
b.
c.
d.
33.
yes
yes
MEDIUM
Asset turnover equals

a.
b.
c.
d.
income divided by average assets.

sales divided by assets.
sales divided by average assets.
assets divided by sales.
ANSWER:
EASY
Chapter 19
36.
19-9
The information below relates to costs, revenues, and assets anticipated for 1999 in B
Division of BVD Corp:
Sales
Variable costs
Average assets employed
Fixed costs
$ 4,000,000
75% of sales
$12,000,000
0
How would each of the following measures be affected if sales rise by $5,000 in X
Division?
a.
b.
c.
d.
ROI
increase
increase
increase
no change
ANSWER:
37.
EASY
100%
4%
25%
2%
ANSWER:
EASY
Which measure is limited by the fact that it uses accounting income?

a.
b.
c.
d.
ROI
RI
EVA
All of the above
ANSWER:
39.
Profit margin
increase
increase
no change
increase
A division of Lucky Co. 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.
b.
c.
d.
38.
Asset turnover
increase
no change
increase
no change
EASY
Z Division of XYZ Corp. has the following information for 1998:

Assets available for use
Target rate of return
Residual income
$1,800,000
10%
$ 270,000
What was Z Division's return on investment for 1998?

a.
b.
15%
10%
19-10
Performance
c.
d.
Chapter 19
25%
20%
ANSWER:
MEDIUM
Use the following information for questions 40-43:

Apple Division of the American Fruit Co had the following statistics for 1998:
$1,000,000 Book Value
$1,500,000 Market Value
Residual income
100,000
Return on investment
15%
40.
What was Apple Division's segment income for 1998?

a.
b.
c.
d.
$150,000
$100,000
$250,000
$ 50,000
ANSWER:
41.
MEDIUM
What was the target rate of return in the American Fruit Company for 1998?
a.
b.
c.
d.
10%
15%
25%
5%
ANSWER:
42.
MEDIUM
If the manager of Apple 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.
b.
c.
$ 50,000
$ 333,333
$1,000,000
Chapter 19
d.
$ 500,000
ANSWER:
43.
19-11
MEDIUM
If expenses increased by $20,000 in Apple Division,

a.
b.
c.
d.
return on investment would decrease.

residual income would increase.
the target rate of return would decrease.
asset turnover would decrease.
ANSWER:
EASY
Use the following information for questions 44 through 46:

T Division of the Alphabet Co. has the following statistics for its 1998 operations:
T Division's return on investment
T Division's residual income
Return on investment (entire Alphabet Co)
44.
Compute EVA assuming the cost of capital is 10% and the tax rate is 40%.
a.
b.
c.
d.
$ 90,000
$ 150,000
$0
$ (60,000)
ANSWER
45.
MEDIUM
What is the target rate of return in the Alphabet Co.?

a.
b.
c.
d.
25%
20%
15%
10%
ANSWER:
46.
$2,000,000
25%
200,000
20%
MEDIUM
If Alphabet Co. evaluates its managers on the basis of return on investment, the manager
of T Division would invest in a project costing $100,000 only if it increased net segment
income by at least
a.
b.
c.
d.
$10,000.
$15,000.
$20,000.
$25,000.
19-12
Performance
Chapter 19
ANSWER:
MEDIUM
47. A Corp. 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.
b.
c.
d.
$200,000
$ 66,667
$ 50,000
The answer can't be determined from this information.
ANSWER:
48.
15%
12%
25%
27%
ANSWER:
MEDIUM
In the X Division of S Co., 1998 segment income exceeded 1998 residual income by
$15,000. Also for 1998, return on investment exceeded the target rate of return by 10%.
What was the level of investment in the X Division for 1998?
a.
b.
c.
d.
$ 15,000
$100,000
$150,000
An answer can't be determined from this information.
ANSWER:
50.
MEDIUM
The Bullwhip Division of Leather Products Co. is considering an investment in a new

project. The project has an estimated cost of $1,000,000. If Leather Products Co. 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.
b.
c.
d.
49.
DIFFICULT
BAD Co. has established a target rate of return of 16% for all divisions. In 1998, 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. For 1998, what was Division Ds return on investment ?
a.
b.
20.83 %
35.71 %
Chapter 19
c.
d.
41.67 %
50.00 %
ANSWER:
51.
MEDIUM
BAD Co. has established a target rate of return of 16% for all divisions. In 1998, 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. For 1998, what was Division Ds residual income?
a.
b.
c.
d.
$ 960,000
$1,380,000
$1.540,000
$1,700,000
ANSWER:
52.
MEDIUM
Bagel Division of Pita Company reported the following results for 1999:
Sales
Expenses
Total assets (1/1/99)
$8,000,000
6,250,000
5,000,000
5,400,000
What was the profit margin of Bagel Division in 1999?

