Responsibility Accounting and Performance Evaluation

Grandpa Jim’s Cookie Company sells homemade cookies made with organic ingredients. His sales are strictly Web based. The business is taking off more than Grandpa Jim ever expected, with orders coming from across the country from both consumers and corporate event planners. Grandpa decides to decentralize and hires a full-time baker who will manage production and product costs and a Web site designer/sales manager who will focus on increasing sales through the Web site. Grandpa Jim can no longer handle the business on his own, so he hires a business manager to work with the other employees to ensure the company is best utilizing its assets to produce profit. Grandpa will then have time to focus on new product development. Now that Grandpa Jim’s Cookie Company has decentralized, identify the type of responsibility center that each manager is managing

Financial performance is measured in many ways. 

Requirements 

1. Explain the difference between lag and lead indicators. 

2. The following is a list of financial measures. Indicate whether each is a lag or a lead indicator: 

a. Income statement shows net income of \(100,000 

b. Listing of next week’s orders of \)50,000

c. Trend showing that average hits on the redesigned Web site are increasing at 5% per week 

d. Price sheet from vendor reflecting that cost per pound of sugar for the next month is $2 

e. Contract signed last month with large retail store that guarantees a minimum shelf space for Grandpa’s Overloaded Chocolate Cookies for the next year

Well-designed performance evaluation systems accomplish many goals. Describe the potential benefits performance evaluation systems offer.

One subunit of Harris Sports Company had the following financial results last month:

Harris—Subunit X Actual Results Flexible Budget Flexible Budget Variance (F or U) % Variance (F or U) 

Direct Materials \( 28,000 \) 25,900 

Direct Labor 13,000 13,800 

Indirect Labor 26,400 23,100 

Utilities 12,300 11,300 

Depreciation 25,000 25,000 

Repairs and Maintenance 4,600 5,600 

Total \( 109,300 \) 104,700

Requirements 

1. Complete the performance evaluation report for this subunit. Enter the variance percent as a percentage of the budgeted amount rounded to two decimal places. 

2. Based on the data presented, what type of responsibility center is this subunit? 

3. Which items should be investigated if part of management’s decision criteria is to investigate all variances exceeding $2,500 or 10%? 

4. Should only unfavorable variances be investigated? Explain.

What is the biggest disadvantage of using ROI to evaluate investment centers?

Consider the following condensed financial statements of Forever Free, Inc. The company’s target rate of return is 40%.

Requirements

1. Calculate the company’s ROI. Round all of your answers to four decimal places.

2. Calculate the company’s profit margin ratio. Interpret your results.

3. Calculate the company’s asset turnover ratio. Interpret your results.

4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.

5. Calculate the company’s RI. Interpret your results.

Wolf Paints is a national paint manufacturer and retailer. The company is segmented into five divisions: Paint Stores (branded retail locations), Consumer (paint sold through home improvement stores), Automotive (sales to auto manufacturers), International, and Administration. The following is selected divisional information for its two largest divisions: Paint Stores and Consumer.

                                      Net Sales         Operating             Average

                                       Revenue           Income             Total Assets

Paint Stores                \( 3,980,000         \) 476,000          $ 1,380,000

Consumer                      1,315,000             195,000            1,600,000

Management has specified a 21% target rate of return.

Requirements

1. Calculate each division’s ROI. Round all of your answers to four decimal places.

2. Calculate each division’s profit margin ratio. Interpret your results.

3. Calculate each division’s asset turnover ratio. Interpret your results.

4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.

5. Calculate each division’s RI. Interpret your results, and offer a recommendation for any division with negative RI.

6. Describe some of the factors that management considers when setting its minimum target rate of return.

The Harris Company is decentralized, and divisions are considered investment centers. Harris has one division that manufactures oak dining room chairs with upholstered seat cushions. The Chair Division cuts, assembles, and finishes the oak chairs and then purchases and attaches the seat cushions. The Chair Division currently purchases the cushions for \(22 from an outside vendor. The Cushion Division manufactures upholstered seat cushions that are sold to customers outside the company. The Chair Division currently sells 800 chairs per quarter, and the Cushion Division is operating at capacity, which is 800 cushions per quarter. The two divisions report the following information:

Chair Division                                                        Cushion Division

Sales Price per Chair                        \) 85            Sales Price per Cushion       \( 32

Variable Cost (other than cushion)    42              Variable Cost per Cushion     13

Variable Cost (cushion)                       22

Contribution Margin per Chair         \) 21   Contribution Margin per Cushion $ 19

Requirements

1. Determine the total contribution margin for Harris Company for the quarter.

2. Assume the Chair Division purchases the 800 cushions needed from the Cushion Division at its current sales price. What is the total contribution margin for each division and the company?

