Chapter 11

Performance Measurement in Decentralized

Organizations

Solutions to Questions

11-1 In a decentralized organization, company’s minimum required rate of return on

decision-making authority isn’t confined to a few operating assets.
top executives; instead, decision-making
authority is spread throughout the organization. 11-6 If ROI is used to evaluate performance,
a manager of an investment center may reject a
11-2 The benefits of decentralization include: profitable investment opportunity whose rate of
(1) by delegating day-to-day problem solving to return exceeds the company’s required rate of
lower-level managers, top management can return but whose rate of return is less than the
concentrate on bigger issues such as overall investment center’s current ROI. The residual
strategy; (2) empowering lower-level managers income approach overcomes this problem
to make decisions puts decision-making because any project whose rate of return
authority in the hands of those who tend to exceeds the company’s minimum required rate
have the most detailed and up-to-date of return will result in an increase in residual
information about day-to-day operations; (3) by income.
eliminating layers of decision-making and
approvals, organizations can respond more 11-7 The difference between delivery cycle
quickly to customers and to changes in the time and throughput time is the waiting period
operating environment; (4) granting decision- between when an order is received and when
making authority helps train lower-level production on the order is started. Throughput
managers for higher-level positions; and (5) time is made up of process time, inspection
empowering lower-level managers to make time, move time, and queue time. Process time
decisions can increase their motivation and job is value-added time and inspection time, move
satisfaction. time, and queue time are non-value-added time.

11-3 The manager of a cost center has 11-8 An MCE of less than 1 means that the
control over cost, but not revenue or the use of production process includes non-value-added
investment funds. A profit center manager has time. An MCE of 0.40, for example, means that
control over both cost and revenue. An 40% of throughput time consists of actual
investment center manager has control over processing, and that the other 60% consists of
cost and revenue and the use of investment moving, inspection, and other non-value-added
funds. activities.

11-4 Margin is the ratio of net operating 11-9 A company’s balanced scorecard should
income to total sales. Turnover is the ratio of be derived from and support its strategy.
total sales to average operating assets. The Because different companies have different
product of the two numbers is the ROI. strategies, their balanced scorecards should be
different.
11-5 Residual income is the net operating
income an investment center earns above the 11-10 The balanced scorecard is constructed
to support the company’s strategy, which is a
© The McGraw-Hill Companies, Inc., 2012. All rights reserved.
Solutions Manual, Chapter 11 569
theory about what actions will further the If the internal business processes improve, but
company’s goals. Assuming that the company the financial outcomes do not improve, the
has financial goals, measures of financial theory may be flawed and the strategy should
performance must be included in the balanced be changed.
scorecard as a check on the reality of the theory.

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

570 Managerial Accounting, 14th Edition
Exercise 11-1 (10 minutes)

1. Net operating income

Margin =
Sales
$5,400,000
= = 30%
$18,000,000

2. Sales
Turnover =
Average operating assets

$18,000,000
= = 0.5
$36,000,000

3. ROI = Margin × Turnover

= 30% × 0.5 = 15%

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

Solutions Manual, Appendix 11B 571
Exercise 11-2 (10 minutes)

Average operating assets ...................... £2,200,000

Net operating income ........................... £400,000
Minimum required return:
16% × £2,200,000 ............................ 352,000
Residual income ................................... £ 48,000

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

572 Managerial Accounting, 14th Edition
Exercise 11-3 (20 minutes)

1. Throughput time = Process time + Inspection time + Move time +

Queue time
= 2.8 days + 0.5 days + 0.7 days + 4.0 days
= 8.0 days

2. Only process time is value-added time; therefore the manufacturing

cycle efficiency (MCE) is:
Value-added time 2.8 days
MCE= = =0.35
Throughput time 8.0 days

3. If the MCE is 35%, then 35% of throughput time was spent in value-
added activities, the other 65% was spent in non-value-added activities.

4. Delivery cycle time = Wait time + Throughput time

= 16.0 days + 8.0 days
= 24.0 days

5. If all queue time is eliminated, then the throughput time drops to only 4
days (0.5 + 2.8 + 0.7). The MCE becomes:
Value-added time 2.8 days
MCE= = =0.70
Throughput time 4.0 days
Thus, the MCE increases to 70%. This exercise shows quite dramatically
how lean production approach can improve operations and reduce
throughput time.