a.
b.
c.
d.
68%
35%
32%
22%
ANSWER:
53.
19-13
MEDIUM
Bagel Division of Pita Company reported the following results for 1999:
Sales
Expenses
$8,000,000
6,250,000
5,000,000
5,400,000
What was the asset turnover ratio of Bagel Division in 1999?

a.
b.
c.
d.
1.538
2.97
0.650
1.20
ANSWER:
MEDIUM
19-14
Performance
54.
Chapter 19
Pasta Division of We Make Italian, is evaluated based on residual income generated. For
1998, the 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 We Make Italian is 20%. For
1998, what was the return on investment for Pasta Division?
a.
b.
c.
d.
40%
13%
20%
33%
ANSWER:
55.
c.
d.
EASY
Relative to qualitative performance measures, quantitative performance measures are less

a.
b.
c.
d.
subject to manipulation.
dependent on accounting information.
effective in the pursuit of organizational goals.
subjective.
ANSWER:
EASY
Improved effectiveness and efficiency of a product is considered a ______ performance

measurement?
a.
b.
c.
d.
non-financial
financial
quantitative
qualitative
ANSWER:
58.
MEDIUM
are usually the most well-received by managers.

often reflect long-term organizational goals better than financial performance
measures.
can only be developed in the production area of an organization.
is limited by the number of critical success factors defined by the organization.
ANSWER:
57.
Qualitative non-financial performance measures

a.
b.
56.
EASY
Non-financial performance measures (NFPMs) are better than financial measures in that
NFPMs
Chapter 19
a.
b.
c.
d.
provide a better indication of customer satisfaction.

may better predict the direction of future cash flows.
directly measure how well an organization does those things that create
shareholder value.
all of the above
ANSWER:
59.
b.
c.
d.
EASY
Which of the following would be considered a non-financial performance measurement?

a.
b.
c.
d.
increase in market share

variances from standards
number of customer complaints
cost of engineering changes
ANSWER:
EASY
Which type of financial measure better predicts the direction of future cash flows?
a.
b.
c.
d.
Non-financial Measures
yes
yes
no
no
ANSWER:
62.
EASY
qualitative characteristics that point out sub-optimization activities and throughput

bottlenecks.
both short-term and long-term measures related to critical success factors.
long-term supplier satisfaction levels.
short-term financial viability.
ANSWER:
61.
In selecting non-financial performance measures managers should choose measures that

reflect
a.
60.
19-15
Financial Measures
yes
no
no
yes
EASY
Which of the following would be classified as a non-financial critical success factor?
a.
b.
Quality
no
yes
Technical
Excellence
no
no
Manufacturing
Efficiency
no
no
Manufacturing
Effectiveness
yes
no
19-16
Performance
c.
d.
Chapter 19
yes
yes
ANSWER:
63.
EASY
EASY
Which of the following is necessary for any valid performance measurement?

a.
b.
c.
d.
It must be part of the financial accounting system in use.

It must be quantifiable.
Goal congruence must be promoted by its use.
It must be financial in nature.
ANSWER:
EASY
Process quality yield is used in the measurement of

a.
b.
c.
d.
throughput.
cash flows.
asset turnover.
profit margin.
ANSWER:
66.
yes
yes
profitability
costs
market
sales
ANSWER:
65.
yes
no
Which of the following is not one of the four areas of performance measurements
mentioned in the text?
a.
b.
c.
d.
64.
yes
yes
EASY
An increase in productive processing time will increase

a.
b.
c.
d.
throughput.
process yield.
productive capacity.
ANSWER:
EASY
Chapter 19
67.
Which of the following is the throughput measure?

a.
b.
c.
d.
Processing time/Total time

Good units/Total time
Good units/Processing time
Total units/Total time
ANSWER:
68.
EASY
good units to bad units.

time required to produce a good unit.
total units manufactured that are good.
total time spent to time available.
ANSWER:
EASY
When inventory sits idle in a department, this would not affect the department's
a.
b.
c.
d.
processing time.
throughput.
process quality yield.
dollar days.
ANSWER:
EASY
Process quality yield reflects the proportion of

a.
b.
c.
d.
time it takes to make a good unit.

