CHAPTER 12

PERFORMANCE EVALUATION IN DECENTRALIZED ORGANIZATIONS

TRUE/FALSE
1. Decentralizing authority empowers employees at the higher levels.
LO1 False
Decentralizing authority empowers employees at the lower
levels.
2. Ensuring smooth succession is important for the survival of any company.
LO1 True
3. Decentralization worsens the problem of divergence between individual and
organizational goals by preventing lower-level managers from preparing to move
to upper-level positions.
LO1 False
Decentralization worsens the problem of divergence between
individual and organizational goals by giving control over organization resources
to lower-level managers who are far-removed from the top management of the
firm.
4. Organizations use monitoring, performance evaluation, and incentive schemes to
manage the cost of delegating decisions.
LO1 True
5. Cost center managers are charged with minimizing the cost of producing a
specified level of output or the cost of delivering a specified level of service.
LO1 True
6. Production managers have little control over the volume of production.
LO2 True
7. The controllability principle is always the right approach for choosing
performance measures.
LO2 False
While intuitive, the controllability principle is not always the right
approach for choosing performance measures. Instead, we should rely on
informativeness.
8. Most controllable measures are informative; however an informative measure is
not necessarily controllable.
LO2 True
9. A characteristic of an effective performance measure is that it yields maximum
information about the decisions or actions of the individual or organizational
unit.
LO2 True
10.A characteristic of an effective performance measure is that it is easy to
understand and communicate.
LO2 True

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Balakrishnan/Managerial Accounting, 2e
11.Cost center managers serve two roles in organizations achieving cost targets
for a given level of output in the short term, and making continuous
improvements to increase revenue in the long term.
12.LO3 False Cost center managers serve two roles in organizations
achieving cost targets for a given level of output in the short term, and making
continuous improvements to cut costs in the long term.
13.
14.Organizations typically use budget variances to measure cost center
performance in the long-run.
15.LO3 False In the short term, organizations typically use budget variances
to measure cost center performance.
16.
17.Suma is a philosophy of continuous improvement that encourages and rewards
employees who constantly seek and suggest improvements to activities and
business processes.
18.LO3 False Kaizen is a philosophy of continuous improvement that
encourages and rewards employees who constantly seek and suggest
improvements to activities and business processes.
19.
20.Cost centers for which there is a clear relation between inputs and outputs are
termed discretionary cost centers.
21.LO3 False Cost centers for which there is a clear relation between inputs
and outputs are termed engineered cost centers.
22.
23.Firms often use profit before taxes to evaluate profits centers, computed as
contribution margin less traceable fixed costs.
24.LO3 True
25.
26.Managers of investment centers enjoy little autonomy in decentralized
organizations.
27.LO4 False Managers of investment centers enjoy considerable autonomy in
decentralized organizations.
28.
29.Normally, we exclude interest and taxes from the calculation of an investment
centers profit results from its operations because profit center managers usually
do not influence financial or tax-related decisions.
30.LO4 True
31.
32.Net book value is the original acquisition cost of plant and equipment less
accumulated depreciation.
33.LO4 True
34.
35.The major criticism against ROI is that it is not an effective summary measure of
business profitability.
36.LO4 False A major criticism against ROI is that it fosters underinvestment.
37.
38.Residual income represents the additional profit or value generated by an
investment after meeting the required rate of return.
39.LO4 True

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Performance Evaluation in Decentralized Organizations

40.When intra-company transfers occur, a legally recognized sale takes place even
though the divisions are part of the same company.
41.LO5 False When intra-company transfers occur, no legally recognized sales
takes place because the divisions are part of the same company.

56.

43.From the perspective of determining corporate pre-tax income, a transfer price

does not serve any useful purpose.
44.LO5 True
45.
46.Divisional managers have a keen interest in the transfer price because their
individual compensation often depends on the profit reported by their division.
47.LO5 True
48.
49.Setting effective transfer prices is relatively simply because division managers
strategic and economic considerations for the company as a whole are the same.
50.LO5 False Setting effective transfer prices is difficult because the buying
and selling divisions often do not agree on what constitutes a fair price.
51.
52.A common approach to setting transfer prices is using cost-based transfer prices
(including variable and full cost).
53.LO5 True
54.
55.The profit for a selling department in an inter-company transfer is the transfer
price without considering costs.
Appendix False
The profit for a selling department in an inter-company
transfer is the transfer price less the cost of the transfer.
57.
58.The minimum price that the selling division wants from an inter-company
transfer is the cost of the transfer plus the opportunity cost of the transfer.
59.Appendix True
60.
61.The maximum amount the buying division in an inter-company transfer is willing
to pay is opportunity cost.
62.Appendix True
63.
64.In an inter-company transfer, as long as the maximum price the buying division
is willing to pay is higher than the minimum price the selling division is willing to
accept, both divisions will agree to the internal transfer at any price between
these two amounts.
65.Appendix True
66.
67.In an inter-company transfer, if the maximum price the buying division is willing
to pay is less than the minimum price the selling division is willing to accept,
both divisions will never agree to the internal transfer.
68.Appendix True
69.
70.

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Balakrishnan/Managerial Accounting, 2e
71.

MULTIPLE CHOICE

72.Which of the following is a type of decision a regional manager would make?