3. Assume the Chair Division purchases the 800 cushions needed from the Cushion Division at its current variable cost. What is the total contribution margin for each division and the company?

4. Review your answers for Requirements 1, 2, and 3. What is the best option for Harris Company?

5. Assume the Cushion Division has capacity of 1,600 cushions per quarter and can continue to supply its outside customers with 800 cushions per quarter and also supply the Chair Division with 800 cushions per quarter. What transfer price should Harris Company set? Explain your reasoning. Using the transfer price you determined, calculate the total contribution margin for the quarter.

One subunit of Track Sports Company had the following financial results last month:

Subunit X        Actual Results       Flexible Budget  Flexible Budget   % Variance

                                                                                       Variance (F or U)     (F or U)

Net Sales 

Revenue               \( 474,000                   \) 455,000

Variable 

Expenses                261,000                      255,000

Contribution 

Margin                     213,000                     200,000

Traceable 

Fixed Expenses        38,000                      29,000

Divisional 

Segment Margin    \( 175,000               \) 171,000

Requirements

1. Complete the performance evaluation report for this subunit (round to two decimal places).

2. Based on the data presented and your knowledge of the company, what type of responsibility center is this subunit?

3. Which items should be investigated if part of management’s decision criteria is to investigate all variances equal to or exceeding \(8,000 and exceeding 10% (both criteria must be met)?

4. Should only unfavorable variances be investigated? Explain.

5. Is it possible that the variances are due to a higher-than-expected sales volume? Explain.

6. Will management place equal weight on each of the variances exceeding \)8,000? Explain.

7. Which balanced scorecard perspective is being addressed through this performance report? In your opinion, is this performance report a lead or a lag indicator? Explain.

8. List one key performance indicator for the three other balanced scorecard perspectives. Make sure to indicate which perspective is being addressed by the indicators you list.

Using ROI and RI to evaluate investment centers

Consider the following condensed financial statements of Pure Life, Inc. The company’s target rate of return is 30%.

PURE LIFE, INC. Income Statement For the Year Ended December 31, 2018 Net Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses 2,300,000 2,000,000 300,000 (34,000) 266,000 3,700,000 \( 6,000,000 Operating Income Interest Expense Other Income and (Expenses): Income Before Income Tax Expense Income Tax Expense Net Income 93,100 \) 172,900

PURE LIFE, INC. Comparative Balance Sheet As of December 31, 2018 and 2017 Assets 2018 2017 Cash Accounts Receivable Supplies Property, Plant, and Equipment, net Patents, net Total Assets Accounts Payable Short-term Notes Payable Long-term Notes Payable Common Stock, no Par Retained Earnings Total Liabilities and Stockholders’ Equity Liabilities and Stockholders’ Equity \( 62,000 200 204,000 101,000 \) 394,000 26,800 \( 76,000 600 305,000 163,000 \) 606,000 61,400 52,000 \( 31,000 126,500 169,000 15,500 \) 394,000 148,000 \( 29,000 196,000 205,500 27,500 \) 606,000

Requirements

1. Calculate the company’s ROI. Round all of your answers to four decimal places.

2. Calculate the company’s profit margin ratio. Interpret your results.

3. Calculate the company’s asset turnover ratio. Interpret your results.

4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.

5. Calculate the company’s RI. Interpret your results.

Using ROI and RI to evaluate investment centers

Tiger Paints is a national paint manufacturer and retailer. The company is segmented into five divisions: Paint Stores (branded retail locations), Consumer (paint sold through home improvement stores), Automotive (sales to auto manufacturers), International, and Administration. The following is selected divisional information for its two largest divisions: Paint Stores and Consumer:

Net Sales Revenue Operating Income Average Total Assets

Paint Stores \( 4,000,000 \) 476,000 $ 1,420,000

Consumer 1,300,000 196,000 1,585,000

Management has specified a 19% target rate of return.

Requirements

1. Calculate each division’s ROI. Round all of your answers to four decimal places.

2. Calculate each division’s profit margin ratio. Interpret your results.

3. Calculate each division’s asset turnover ratio. Interpret your results.

4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.