good units to defective units.
total time spent to total time available.
total units produced that are good units.
ANSWER:
72.
Process quality yield reflects the proportion of

a.
b.
c.
d.
71.
EASY
residual income.
net cash flow.
throughput.
ANSWER:
70.
Productive capacity is a measure used in computing

a.
b.
c.
d.
69.
19-17
EASY
Holding total production in units constant, as the proportion of defective units to total
units declines, all of the following measures will be affected, except
19-18
Performance
a.
b.
c.
d.
Chapter 19
total unit sales.

throughput.
process quality yield.
process productivity.
ANSWER:
73.
EASY
Which of the following would not be an appropriate cost driver to measure internal
failure?
a.
b.
c.
d.
design error
product failure
machine reliability
operator error
ANSWER:
EASY
When assessing performance, one way to compensate for differences among divisions of a
multinational organization would be for the parent company to
a.
b.
c.
d.
use different target rates of return to compute residual incomes.

modify the return on investment calculation so that foreign currency fluctuations
are removed from all financial statement figures.
classify all domestic divisions as investment centers and all foreign divisions as
profit centers.
use financial performance measures for units whose records are kept in the
domestic currency and non-financial measures for units whose records are kept in a
foreign currency.
ANSWER:
76.
EASY
total units divided by non-value-added processing time.

total units divided by value-added processing time.
value-added processing time divided by total units.
value-added processing divided by total time.
ANSWER:
75.
Process productivity is calculated as

a.
b.
c.
d.
74.
MEDIUM
If performance measures are perfect proxies for organizational goals,
Chapter 19
a.
b.
c.
d.
sub-optimization will be enhanced.

sub-unit managers will strive to achieve organizational goals.
sub-units can all be decentralized.
residual income will rise.
ANSWER:
77.
EASY
The following information is made available for June, what is the throughput per hour?
Good units manufactured
Value-added hours of manufacturing time
Total units manufactured
Total hours of manufacturing time
a.
b.
c.
d.
EASY
The following information is made available for June, what is the process quality yield?
Value-added hours of manufacturing time
Total units manufactured
Total hours of manufacturing time
a.
b.
c.
d.
40,000
20,000
50,000
30,000
50%
75%
80%
125%
ANSWER:
79.
40,000
20,000
50,000
30,000
1.3 units (rounded)

2.0 units
1.8 units
.8 units
ANSWER:
78.
19-19
EASY
One of the products manufactured by I Can Fly TOO, Company is a plastic disk. The
information below relates to the Disk Production Department:
Good units produced
Units started in production
200,000
250,000
19-20
Performance
Chapter 19
Processing time (budgeted hours)

Processing time (total hours)
Value-added processing time
425
400
300
What is the process quality yield in the Disk Production Department?

a.
b.
c.
d.
75%
44%
80%
125%
ANSWER:
80.
EASY
Good units produced
200,000
250,000
425
400
300
What is the throughput per hour in the Disk Production Department?

a.
b.
c.
d.
470 units
500 units
625 units
667 units
ANSWER:
81.
MEDIUM
Good units produced
200,000
250,000
Chapter 19

425
400
300
What is the process productivity in the Disk Production Department?

a.
b.
c.
d.
588
625
667
833
ANSWER:
82.
financial measures
environmental measures
business process measures
personnel measures
ANSWER:
EASY
managers a way to judge past performance.

stockholders a way to judge current performance.
managers a way to forecast future performance.
stockholders a way to tie strategy to profitability.
ANSWER:
MEDIUM
In a balanced scorecard, measurements should be directly linked to

a.
b.
c.
d.
organizational strategy and values.

the cost management system.
current organizational profitability.
activity-based management concepts.
ANSWER:
85.
A primary purpose of a balanced scorecard is to give

a.
b.
c.
d.
84.
MEDIUM
Which of the following is not a balanced scorecard category?

a.
b.
c.
d.
83.
EASY
Customer measures on the balanced scorecard should be

a.
b.
c.
d.
Internal
yes
no
no
yes
External
no
yes
yes
yes
Monetary
no
yes
no
yes
Non-monetary
yes
no
yes
yes
19-21
19-22
Performance
Chapter 19
ANSWER:
86.
c.
d.
records the variances between budgeted and actual revenues and expenses.
can be used at multiple organizational levels by redefining the categories and
measurements.
is most concerned with organizational financial solvency and business processes.
all of the above.
ANSWER:
MEDIUM
Rapid time-to-market of new products

Corporate financial profits
On-time delivery
Decrease in reworked products
ANSWER:
EASY
On a balanced scorecard, which of the following would be most appropriate to measure

production process integrity?
a.
b.
c.
d.

Low employee turnover
Decrease in reworked products
ANSWER:
89.

customer service?
a.
b.
c.
d.
88.
MEDIUM
A balanced scorecard
a.
b.
87.
EASY

innovation:
a.
b.
c.
d.