A. Pricing.
B. Promotion.
C. Office management.
D. A and B only.
E. A, B and C are decisions a regional manager would make.
73.LO1 E
74.
75.Which of the following is not a benefit of decentralization?
A. Permits timely decisions with the best available information.
B. Better coordination of decisions.
C. Trains future managers.
D. Empowers employees and increases job satisfaction.
76.LO1-Pretest-B
77.
78.The benefits of decentralization include all of the following except:
A. It forces top levels of management to focus on individual units.
B. It empowers more employees at lower levels of management.
C. It allows for better and more timely decision making.
D. It trains future managers.
79.LO1-Self test-A
80.
81.Which of the following is not a benefit of decentralization?
A. Trains future managers.
B. Simple to coordinate decisions.
C. Empowers employees and increases job satisfaction.
D. Permits timely decisions.
E. All of the above are benefits of decentralization.
82.LO1 B
83.
84.Which of the following is not a cost of decentralization?
A. Might lead to an emphasis on local versus global goals.
B. Requires costly coordination of decisions.
C. Leads to improper decisions due to divergence between individual and
organizational goals.
D. Fails to train future managers.
E. All of the above are costs of decentralization.
85.LO1 D
86.
87.Which of the following is not a responsibility center?
A. Investment center.
B. Cost center.
C. Administrative center.
D. Profit center.
E. All of the above are responsibility centers.
88.LO1 C
89.
90.Which of the following is not an example of a cost center?

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Performance Evaluation in Decentralized Organizations

A. Plant maintenance.
B. Sears store.
C. Human resources.
D. Data processing.
E. General administration.
91.LO1 B
92.
93.Which of the following is not an example of a profit center?
A. Production department of a manufacturing plant.
B. An individual product line at Proctor and Gamble.
C. A retail store.
D. All of the above are examples of profit centers.
E. None of the above is an example of a profit center.
94.LO2 A
95.
96.What is the main focus for a manager of a profit center?
A. Maximizing revenues and minimizing costs.
B. Maximizing revenues.
C. Minimizing costs.
D. Maximize returns from invested capital.
97.LO2-Posttest-A
98.What does the informativeness principle state about the choice of performance
measures that are selected by a company?
A. A performance measure is informative if it is controllable by the manager.
B. A performance measure is informative if it is evaluated relative to other firms
in the industry.
C. A performance measure is informative if it reflects the consequences of the
actions taken by the decision maker.
D. A performance measure is informative if it provides information about a
managers effort, even if the manager does not have control over it.
99.LO2-Post test-D
100.
101. A production manager should be held accountable for:
A. Production delays.
B. Production delays and overall volume of production.
C. Changing prices.
D. Changing prices and overall volume of production.
E. Losses due to natural disasters.
102. LO2 A
103.
104. Income statements prepared by segment are useful when they are prepared:
A. On a cash basis.
B. In a multi-step format.
C. On a contribution (cost behavior) basis.
D. On an accrual basis.
105. LO2- Self test-C

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Balakrishnan/Managerial Accounting, 2e
106. The CFO of Infinity Systems is deciding which performance measures to use
for one of the companys investment centers. Which three measures will help
insure the performance measurement system is most effective?
a. The measures should align employee and organizational goals, be easy to
communicate and generate the largest amount of revenues.
b. The measures should be easy to measure, easy to understand, and must
generate the largest profits.
c. The measures should align employee and organizational goals, be easy to
measure, and easy to understand.
d. The measures should be easy to measure, easy to communicate, and hold
managers responsible for as little as possible.
107. LO2-Pretest-C
108.
109. Which of the following is not a characteristic of effective performance
measures?
A. Is easy to understand and communicate.
B. Is easy to measure.
C. Separates employee and organizational goals.
D. Yields maximum information about the decisions or actions of the individual
or organizational unit.
E. All of the above are characteristics of effective performance measures.
110. LO2 C
111.
112. Ideally, the best performance measures:
a. Reflect the decision rights assigned to the individual/organizational unit.
b. Yield the maximum information about the decisions or actions of the
individual/organizational unit.
c. Have low measurement error.
d. Are easy to understand and communicate.
e. All of the above.
113. LO2 E
114.
115. To make effective trade-offs among the attributes of performance measures,
organizations often use:
a. A combination of performance measures.
b. Only financial performance measures.
c. Avoid using more than one measure.
d. Select a single performance measure that possesses of the characteristics of
an effective performance measure.
e. None of the above.
116. LO2 A
117.
118. Which of the following is not a role of a cost center manager in an
organization?
a. To achieve cost targets for a given level of output in the short term.
b. Making continuous efficiency improvements to cut costs in the long term.
c. To achieve sales targets for a given level of output.
d. Neither A nor B are roles of a cost center manager.
119. LO3 C
120.

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Performance Evaluation in Decentralized Organizations

121. Which of the following does not describe Kaizen?
a. Encourages and rewards employees who constantly seek and suggest
improvements to activities and business processes.
b. Is a philosophy of continuous improvement.
c. Involves comparing the effectiveness and efficiency of various activities and
business processes in a firm against the best practices in the industry.
d. None of the above statements describe Kaizen.
e. All of the above describe Kaizen.
122. LO3 C
123.
124. A cost center for which there is a clear relation between inputs and outputs is
referred to as a:
a. Discretionary cost center.
b. Budget center.
c. Engineered cost center.
d. Kaizen center.
e. None of the above.
125. LO3 C
126.
127. Which of the following is not a performance measure used to evaluate a
profit centers manager?
a. Customer satisfaction.
b. How well the manager utilizes funds made available to his/her division.
c. Employee turnover.
d. Market share.
e. All of the above are performance measures used to evaluate a profit centers
manager.
128. LO3 B
129.
130. Firms often view investment centers as:
a. Support activities.
b. Discretionary cost centers.
c. Stand-alone businesses.
d. Revenue centers.
e. None of the above.
131. LO3 C
132.
133. Which of the following is not a popular measure of investment center
performance?
a. Employee turnover.
b. Return on investment.
c. Residual income.
d. Economic value added.
e. None of the above.
134. LO4 A
135.
136. When a company is attempting to increase return on investment (ROI) it
should work to:
a. Decrease sales.
b. Decrease profits.