5. Calculate each division’s RI. Interpret your results, and offer a recommendation for any division with negative RI.

6. Describe some of the factors that management considers when setting its minimum target rate of return.

Preparing a financial budget—budgeted income statement and balance sheet 

Bradley Company has the following post-closing trial balance on December 31, 2018:

The company’s accounting department has gathered the following budgeting information for the first quarter of 2019: 

Budgeted total sales, all on account                                   $ 305,000                            Budgeted direct materials to be purchased and used           32,000                               Budgeted direct labor cost                                                       12,500                    Budgeted manufacturing overhead costs: 

Variable manufacturing overhead                                             2,100                  Depreciation                                                                                1,300                  Insurance and property taxes                                                    1,350                        Budgeted cost of goods sold                                                   72,000                      Budgeted selling and administrative expenses: 

Salaries expense                                                                          7,000                               Rent expense                                                                                2,000                    Insurance expense                                                                        1,100 Depreciation expense                                                                     550                   Supplies expense                                                                         15,250                  Budgeted cash receipts from customers                                 263,500              Budgeted income tax expense                                                    41,000                  Budgeted purchase and payment for capital expenditures                           (additional equipment)                                                                 43,000 

Additional information: 

a. Direct materials purchases are paid 70% in the quarter purchased and 30% in the next quarter. 

b. Direct labor, manufacturing overhead, selling and administrative costs, and income tax expense are paid in the quarter incurred. 

c. Accounts payable at December 31, 2018 are paid in the first quarter of 2019. Requirements 

1. Prepare Bradley Company’s budgeted income statement for the first quarter of 2019. 

2. Prepare Bradley Company’s budgeted balance sheet as of March 31, 2019

Fill in the blanks with the phrase that best completes the sentence. Some phrases may be used more than once and some not at all.

Phrases:

• cost center
• revenue center
• investment center
• lower
• profit center
• higher
• responsibility center

1. The maintenance department at the local zoo is a(n)___________              

2. The gift shop at the local zoo is a(n)____________                     

3. The menswear department of a department store, which is responsible for buying and selling merchandise, is a(n)_______________                

4. The production line at a manufacturing plant is a(n)           

5. A( n)________________is any segment of the business whose manager is accountable for specific activities.

6. A division of a beverage manufacturing company responsible for a particular brand of soft drink is a(n)_______________              

7. The sales manager in charge of a shoe company’s northwest sales territory oversees a(n)

8. Managers of cost and revenue centers are at_____________ levels of the organization than are managers of profit and investment centers.______

Classify each key performance indicator according to the balanced scorecard perspective it addresses. Choose from the following: financial perspective, customer perspective, internal business perspective, or learning and growth perspective.

9. Number of repeat customers

10. Employee turnover

11. Revenue growth

12. Number of on-time deliveries

13. Number of defects found during the manufacturing process

Match the responsibility center to the correct responsibility report.

Padgett Company has compiled the following data:

Net sales revenue                                      $1,000,000

Operating income                                      60,000                                    

Average total assets                                  400,000

Management’s target rate of return       12%

Compute the following amounts for Padgett:

1.  Profit margin ratio
2. Asset turnover ratio           
3. Return on investment 
4. Residual income

Sheffield Company manufactures power tools. The Electric Drill Division (an investment center) can purchase the motors for the drills from the Motor Division (another investment center) or from an outside vendor. The cost to purchase from the outside vendor is \(20. The Motor Division also sells to outside customers. The motor needed by the Electric Drill Division sells for \)25 to outside customers and has a variable cost of $15. The Motor Division has excess capacity.

21. If Sheffield Company allows division managers to negotiate transfer prices, what is the minimum amount the manager of the Motor Division should consider? 

22. What is the maximum transfer price the manager of the Electric Drill Division should consider?

Explain the difference between a centralized company and a decentralized company.

List the advantages of decentralization.

List the disadvantages of decentralization.

What is goal congruence?

Usually, which outweighs the other in decentralization—advantages or disadvantages?

Question: What is the purpose of a responsibility accounting system?

What is a responsibility center?

Question: List the four types of responsibility centers, and briefly describe each.

What is a performance evaluation system?

What are the goals of a performance evaluation system?

Explain the difference between a lag indicator and a lead indicator.

How is the use of a balanced scorecard as a performance evaluation system helpful to companies?

What is a key performance indicator?

What are the four perspectives of the balanced scorecard? Briefly describe each.

Explain the difference between a controllable and a non-controllable cost.

What is the typical focus of responsibility reports for cost centers, revenue centers, and profit centres?

What are two key performance indicators used to evaluate investment centers?

Describe the two ways ROI can be calculated.

What does ROI measure?

Question: How is RI calculated?

What does RI measure?

What is the biggest advantage of using RI to evaluate investment centers?

 List the disadvantages of decentralization.

What is goal congruence?

What is a responsibility center?

List the advantages of decentralization.

 Decentralization divides company operations into various reporting units. Most decentralized subunits can be described as one of four different types of responsibility centers.

Requirements 

1. Explain why companies decentralize. Describe some typical methods of decentralization. 

2. List the four most common types of responsibility centers, and describe their responsibilities.

What is a key performance indicator?

Explain the difference between a lag indicator and a lead indicator.

How is the use of a balanced scorecard as a performance evaluation system helpful to companies?

What are some limitations of financial performance measures?

What is a transfer price?

Explain the difference between market-based transfer prices and cost-based transfer prices.