On-time delivery
Manufacturing cycle efficiency
ANSWER:
EASY
Chapter 19
90.

financial performance?
a.
b.
c.
d.
Market share
Customer retention
Percentage of sales from new products
Investment in intellectual capital
ANSWER:
91.
MEDIUM
Which of the following would not normally affect the compensation strategy of a firm?
a.
b.
c.
d.
organizational goals
location of firm
competition
number of subsidiaries
ANSWER:
EASY
Managers should be paid

a.
b.
c.
d.
on a periodic basis.
based on results achieved.
using ESOPs.
on a piece rate basis.
ANSWER:
94.
EASY
consistency at all levels in the organization.

adaptability to differing situations in the organization.
efficiency of application to all individuals in the organization.
flexibility to delay rewards although performance objectives have been met.
ANSWER:
93.
A primary characteristic of a performance management system is

a.
b.
c.
d.
92.
19-23
EASY
Financial incentives are

a.
b.
c.
d.
different from monetary rewards

the same thing as a salary element
provided to all employee groups.
available to top management whose performance exceeds targeted objectives
19-24
Performance
Chapter 19
ANSWER:
95.
set performance rewards

identify performance measures
determine reward
identify critical success factors
ANSWER:
EASY
Merit pay is
a.
b.
c.
d.
a contingent amount of pay that is earned by managers whose subunits meet a

target rate of return.
always for a limited period of time and must be re-earned each period.
any pay earned when the company is profitable.
a pay increment received when a specific performance level is achieved.
ANSWER:
EASY
Contingent pay
a.
b.
c.
d.
is always paid in stock options.

is the sole source of pay an employee receives from his/her employer.
is received in addition to the basic wage and is dependent upon performance
exceeding some performance objective.
can only apply to individual performance.
ANSWER:
99.
EASY
are not needed in a performance-based plan.

must be stated for a performance-based plan to work.
are essential for a periodic compensation plan to be successful.
are unnecessary for a merit pay plan.
ANSWER:
98.
Objectives for a pay plan

a.
b.
c.
d.
97.
EASY
Which of the following steps in the performance reward plan model comes before the
others listed?
a.
b.
c.
d.
96.
EASY
Piece rate pay

a.
b.
c.
d.
is a suitable pay plan for low-IQ workers.

involves a salary plus pay for each unit produced or carried out.
encourages quality output.
does not encourage workers to look at the company's well being.
Chapter 19
ANSWER:
100.
monthly salary
cafeteria plan
profit sharing
pensions
ANSWER:
EASY
profit sharing
pensions
piece rate
merit pay
ANSWER:
EASY
Which performance plan best promotes quality of the product or service?

a.
b.
c.
d.
piece rate
health insurance
pensions
profit sharing
ANSWER:
103.
Which performance plan is most tied to company objectives?

a.
b.
c.
d.
102.
EASY
Which of the following pay plans encourages the improvement of the overall company's
well-being?
a.
b.
c.
d.
101.
19-25
EASY
Employee stock ownership in the employees' firm

a.
b.
c.
d.
will encourage short term earnings growth patterns.

will encourage employees to take a longer term perspective regarding their
performance in the company.
is not suitable for hourly or salaried employees.
is common for management in American firms.
ANSWER:
MEDIUM
19-26
Performance
104.
Chapter 19
A pay plan that gives an employee cash or stock equal to the difference between some
specified stock price and the quoted market price at some future time period is
a.
b.
c.
d.
stock appreciation rights .

an ESOP.
profit sharing.
merit pay .
ANSWER:
105.
EASY
contingent pay
profit sharing
cafeteria plans
stock appreciation rights
ANSWER:
MEDIUM
The traditional compensation package provides

a.
b.
c.
d.
fixed monthly or weekly salaries.

the same salary structure for all groups of employees.
no incentive for non-top management to improve performance.
no need to include incentive compensation.
ANSWER:
107.
Which of the following types of employee compensation are tax-exempt?

a.
b.
c.
d.
106.
EASY
Compensation packages for executives of American firms

a.
b.
c.
d.
are beginning to emphasize the long-term commitment executives should have in

the firm.
are considered comparable to packages earned by European and Asian executives.
are shifting towards lower percentages of annual incentives.
are shifting away from long-term awards.
ANSWER:
EASY
Chapter 19
108.
Perks include all of the following except

a.
b.
c.
d.
free child care.

free parking.
recreational memberships.
hourly wages.
ANSWER:
109.
profit sharing.
an employee stock option plan.
contingent pay.
monthly salary.
ANSWER:
EASY
Which performance plan is most motivating?