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Balakrishnan/Managerial Accounting, 2e
c. Increase costs.
d. Decrease operating assets.
137. LO4- Self test-D
138.
139. When measuring average operating assets, depreciable fixed assets may be
included at any value except:
a. Gross book value.
b. Net book value.
c. Current replacement value.
d. Original cost less estimated salvage.
140. LO4-Self test-D
141.
142. The Gallagher Company is decentralized and has a required opportunity cost
of capital of 20%. The West division, whose current return on investment (ROI) is
15%, is considering an investment which will earn a return of 18%. The East
Division, whose current ROI is 25%, is considering an investment which will earn
a return of 22%. If the objective is to maximize ROI, each division will make the
following choice:
143. West
East
a. Reject
Accept
b. Accept
Reject
c. Accept
Accept
d. Reject
Reject
144. LO4-Self test-B
145.
146. Supercircuits is a decentralized company and has a required opportunity cost
of capital of 15%. The home computer division, whose current ROI is 10%, is
considering an investment which will earn a 13% return. The gaming division,
whose current ROI is 20%, is considering an investment which will earn a 17%
return. If the objective is to maximize residual income, each division will make
the following choice:
147. Computer Gaming
a. Reject
Accept
b. Accept
Reject
c. Accept
Accept
d. Reject
Reject
148. LO4-Self test-A
149.
150. The Hoboken Company has two divisions, North and South. In July,
contribution margin for North was $126,000 and sales in the South division were
$375,000 with a contribution margin ratio of 40%. Traceable fixed costs for the
divisions totaled $101,000. If net operating income was $69,000, then total
fixed costs must have been:
a. $106,000
b. $207,000
c. $282,000
d. $170,000
151.
LO4-Self test-B
152.

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Performance Evaluation in Decentralized Organizations

153.

The Brett Company has provided the following information for its two stores:
154. Store A
Store B
Total
155.
Sales
$700,000
$500,000
$1,200,000
156.
Variable expenses
420,000
350,000
770,000
157.
Contribution margin
280,000
150,000
430,000
158.
Traceable fixed costs
80,000
50,000
80,000
159.
Segment margin
200,000
100,000
300,000
160.
Common fixed expenses
160,000
161.
Net operating income
$140,000
162.
If Store B increases its sales by $50,000 with no change in fixed
expenses the overall company net income will:
a. Increase by $12,500.
b. Increase by $35,000.
c. Increase by $50,000.
d. Increase by $15,000.
163.
LO4-self test-D
164.
165. In 2013 the Yankee Company had average operating assets of $200,000. If
the company reported a return on investment of 50% then net operating income
for 2013 must have been:
a. $100,000
b. $50,000
c. $400,000
d. $200,000
166. LO4-Self test-A
167.
168. In 2013 the Porter Company reported the following information:
169.
Sales
$1,100,000
170.
Average operating assets
$600,000
171.
Residual income
$42,000
172.
Return on investment
22%
173.
The companys required rate of return was:
a. 11.3%
b. 33.3%
c. 15%
d. 29%
174.
Lo4-Self test-C
175.
176. The Greenberg Company reported average operating assets of $400,000 and
sales of $1,200,000 in 2013. If the companys margin is 12%, their ROI must
have been:
a. 24%
b. 36%

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Balakrishnan/Managerial Accounting, 2e
c. 33.3%
d. 40%
177. LO4-Self test-B
178.
179. The Allentown Company reported operating income of $25,000 for 2013. If
average operating assets for the year were $80,000 and the company had a
required return of 12% the companys residual income was:
a. $28,000
b. $22,000
c. $15,400
d. $6,600
180. LO4-Self test-C
181.
182. The Grisham Company has reported the following information for 2013:
183.
Net operating income after tax (NOPAT)
$1,200,000
184.
Invested capital
$7,500,000
185.
Current liabilities
$980,000
186.
Weighted average cost of capital
16%
187.
The companys economic value added is:
a. $156,800
b. $220,000
c. $1,008,000
d. $851,200
188. LO4-Self Test-A
189.
190. The Versa Company had the following results for 2013:
191.
Net operating income
$6,000
192.
Turnover
3.5
193.
ROI
15%
194.
Versa Companys average operating assets were:
a. $140,000
b. $40,000
c. $490,000
d. $21,000
195. LO4-Self test-A
196.
197. Quest Retail uses profit before taxes to evaluate its individual stores which
are considered profit centers. The following information is provided concerning
the Southside store for 2013:
198. Contribution margin: $5,000,000
199. Traceable fixed costs: $2,000,000
200. Budgeted segment margin: $3,500,000
201. Last years segment margin: $2,900,000
202.
How much are the variance from the budget and the variance from last
year?
A. Budget: 14.29% U Last year: 3.45% F
B. Budget: 14.29% F Last year: 3.45% U
C. Budget: 16.67% U Last year: 3.33% F
D. Budget: 16.67% F Last year: 3.33% U
203. LO4-Pretest-A

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Performance Evaluation in Decentralized Organizations