a.
b.
c.
d.
health insurance
piece rate
hourly wages
pensions
ANSWER:
MEDIUM
A person who specializes in taking over other firms is called a(n)

a.
b.
c.
d.
shirker(s).
raider(s).
expatriate(s).
none of the above.
ANSWER:
113.
EASY
company lunch rooms.

flexible fringe benefit programs.
ESOPs.
pensions.
ANSWER:
112.
Cafeteria plans are

a.
b.
c.
d.
111.
EASY
A pay plan that does not encourage the overall company good is
a.
b.
c.
d.
110.
EASY
The average compensation for chief executives was lowest in
19-27
19-28
Performance
a.
b.
c.
d.
Chapter 19
the United States.

Canada.
Japan.
France.
ANSWER:
114.
MEDIUM
The average compensation level for manufacturing employees was shown in the text as
being highest in
a.
b.
c.
d.
Japan.
Britain.
the United States.
Germany.
ANSWER:
115.
MEDIUM
Expatriate employees
a.
b.
c.
d.
should be paid a base comparable to what he/she was earning domestically.

will be paid more than corresponding managers in their home country.
will always pay taxes in the country in which they are based.
should receive retirement benefits based on local currencies.
ANSWER:
MEDIUM
SHORT ANSWER/PROBLEMS
1.
Discuss economic value added.

a.
What is it intended to do?
Chapter 19
b.
c.
d.
e.
19-29
How is it measured?
How is the measurement different than that of RI?
Why is EVA a better performance measure of RI?
What is the major problem with using EVA as a long-term performance measure?
ANSWER:
a.
b.
c.
d.
e.
More directly align the interests of common shareholders and managers.

EVA = A/Tax profit (market value of invested capital x cost of capital %).
EVA uses after-tax profit, cost of capital and market value of assets invested. RI
uses segment income, target rate of return and book value of assets invested.
Because it recognizes that there may be a significant difference between book
value and market value of assets. The market value of a company is reflected in
stock prices which are another measure of performance evaluation.
EVA includes the increased investment immediately even though significant income
may not occur until sometime in the future. Most investments will show decreased
short-term performance (EVA) and may cause a company to refuse projects that
are profitable in the long-term (similar to shortcomings of the payback method).
MEDIUM
2.
What items affect comparability of different divisions within the same company on the
basis of EVA, ROI and RI?
ANSWER:
a.
b.
c.
Each measure is based on accounting income which can be manipulated in the

short-term by accounting methods used, which can differ between investment
centers.
The measurement of the asset base is affected by the choice of what to include, and
may include items that relate to decisions made by prior managers.
All measures focus primarily on how well the segments do in isolation with results
compared to prior years for the same segment, rather than relative company-wide
objectives.
MEDIUM
3.
Why is it likely that a subordinate manager would be more attentive to certain

performance measures than overall corporate objectives to guide his decision making?
ANSWER:
Managers are evaluated based on how their actual results compare to specific measures of
performance. These performance measures are intended to be surrogates for the overall
corporate goals as they apply to specific managers. Thus performance measures are
selected by the extent to which
they are good proxies for corporate goals (that is the
19-30
Performance
Chapter 19
extent to which they operationally define, and are consistent with, corporate goals) and are
intended to be major focal points for managers.
MEDIUM
4.
What are some of the major problems associated with accrual-based accounting
performance measures?
ANSWER:
There are two major problems with accrual-based accounting numbers. The first problem
is that they can be easily manipulated by managers. For example, the timing of end of
period transactions can be accelerated or delayed to affect performance measures.
Secondly, accounting measures cannot capture all corporate goals. Accounting measures
are particularly inappropriate to measure qualitative changes in the workforce, qualitative
changes in products, and achievement of social and non-monetary objectives.
Additionally, accounting measures reflect only a short-term perspective of operations
rather than a long-range goal orientation.
MEDIUM
5.
What distinct advantage does a return on investment measure have over a residual income
measure? Explain.
ANSWER:
The advantage of ROI measure over RI is that ROI facilitates a comparison of
organizational sub-units of differing sizes. Because ROI is a performance measure that
automatically scales for size, large and small sub-units can be compared to each other
(subject to all the factors that should be considered when two units in different industries,
different geographical areas, etc. are compared).
MEDIUM
6.
How can return on investment result in sub-optimization when it is used as a performance

measure?
ANSWER:
Because performance measures are used to reward performance, managers use them as
decision criteria when they evaluate alternative courses of action. For example, if ROI is
the performance criterion, a division manager will only invest in new projects that will
result in an increase in his/her division's ROI. This is sub-optimal if the overall
organization would be better off by the division manager's investment in available projects
with lower ROIs.
MEDIUM
Chapter 19
7.
19-31
Define residual income. Evaluate residual income as a measure of performance.