204.
205. Stringer Co. compiled the following information from its financial records for
its retail segment for 2013:
206. Sales revenue
207. $
6,700,000
208. Variable costs
209. 4,000,0
00
210. Total assets
211. 14,400,
000
212. Traceable fixed
213. 920,000
costs
214. Income taxes
215. 850,000
216.
Calculate ROI for Stringer assuming the manager of the segment is
able to significantly influence the corporate tax burden.
A. 46.5%
B. 6.46%
C. 12.36%
D. 25.69%
217. LO4-Post test-B
218.
219. How much will ROI change if the profit margin increases from 8% to 10%, the
required rate of return increases from 9% to 12%, and asset turnover stays the
same at 2.1?
A. Increase of 4.2%
B. Increase of 2.0%
C. Increase of 3.0%
D. Decrease of 1.0%
220. LO4-Post test-A
221.
222. Which of the following best describes residual income?
A. The revenue generated per each dollar of investment
B. The profit generated per each dollar of investment
C. The amount an investment generates above and beyond the required rate of
return on operating assets
D. The amount an investment must generate at the required rate of return
223. LO4-Post test-C
224.
225. Tonal Company compiled the following information for the year
ending December 31, 2013:
226. NOPAT
227. $
800,000
228. Sales
229. 6,400,00
0
230. Net income
231. 620,000
232. Invested capital
233. 3,500,00
0
234. Current liabilities
235. 340,000
236.
Tonals expected rate of return is 12% and its WACC is 9.5% How
much is EVA?
A. $300,200

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Balakrishnan/Managerial Accounting, 2e
B. $379,200
C. $499,800
D. $420,800
237. LO4-Post test-C
238.
239. Which of the following is not an option in deciding how to incorporate
depreciable fixed assets in measuring divisional investment?
a. Net book value.
b. Gross book value.
c. Transfer price.
d. Replacement cost of the asset.
e. Current value of the asset.
240. LO4 C
241.
242. Which of the following describes ROI?
a. It fosters underinvestment.
b. It ignores future period considerations.
c. It is less suitable for evaluating long-term performance.
d. None of the above.
e. All of the above.
243. LO4 E
244.
245. What does return on investment (ROI) measure?
A. The profit generated by a segment that exceeds the required rate of return
B. The revenue generated per dollar of investment by a segment
C. The profit generated per dollar of investment by a segment
D. The replacement value of assets invested in a division or segment
246. LO4-Pretest-C
247.
248. Given a profit margin of 12%, total revenue of $410,000, an operating profit
of $25,000, and an asset turnover of 0.35, what is the ROI?
A. 6.1%
B. 2.5%
C. 5.1%
D. 4.2%
249. LO4-Pretest-D
250.
251. Which of the following is not a disadvantage of residual income?
A. RI rankings depend crucially on the rate of return.
B. Magnitude of RI depends on the size of the investment
C. RI may generate rankings of investments that differ from rankings made
using ROI.
D. RI can lead to underinvestment.
252. LO4-Pretest-D
253.
254. Which of the following is the formula for ROI?
a. Profit Investment.
b. (Profit Sales) x (Sales Investment).
c. Profit margin x Asset Turnover.
d. None of the above.

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Performance Evaluation in Decentralized Organizations

e. All of the above.
255. LO4 E
256.
257. Gant Manufacturing Company has provided the following financial
information:
258. Sales
259. $4
00,000
260. Variable
261. $2
Expenses
50,000
262. Fixed Expenses
263. $5
0,000
264. Investment in
265. $3
Fixed Assets
00,000
266. Required Rate of
267. 5
Return
%
268. What is Gants residual income?
a. $80,000.
b. $95,000.
c. $100,000.
d. $85,000.
e. None of the above.
269. LO4 D
270.
271. Which of the following is not a common approach to transfer pricing?
a. Variable cost-based transfer prices.
b. Full cost -based transfer prices.
c. Market-based transfer prices.
d. Negotiated transfer prices.
e. All of the above are common approaches to transfer pricing.
272. LOLO5 E
273.
274. What belief does EVA reflect concerning the responsibility of managers?
A. Managers should be primarily responsible for investing in research and
development.
B. Managers should be responsible for generating operating revenues and
covering operating costs.
C. Managers should be responsible for generating profits to cover both
operating and capital costs.
D. Managers should be responsible for generating an acceptable profit margin.
275. LO5-Pretest-C
276.
277. Which of the following is not a reason for using transfer pricing?
A. Pre-tax profits of a corporation will be larger.
B. Divisional income evaluation
C. Resource allocation among segments
D. Tax planning at the corporate level
278. LO5-Pretest-A
279.
280. Which one of the following is not true about transfer pricing?
A. MNCs can transfer income from high-tax countries to low-tax countries.