ANSWER:
Residual income is the remainder of net profit once a target cost of capital has been taken
into consideration. Residual income is determined by deducting from net income a
prescribed or imputed interest charge on assets. This method allows an organization to
use different rates of interest for various organizational assets. A main advantage of using
RI is that it overcomes some limitations of ROI (sub-optimization).
MEDIUM
8.
What are some common problems encountered in determining ROI?

ANSWER:
Net income and investment involved can both be calculated several ways. Multiple
calculations are often presented to show the different factors that effect ROI, changes in
sales, expenses, and capital investments.
MEDIUM
9.
Discuss management uses of flexible budgets.

ANSWER:
Flexible budgets are important to managers in performing a variety of functions.
Formulating budgets commits certain activities agreed to during the planning process to
specific monetary amounts. The flexible budget provides the means to estimate costs at
various levels of activity. The control function is undertaken to assure that actual
operations meet planned operations. Through this function, deviations are determined and
variances can be ascertained. Managers also use flexible budgets in performance
evaluation. Evaluation is more meaningful with valid and accurate data to make the
process of evaluation beneficial to all involved.
MEDIUM
Use the following information for questions 10 and 11:
19-32
Performance
Chapter 19
Deep Sea Division is one of the operating units of Global Treasure Hunters Inc.. Some of this
division's 1998 operating results follow:
Sales
Profit margin
Target return
Residual income
10.
$3,000,000
10%
15%
$
60,000
What was the segment income of Deep Sea Division for 1998?
ANSWER:
Segment income = Profit Margin * Sales = .10 * $3,000,000 = $300,000
EASY
11.
What was the return on investment in the Deep Sea Division for 1998?
ANSWER:
ROI = Segment Income/Assets
Segment Income = $3,000,000 * .10 = $300,000
Assets = ($300,000 - $60,000)/.15 = $1,600,000
ROI = $300,000/$1,600,000 = 18.75%
MEDIUM
Use the following information for questions 12 and 13:

Northern Division of Utah Chemical Co. produced the following operating results in 1998:
Sales
Segment income
Assets
$10,000,000
1,500,000
6,000,000
Northern Division is considering a $1,000,000 investment in a new project. Northern estimates

that its return on investment (for all of its operations) would be at 22% with the new investment.
12.
How much net segment income is the new project expected to produce?
ANSWER:
the total of the new segment income = .22($6,000,000+$1,000,000) =
.22($7,000,000) = $1,540,000
the portion of the total segment income that is produced by the new project =
Chapter 19
19-33
$1,540,000 - $1,500,000 = $40,000

MEDIUM
13.
If the manager of Northern Division is evaluated on return on investment alone, will she
invest in the new project? Explain.
ANSWER:
The manager would not invest in the new project because the new project would lower
the Division's ROI from the current 25% ($1,500,000/$6,000,000) to 22%. The new
project only generates an ROI of 4% ($40,000/$1,000,000)
MEDIUM
14.
The manager of the Dallas Division of Walking Tours of America is preparing the budget
for 1999. At this point, she has determined that average total assets for 1999 will equal
$4,000,000. She is evaluated on the amount of residual income generated by her division.
Assume variable costs in Dallas Division are expected to equal 60% of total sales and
fixed costs are expected to equal $400,000 in 1999.
a.
b.
Compute the sales level that would generate a 20% return on investment.
Assuming the rate of return is 15%, determine the level of sales that would
generate $200,000 of residual income.
ANSWER:
a.
The required net income = 20% x $4,000,000 = $800,000.

sales = net income + fixed costs + variable costs
sales = $800,000 +| $400,000 + (.60 x sales)
sales x 40% = $1,200,000
sales = $3,000,000
b.
sales = fixed costs + variable costs + required return + residual income