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Balakrishnan/Managerial Accounting, 2e
B. Transfer prices can be cost-based or market-based.
C. An MNC entering a new foreign market may want to enable its subsidiary in a
country to compete effectively by charging a high transfer price.
D. Most countries have no restrictions on foreign currency exchange.
281. LO5-Post test-D
282.
283. Which of the following transfer price approaches is most appropriate for a
short-term problem in which the selling division has excess capacity?
a. Variable cost-based transfer prices.
b. Full cost-based transfer prices.
c. Market-based transfer prices.
d. Negotiated transfer prices.
e. None of the above.
284. LO5 A
285.
286. Which of the following transfer prices, in theory, is the most sound because it
provides the best measure of the opportunity cost of inter-divisional transfers?
a. Variable cost-based transfer prices.
b. Full cost-based transfer prices.
c. Market-based transfer prices.
d. Negotiated transfer prices.
e. None of the above.
287. LO5 C
288.
289. Which of the following transfer prices always results in both divisions
voluntarily making the right decisions from the perspective of the company as a
whole?
a. Variable cost-based transfer prices.
b. Full cost-based transfer prices.
c. Market-based transfer prices.
d. Negotiated transfer prices.
e. None of the above.
290. LO5 C
291.
292. Which of the following transfer prices gives divisions considerable autonomy?
a. Variable cost-based transfer prices.
b. Full cost-based transfer prices.
c. Market-based transfer prices.
d. Negotiated transfer prices.
e. None of the above.
293. LO5 D
294.
295. The minimum price that the selling division wants from an inter-company
transfer is:
a. The cost of the transfer plus the opportunity cost of the transfer.
b. The cost of the transfer less the opportunity cost of the transfer.
c. The normal selling price of the item plus the opportunity cost of the transfer.
d. The normal selling price of the item less the opportunity cost of the transfer.
e. The normal selling price.
296. Appendix A

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Performance Evaluation in Decentralized Organizations

297.
298. The maximum amount the buying division is willing to pay for an intercompany transfer is:
a. The cost of the transfer.
b. The cost of the transfer plus the opportunity cost of the transfer.
c. The cost of the transfer less the opportunity cost of the transfer.
d. The normal selling price of the item.
e. The opportunity cost of the transfer.
299. Appendix E
300.
301. Given the following information, what is the maximum transfer price Division
B should be willing to pay Division A for its product?
302. Division A:
303.
304.
Production capacity
305. 10,000
units
306.
Selling price per unit
307. $50
308.
Variable production cost
309. $20
per unit
310.
Variable selling cost per
311. $5
unit
312. Division B
313.
314.
Number of Division A
315. 2,000
units needed
316.
Price per unit paid to
317. $32
outside supplier
A. $50
B. $20
C. $25
D. $32
E. None of the above.
318. Appendix D
319.
320. Given the following information, what is the minimum transfer price Division
A should be willing to accept from Division B for its product?
321.
322. Division A:
323.
324.
Production
325. 10,000
capacity
units
326.
Selling price per
327. $50
unit
328.
Variable
329. $20
production cost per unit
330.
Variable selling
331. $5
cost per unit
332. Division B
333.
334.
Number of
335. 2,000
Division A units needed
336.
Price per unit paid 337. $32
to outside supplier

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Balakrishnan/Managerial Accounting, 2e
338. What is the maximum transfer price Division B should be willing to pay
Division A for its product?
$50
$20
$25
$32
None of the above.
Appendix C

A.
B.
C.
D.
E.
339.
340.
341. An electronics firm has two divisions, A and B. Division As annual sales are
2,500 units. The units sell for $200 each and have variable product costs of
$150 each. Division B would like to buy 100 units from Division A units, but has
received a quote from an outside supplier of $160 per unit. Suppose Division A
has ample capacity to produce an additional 100 units with no effect on its sales
to outside customers. What is the effect on Division As profit if it sells the 100
units to Division B for $160?
a. $16,000 increase.
b. $1,000 increase.
c. $5,000 increase.
d. $4,000 increase.
e. None of the above.
342. Appendix B

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Performance Evaluation in Decentralized Organizations

343. Problems
344.
1. As organizations grow, both the number and type of decisions owners and
managers face increase rapidly. Often, organizations have no other choice but to
decentralize. The decision to decentralize has both benefits and costs.
345.
346.
Required:
347.
a. What is a decentralized organization?
348.
b. List three benefits associated with decentralization.
349.
c. List three costs associated with decentralization.
350.
351.
2. Although it is not possible to completely eliminate the costs of delegating
decisions, organizations take various measures to manage these costs. One
method is to create organizational sub-units, or responsibility centers.
352.
353.
Required:
354.
a. List the three common types of responsibility centers and give an example
of each.
355.
b. For each responsibility center list the primary responsibilities of the
manager.
356.
357.
358.
3. Evaluating cost and profit centers is an essential part of an organizations
process in a decentralized environment.
359.
360.
Required:
361.
a. How do organizations typically evaluate cost center performance in the
short-term?
362.
b. Discuss two long-term performance measures used to evaluate long-term
reductions in cost.
363.
c. What is the difference in engineered cost centers and discretionary cost
centers?
364.
365.

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Balakrishnan/Managerial Accounting, 2e
4. Watson Bicycle Manufacturing has provided the following information on the
current years activities. Watson uses the net book value to compute ROI.
366.
367. Sales
368. $1
00,000
369. Variable costs
370. $3
0,000
371. Original costs of assets
372. $2
00,000
373. Accumulated
374. $7
depreciation
0,000
375. Replacement costs of
376. $1
assets
70,000
377. Average investment
378. $1
20,000
379. Net profit
380. $4
5,000
381. Watsons minimum
382. 30
required return
%
383.
384.
Required:
385.
a. Calculate Watsons ROI.
386.
b. Calculate Watsons residual income.
387.
388.
389.
390.
391.
5. Most companies issue guidelines for setting transfer prices. However, they
usually give some autonomy to the division managers.
392.
393.
Required:
394.
a. List three common approaches to setting transfer prices.
395.
b. List one advantage and one disadvantage associated with each of the three
approaches.
396.
397.
398.
399.
6. Mitchells Manufacturing Company has two divisions: Eastern and Western. The
Eastern division manufactures a digital camera with a selling price of $220,
variable costs of $80 and allocated fixed costs of $20 per unit. Western has
asked to purchase 100 cameras. Eastern has ample capacity to produce the 100
units. Western can purchase a camera of equal quality and features from an
outside supplier at $175 per unit.
400.

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Performance Evaluation in Decentralized Organizations

401.
Required:
402.
a. What is the minimum transfer price the Eastern division would be willing to
accept?
403.
b. What is the maximum transfer price the Western division would be willing to
pay?
404.

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Balakrishnan/Managerial Accounting, 2e
405.
Problem solutions
406.
1. Benefits and Costs of Decentralization (LO1)
a. A decentralized organization is one in which decision making is not limited
to upper-level executives, but authority is delegated to lower-level
managers.
407.
b. Benefits:
Permits timely decisions.
Tailors managerial skills and specializations to job requirements.
Empowers employees and increases job satisfaction.
Trains future managers.
408.
c. Costs:
Might lead to an emphasis on local versus global goals.
Requires costly coordination of decisions.
Leads to improper decisions because of divergence between
individual and organization goals.
409.
2. Responsibility Centers (LO2)
a. Types and examples:
Cost center examples include plant maintenance, data processing,
human resources, production, and general administration.
Profit center examples include product lines, division, regions, and
retail stores.
Investment center examples include large independent divisions.
410.
b. Responsibilities of managers:
Cost center:
o Minimize the cost of producing output.
o Minimize the cost of delivering a level of service.
o Improve the efficiency of operations by finding ways to cut
costs and minimize waste.
411.
Profit center:
o Minimize costs.
o Maximize revenues.
412.
Investment center:
o Maximize the returns from invested capital.
o Put the capital invested by owners and shareholders to the
most profitable use.

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Performance Evaluation in Decentralized Organizations

3. Evaluating Cost and profit Centers (LO3)
413.
a. In the short term, organizations typically use budget variances to measure
cost center performance.
414.
b. Benchmarking is a process that involves comparing the effectiveness and
efficiency of various activities and business processes in a firm against the
best practices in the industry. Such best practices are not controllable by the
decision maker, but still are useful performance measures. For example, a
firm may hold a manager accountable for achieving greater reductions in
cycle time than attained by immediate competitors.
415.
416. Kaizen is a philosophy of continuous improvement. This initiative encourages
and rewards employees who constantly seek and suggest improvements to
activities and business processes. One way to implement continuous
improvement is to hold managers accountable for achieving performance
reductions.
417.
c. Engineered cost centers are cost centers for which there is a clear relation
between inputs and outputs. Discretionary costs centers are cost centers for
which there is no clear relationship between inputs and outputs.
418.
419.
4. Performance Measurement (LO4)
a. ROI = Profit Investment (net book value)
420. $45,000 $120,000 = 37.5%
421.
b. Residual income = Profit (Required Return x Investment)
422. $45,000 (.30 x $120,000)
423. $45,000 - $36,000 = $9,000
424.
425.
426.

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Balakrishnan/Managerial Accounting, 2e
5. Transfer pricing (LO5)
a. Three common approaches:
Cost-based transfer prices
Market-based transfer prices
Negotiated transfer prices
b. Advantages and disadvantages:
Cost-based transfer prices. Advantage: appropriate for a shortterm problem in which the selling division has excess capacity.
Disadvantage: there is no guarantee that cost-based transfer
prices will lead to the right quantity of transfers taking place.
Market-based transfer prices. Advantage: most sound because the
market price provides the best measure of the opportunity cost of
inter-divisional transfers. Also always results in both divisions
voluntarily making the right decisions from the perspective of the
company as a whole. Disadvantage: difficult to identify a market
price because there may be no ready market for the transferred
goods or services.
Negotiated transfer prices: Advantage: gives divisions
considerable autonomy and if the managers behave rationally
effective decisions will result. Disadvantage: negotiations may be
time-consuming and difficult because of the conflicting interests of
the managers.
427.
428.
429.
6. Transfer pricing (Appendix)
430.
a. The minimum amount Eastern should accept is $80.
431.
b. The maximum amount Western should be willing to pay Easter is $175.
432.
433.

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Performance Evaluation in Decentralized Organizations

434. Short Answer Questions
1. Why do firms decentralize?
435.
2. List two benefits and two costs associated with decentralization.
436.
3. What are the three common forms of responsibility centers we find in
organizations?
437.
4. What are the responsibilities of a cost center manager?
438.
5. What are the responsibilities of a profit center manager?
439.
6. What are the responsibilities of an investment center manager?
440.
7. What are the two key principles of performance measurement?
441.
8. List three characteristics of an effective performance measure.
442.
9. How are cost center managers commonly evaluated?
443.
10.What does the term kaizen mean?
444.
11.How are profit center managers commonly evaluated?
445.
12.Define ROI. List two advantages and two disadvantages of using ROI as a
measure to evaluate investment centers.
446.
13.Define residual income. What is the difference between economic value added
(EVA) and residual income?
447.
14.Why is transfer pricing necessary in organizations with multiple divisions?
448.
15.What are the three common approaches to transfer pricing? List one advantage
and one disadvantage associated with each of these three approaches.