sales = $400,000 + (.60 x sales) + (.15 x sales) + $200,000
sales = $2,400,000
19-34
Performance
Chapter 19
MEDIUM
15.
The following information is given for Blue and Red Divisions of Color Company.
Sales
Var. cost of goods sold
Fixed manufacturing costs
Variable selling
Fixed admin. (50% allocated)
Fixed selling (20% allocated)
Assets at cost
Accumulated depreciation
a.
b.
Blue
$600,000
200,000
50,000
30,000
20,000
50,000
800,000
200,000
Red
$300,000
150,000
40,000
5,000
4,000
30,000
600,000
100,000
If Color uses income to evaluate division managers, compute net income that
should be used for that purpose given the limited data above.
If Color uses ROI to evaluate division managers and uses historical cost as the
investment base, compute the ROI for Blue and Red.
ANSWER:
a.
Sales
CGS
Gross Margin
Variable selling
Fixed admin
Blue
$600,000
(250,000)
$350,000
(30,000)
(10,000)
Red
$ 300,000
( 190,000)
$ 110,000
(5,000)
(2,000)
Chapter 19
Fixed selling
Controllable income
b.
19-35
(40,000)
$ 270,000
Blue
$270,000 $800,000
= 33.75%
(24,000)
$ 79,000
Red
$79,000 $600,000
= 13.17%
MEDIUM
16.
Information for two divisions of M & M Company is given below:

Net income
Capital investment
a.
b.
Peanut Plain
$ 60,000
$100,000
$400,000
$500,000
If M & M charges each division 12% for capital employed, compute residual
income for Peanut and Plain.
Compute the ROI for each division.
ANSWER:
a.
Net income
Interest charge
Residual income
b.
ROI
MEDIUM
Peanut
$60,000
(48,000)
$12,000
Plain
$100,000
(60,000)
$ 40,000
$60,000 $400,000 $100,000 $500,000

= 15%
= 20%
19-36
Performance
17.
Chapter 19
Creative Business Solutions (CBS), a division of Doug Jorgenson CPA, buys and installs
modular office components. For the most recent year, the division had the following
performance targets:
Asset turnover
Profit margin
Target rate of return on investments for RI
Cost of capital
Income tax rate
2.5
6%
13%
10%
40%
Actual information concerning the companys performance for last year follows:
Total assets at beginning of year
Total assets at end of year
Total invested capital (annual average)
Sales
Variable operating costs
Direct fixed costs
Allocated fixed costs
$3,600,000
5,300,000
8,000,000
9,000,000
3,650,000
4,770,000
675,000
Required:
a. For CBS, 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 CBS.
d. Using your answers from part b., compute the residual income of CBS.
e. Compute the EVA of CBS. 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 CBS.
Chapter 19
19-37
17. (contd.)
ANSWER:
a.
Sales
Variable costs
Direct fixed costs
Segment margin
$ 9,000,000
(3,650,000)
(4,770,000)
$ 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
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 aftertax 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.
19-38
Performance
f.
Chapter 19
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 CBS 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.
DIFFICULT
18.
The IHM Company produces small plastic dolls in its Nevada manufacturing plant. The
company is currently evaluating ways to improve productivity. The accountant of the
firms 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
data from the firm for June 1998:
Total units attempted
a.
b.
c.
d.
e.
6,000,000
4,800,000
800
600
How many defective units were produced in June?

Compute manufacturing cycle efficiency for June.
Compute the process productivity in June.
Compute the process quality yield in June.
Compute the hourly throughput for June.
ANSWER:
a.
b.
c.
d.
e.
Defective units = 6,000,000 - 4,800,000 = 1,200,000

MCE = 600 800 = 75%
Process productivity = 6,000,000 600 = 10,000 units per hour
Process quality yield = 4,800,000 6,000,000 = 80%
Throughput = 10,000 x .75 x .8 = 6,000 dolls per hour
MEDIUM
19.
Identify the steps to follow in establishing the performance reward system for a company.
ANSWER:
The steps are in the following order:

1. set strategic goals
2. identify the critical success factors
3. set the compensation strategy
Chapter 19
4.
5.
6.
7.
19-39
identify performance measures

set performance rewards
measure/monitor performance
determine rewards
MEDIUM
20.
Discuss pay-for-performance plans.

ANSWER: Employees should be encouraged by compensation plans to perform and be
loyal to the organization. Performance measures should be related to a company's
operational targets. These performance measures do not have to be evenly weighted.
Management can assign higher weights to more important performance measures as they
are related to the corporate goals.
MEDIUM
21.
Discuss the rethinking taking place regarding the time frame used in American business
performance systems.
ANSWER:
Historically, American time frames for performance has been short term, often only one
year. Presumably management tries to do what is best for the firm and its owners. Thus,
shareholder wealth maximization should be the primary focus of management. Short term
profit maximization doesn't necessarily result in long-run shareholder wealth maximization.
To encourage this different attitude, employees and management are being asked to take a
longer run perspective. This is enhanced with employee stock ownership in their firm.
MEDIUM
22.
Are individual performance plans suitable for the Japanese worker? Why?
ANSWER:
The Japanese worker tends to be more group oriented. These workers view
themselves a team working together for some common goal. Thus, individual
performance plans would not work well in Japan.
MEDIUM
19-40
Performance
23.
Chapter 19
What is a golden parachute and why is it used?