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Balakrishnan/Managerial Accounting, 2e
449. Short Answer Solutions
1. (LO1)
Firms decentralize because, as organizations grow, the number and
types of decisions that need to be made increase substantially. A single
individual will not have the relevant expertise and knowledge to make all of
these decisions thus, firms delegate decision-making responsibility.
450.
2. (LO1)
The benefits include (1) timely decisions, (2) tailoring managerial skills
and specializations to job requirements, (3) empowering employees, and (4)
training future managers. The costs include (1) an emphasis on local versus
global goals, (2) requires coordination of decisions, and (3) can lead to improper
decisions because of a divergence between individual and organizational goals.
3. (LO2)
(1) Cost centers, (2) Profit centers, and (3) Investment centers
451.
4. (LO2)
Minimize the cost of producing a specified level of output or service.
452.
5. (LO2)
Both minimize costs and maximize revenues. That is, maximize profit
453.
6. (LO2)
Maximize the returns from invested capital, or to put the capital
invested by owners and shareholders of the organizations to the most profitable
uses
454.
7. (LO2)
Controllability and informativeness
455.
8. (LO2)
An ideal performance measure (1) aligns employee and organizational
goals, (2) yields maximum information about the decision or actions of the
individual or organizational unit, (3) is easy to measure, and (4) is easy to
understand and communicate.
456.
9. (LO3)
In the short-term, via budget variances. In the long-term, by
techniques such as benchmarking and kaizen
457.
10.(LO3)
Kaizen is a philosophy of continuous improvement
458.
11.(LO3)
By budget variances and comparing actual profit with past profit and
industry profit. Organizations also use revenue-oriented measures such as
customer satisfaction and market share. Additional cost-oriented measures
might focus on employee turnover or process improvements
459.
12.(LO4)
ROI = return on investment = profit divided by investment. ROI is an
effective summary of business profitability it controls for size by expressing the
return per investment dollar. Consequently, it is easy to compare the
performance of investment centers of different size. We also can decompose ROI
into smaller pieces, allowing managers to see how individual actions map into
overall profitability. The major criticism of ROI is that it can foster
underinvestment. For example, if current ROI is 20%, a manager may not invest
in a project with an ROI of 18% even though the firms cost of capital is 15%. It
also favors divisions with older assets.
460.

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Performance Evaluation in Decentralized Organizations

13.(LO4)
Residual income = Profit (required return * Investment). Residual
income represents the additional profit or value generated by an investment
after meeting the required rate of return. Economic value added is a modified
calculation of residual income it uses a weighted average cost of capital and
adjusts for the operating and capital costs of a business, including taxes.
461.
14.(LO5)
Because multiple divisions often deal with each other in the normal
course of business, diverting a portion of their resources from external business
to serve internal needs
462.
15.(LO5)
(1) Cost-based transfer prices, (2) market-based transfer prices, and
(3) negotiated transfer prices. Market based prices do best in evaluating
opportunity costs and in preserving arms-length transactions. But, the market
may not exist. Negotiated transfer prices truly respect autonomy but might be
time consuming and tedious. Cost-based prices can be used under all situations
but defining what is the right cost and the right markup to use can lead to many
disputes.
463.

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Balakrishnan/Managerial Accounting, 2e
464. Short Essays
465.

1. Organizational experts say that decentralization co-locates knowledge and decision rights.
What does this statement mean? Is decentralization always beneficial? What are the costs
associated with delegating decision making to lower levels of an organization?

466.
2. Some argue that decentralization results in maximizing profit division by division. It may not
lead to profit maximization at the overall firm level. Do you agree? Why or why not?

467.
3. Why not simply evaluate the performance of all divisional managers based on the entire

firms profit? That way, we do not have to worry about divisional managers not acting in the
firms best interests. Is this a reasonable argument? Why or why not?

468.
4. When evaluating investment centers, what are some of the disadvantages of using net book
value to measure investment?

469.
5. Two divisions with exactly the same return on investment (ROI) can have different residual
incomes (RI). Why?

470.
6. Some argue that both ROI and RI motivate managers to focus on short-term performance,

since both the measures are calculated using operating performance (i.e., operating income).
Yet, ROI is widely used as a performance measure. Provide a brief discussion.

471.
7. Explain why capacity utilization in a supplying division is such an important consideration when
choosing a transfer pricing policy.

472.
8. A firm often obtains services from subsidiaries in which the firms key officers may hold
minority ownership. What incentive conflicts do such arrangements pose?

473.
9. Discuss some problems that arise when pricing the transfer of intellectual property.
474.

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Performance Evaluation in Decentralized Organizations

475. Short Essay Solutions
1. (LO1) The phase co-locates knowledge and decision rights means giving
the decision making authority to individuals in the organization that have the
requisite knowledge and information to make the right decision. For example,
decisions regarding material purchases in a manufacturing company such as
when to purchase, how much to purchase, which suppliers to purchase from
is best left to individuals dealing with the purchase function routinely.
Similarly, sales promotion decisions are best made by marketing personnel
who have the best knowledge of market conditions and consumer behavior.
Decentralization of decision making is not always beneficial because it might
to lead decision makers at lower levels to choose actions that are in their best
interests and not necessarily in the best interests of the firm. It also requires
considerable coordination across all levels in the organization to ensure that
all decisions are properly coordinated.
476.
2. (LO1) Yes. Decentralization promotes local maximization and not global
maximization. Each divisional manager is interested in casting his/her own
performance in the best possible light relative to other divisional managers.
As long as divisional profit is used to evaluate performance, each divisional
manager has a natural incentive to find ways in which to increase his/her own
divisional profit even if the chosen ways might hurt other divisions.
477.
3. (LO2) The problem with this argument is that each manager cannot control
actions of the other managers, and the impact of their actions on the firms
profit. Thus, it is possible that even though the division is doing extremely
well, its manager may not receive commensurate reward if the firm as a
whole is not doing well because of the actions of other managers.
478.
4. (LO4) When the net book value is used to measure investment, the assets
age becomes a factor. As the asset becomes older, the accumulated
depreciation increases and the net book value decreases. Consequently, ROI
often is higher for older assets. As a result, managers may have less of an
incentive to undertake timely asset replacement decisions.
479.
5. (LO4) Consider the following example. Division A has an income of $10,000
on an investment of $100,000. Division B has an income of $100,000 on an
investment of $1,000,000. Assume that the require rate of return is 8%.
480. The ROI for both the divisions is 10%. But the residual income for
Division A is $2,000 (=$10,000 (8% $100,000)), and the residual income
for Division B is $20,000 (=$100,000 (8% $1,000,000)). Why? This is
because the residual income is sensitive to project size. All else equal, larger
investments will have higher residual incomes.
481.
6. (LO4) Yes, both ROI and RI are short-term performance measures. ROI is
widely used because it is easy to compute and is well understood. As we
learned in the chapter, ROI can be conveniently decomposed into profitability
and asset turnover ratios. By evaluating the trends in these ratios, one can
make reasonable assessments of the firms future. Also, ROI is but one of

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Balakrishnan/Managerial Accounting, 2e
several measures that analysts and outsiders employ to evaluate the firms
performance and its future potential.
482.
7. (LO5) When the supplying division is fully utilized, any transfer to the buying
division is diverting capacity away from profitable use of its capacity. Unless
the firm can earn a great profit by diverting capacity, it does not make sense
to transfer. In a decentralized environment in which both the buying and
selling divisions are acting as profit centers, the transfer price must
compensate the selling division for lost profit. The buying division will be
willing to do so only if it is still able to make a profit for itself. In this case, the
company as a whole is better off because the selling divisions capacity will
have been put to the most profitable use!
483.
8. (LO5) In such instances, there is a natural incentive for the firms
management to provide business to its subsidiaries even if the same services
can be obtained from other sources for lower prices and at better quality.
484.
9. (LO5) Intellectual property is inherently difficult to price. It is very much
unlike a typical product which has a certain definite determinable life, and
whose cost of production is determinable to a fair degree of accuracy. On the
other hand, the life of intellectual property is difficult to estimate. Sometimes
new technologies emerge suddenly rendering the intellectual property totally
worthless immediately. On the other hand, some intellectual property has
indefinite lives. Another problem is that the dissemination of intellectual
property is not easily controllable. The acute problem of piracy in the
software industry is a good example.
485.

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Performance Evaluation in Decentralized Organizations

486. Exercises
1. Karl Krader oversees a staff of over 200 persons and a budget of close to a
million dollars per year. He is responsible for the upkeep of all buildings and
equipment at a large university. However, any reconstruction project is budgeted
and administered separately. Karls responsibilities include selection and
evaluation of personnel, negotiating with suppliers, choosing the kinds of
landscaping, and so on. Karls services, however, are not priced out to the user
departments or to individual units within the university.
487.
488.
Required:
489.
a. Should Karl be evaluated as a profit center or a cost center?
490.
b. How should the university evaluate Karls performance?
2. The Production Department of Advent Cordless Phones is a cost center. The
following table provides budgeted and actual cost information for the most
recent year.
491. Budget Actual
492. Production volume (units) 175,000 200,000
493. Total variable costs $7,875,000 $9,450,000
494. Total fixed costs 1,200,000 $1,350,000
495.
496. Required:
497. Evaluate the performance of the Production Department.

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Balakrishnan/Managerial Accounting, 2e
498. Exercise Solutions
1. (LO1)
a. We believe that Karl should be evaluated as a cost center. While he provides
a useful and visible service, there is no direct impact on revenue. Further, he
does not influence prices or determine the level of output. His job is to keep
up the buildings to specified quality levels within allowed costs. This is a
central characteristic of a cost center.
499.
b. The university should use a mix of financial and non-financial measures.
Relying on financial measures alone is not advisable because Karl can always
postpone maintenance to come in below budgeted expenditures. However,
we do need to make sure that the budget is not over-spent by a lot. Nonfinancial measures such as time to respond to complaints and general score
on upkeep seem useful as a way to make sure that Karl is providing the
desired service quality.
500.
2. (LO3)
The data pertain to an engineered cost center. That is, volume affects
total cost. We need to construct a flexible budget and perform cost variance
analysis. We have:

517.

Bu
dget

503.

501.

502.

Flexible
budget*

505. Production volume

(units)

506. 17 507.
5,000

200,
000

504.
508.

Act
ual
200,
000

509.

Total variable costs

510. $7, 511. $9,0

875,0
00,000
00

512. $9,4
50,000

513.

Total fixed costs

514. 1,2 515. 1,20

00,00
0,000
0

516. $1,3
50,000

* As we know from Chapter 8, the flexible budget adjusts costs for the actual volume
of operations. Thus, we have ($7,875,000/175,000) 200,000 = $9,000,000. Fixed
costs do not change.

518.
519.
After adjusting for volume, the efficiency variance is $450,000 U and
the fixed cost spending variance is $150,000 U. While some of the cost over-runs
might be legitimately attributed to the higher volume (e.g., poorer quality
materials, more supervisors hired etc), the increase is significant and warrants
investigation. Overall, the data reflect considerable cause for concern.
520.
521.

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