ANSWER:
A golden parachute is a benefit package awarded to managers if their firm is taken over
and they are terminated. This normally follows a hostile takeover of their firm.
Proponents of parachutes say that they allow managers to devote their limited time to
serving the interests of their company's stockholders in an unbiased manner. Others say
parachutes lead to entrenched managers and reward managers who may have mismanaged
their firm which created the conditions that resulted in the hostile takeover.
MEDIUM
24.
Deferred compensation techniques are currently used in the American work place. What
are they and how do they benefit the employer and the employee?
ANSWER:
Deferred compensation is pay that was earned on current performance but is paid later to
the employee. The compensation may include profit sharing plans, pensions, and stockbased plans like ESOPs. The payment by the employer can be deducted currently for tax
purposes but the employee doesn't recognize it as income until it is received. In stock
option plans, earnings in the plan are not taxable to the employee until the plan is
distributed. Size of the plans are affected by the firm's stock value and encourage
employees to take a more positive attitude about the company's future.
MEDIUM
25.
Comment on differences regarding employee performance that exists between for-profit

and not-for-profit organizations.
ANSWER:
In a for profit entity, stockholders and their representatives, the board of directors,
maintain oversight of the company and its officers. These individuals are directly
concerned about the effectiveness and efficiency of operations because they are
the
residual claimants who are paid (in the form of dividends and stock value increases) only
after all other involved parties receive their compensation.
In NFP organizations, no overriding interest group comparable to stockholders keeps herd
on the performance of managers in the entity. Performance rewards are less effective in
these operations. Pay and performance rewards in NFPs have often not been regarded as
Chapter 19
19-41
adequate by NFP employees. Attempts are being made in this sector to incorporate some
performance factors in its compensation system.
MEDIUM
26.
Explain why the average worker in a plant or office may feel dissatisfied with the salary
structure in American operations today.
ANSWER:
Exhibit 22-8 in the text indicates that CEOs in the U.S. average compensation far exceed
comparable CEOs in other industrial countries. No other country's CEOs approach U.S.
CEO compensation. Even U.S. managers are relatively low ranked compared to other
countries. Employees' compensation in U.S. manufacturing plants are one of the lowest in
the industrialized world. Thus, American workers feel they are being short-changed or the
CEOs are being overpaid.
MEDIUM

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CHAPTER 19

MEASURING AND REWARDING ORGANIZATIONAL PERFORMANCE

Variance analysis would be appropriate to measure performance in

cost centers and investment centers.

Using a single performance evaluation criterion for an investment center

is most effective because a manager can concentrate on a single goal.

Net cash flow could be used to measure performance in

investing, financing, and borrowing activities.

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

Measuring and Rewarding Organizational

Measuring and Rewarding Organizational Performance

If sales and expenses both rise by $100,000

residual income will increase.

ABC Corp. president

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

The return on investment (ROI) ratio measures

only asset turnover.

Which of the following would be an appropriate alternative to the use of ROI in

Measuring and Rewarding Organizational

Cost and revenue

Return on investment is computed by dividing income by

Measuring and Rewarding Organizational Performance

Profit margin indicates the portion of sales that

covers fixed expenses.

Profit margin equals

income divided by sales.

an increase in the profit margin ratio to above 30%.

The Du Pont model measures

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

Residual income is used as a performance measure in

If a new project generates a positive residual income, the

project's return on investment is less than the target rate.

contribution margin and asset turnover.

The Du Pont model measures ROI as it is affected by

Measuring and Rewarding Organizational

A prospective project under consideration by P Division of C Co. has an estimated

project generates a negative return on investment.

Measuring and Rewarding Organizational Performance

Residual income is the

contribution margin of an investment center, less the imputed interest on the

If a division generates a positive residual income then the divisions

asset turnover was very high.

Residual income is determined as

income times the asset turnover rate.

Residual income is an example of a ____________ performance measurement.

Residual income is used as a performance measure in which of the following types of

If sales and expenses both rise by $100,000, profit margin will

decrease and asset turnover will decrease.

increase in residual income.

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

Measuring and Rewarding Organizational

Asset turnover equals

income divided by average assets.

Measuring and Rewarding Organizational Performance

Which measure is limited by the fact that it uses accounting income?

Z Division of XYZ Corp. has the following information for 1998:

What was Z Division's return on investment for 1998?