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

Solutions Manual, Appendix 11B 573
Exercise 11-5 (20 minutes)

1. (b) (c)
Net Average
(a) Operating Operating ROI
Sales Income* Assets (b) ÷ (c)
$4,500,000 $290,000 $800,000 36.25%
$4,600,000 $300,000 $800,000 37.50%
$4,700,000 $310,000 $800,000 38.75%
$4,800,000 $320,000 $800,000 40.00%
$4,900,000 $330,000 $800,000 41.25%
$5,000,000 $340,000 $800,000 42.50%
*Sales × Contribution Margin Ratio – Fixed Expenses

2. The ROI increases by 1.25% for each $100,000 increase in sales. This
happens because each $100,000 increase in sales brings in an additional
profit of $10,000. When this additional profit is divided by the average
operating assets of $800,000, the result is an increase in the company’s
ROI of 1.25%.
Increase in sales................................................... $100,000 (a)
Contribution margin ratio ...................................... 10% (b)
Increase in contribution margin and net operating
income (a) × (b) ................................................ $10,000 (c)
Average operating assets ...................................... $800,000 (d)
Increase in return on investment (c) ÷ (d) ............. 1.25%

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

574 Managerial Accounting, 14th Edition
Exercise 11-6 (15 minutes)

1. Net operating income

Margin =
Sales
$800,000
= = 10%
$8,000,000
Sales
Turnover =
Average operating assets
$8,000,000
= = 2.5
$3,200,000
ROI = Margin × Turnover
= 10% × 2.5 = 25%

2. Net operating income

Margin =
Sales
$800,000(1.00 + 4.00)
=
$8,000,000(1.00 + 1.50)

$4,000,000
= = 20%
$20,000,000
Sales
Turnover =
Average operating assets

$8,000,000 (1.00 + 1.50)

=
$3,200,000
$20,000,000
= = 6.25
$3,200,000
ROI = Margin × Turnover

= 20% × 6.25 = 125%

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

Solutions Manual, Appendix 11B 575
Exercise 11-6 (continued)

3. Net operating income

Margin =
Sales
$800,000 + $250,000
=
$8,000,000 + $2,000,000
$1,050,000
= = 10.5%
$10,000,000
Sales
Turnover =
Average operating assets

$8,000,000 + $2,000,000
=
$3,200,000 + $800,000
$10,000,000
= = 2.5
$4,000,000
ROI = Margin × Turnover

= 10.5% × 2.5 = 26.25%

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

576 Managerial Accounting, 14th Edition
Exercise 11-7 (20 minutes)
1. ROI computations:
Net operating income Sales
ROI = ×
Sales Average operating assets
$630,000 $9,000,000
Perth: × = 7% × 3 = 21%
$9,000,000 $3,000,000
$1,800,000 $20,000,000
Darwin: × = 9% × 2 = 18%
$20,000,000 $10,000,000

2. Perth Darwin
Average operating assets ................... $3,000,000 $10,000,000
Net operating income ......................... $630,000 $1,800,000
Minimum required return on average
operating assets—16% × Average
operating assets .............................. 480,000 1,600,000
Residual income ................................ $150,000 $ 200,000

3. No, the Darwin Division is simply larger than the Perth Division and for
this reason one would expect that it would have a greater amount of
residual income. Residual income can’t be used to compare the
performance of divisions of different sizes. Larger divisions will almost
always look better. In fact, in the case above, Darwin does not appear to
be as well managed as Perth. Note from Part (1) that Darwin has only
an 18% ROI as compared to 21% for Perth.

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

Solutions Manual, Appendix 11B 577
Exercise 11-8 (15 minutes)

Company A Company B Company C

Sales ........................................ $400,000 * $750,000 * $600,000 *
Net operating income ................ $32,000 $45,000 * $24,000
Average operating assets ........... $160,000 * $250,000 $150,000 *
Return on investment (ROI) ....... 20% * 18% * 16%
Minimum required rate of return:
Percentage ............................. 15% * 20% 12% *
Dollar amount ........................ $24,000 $50,000 * $18,000
Residual income ........................ $8,000 $(5,000) $6,000 *
*Given.

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

578 Managerial Accounting, 14th Edition
Exercise 11-9 (30 minutes)
1. Computation of ROI.
$300,000 $6,000,000
Division A: ROI = × = 5% × 4 = 20%
$6,000,000 $1,500,000
$900,000 $10,000,000
Division B: ROI = × = 9% × 2 = 18%
$10,000,000 $5,000,000
$180,000 $8,000,000
Division C: ROI = × = 2.25% × 4 = 9%
$8,000,000 $2,000,000

2. Division A Division B Division C

Average operating assets .... $1,500,000 $5,000,000 $2,000,000
Required rate of return........ × 15% × 18% × 12%
Minimum required return ..... $ 225,000 $ 900,000 $ 240,000
Actual net operating income $ 300,000 $ 900,000 $ 180,000
Minimum required return
(above) ........................... 225,000 900,000 240,000
Residual income ................. $ 75,000 $ 0 $ (60,000)

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

Solutions Manual, Appendix 11B 579
Exercise 11-12 (30 minutes)
1. Net operating income
Margin =
Sales
$16,000
= = 2%
$800,000
Sales
Turnover =
Average operating assets

$800,000
= =8
$100,000
ROI = Margin × Turnover
= 2% × 8 = 16%

2. Net operating income

Margin =
Sales
$16,000 + $6,000
=
$800,000 + $80,000
$22,000
= = 2.5%
$880,000
Sales
Turnover =
Average operating assets

$800,000 + $80,000
=
$100,000
$880,000
= = 8.8
$100,000
ROI = Margin × Turnover

= 2.5% × 8.8 = 22%

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

580 Managerial Accounting, 14th Edition
Exercise 11-12 (continued)

3. Net operating income

Margin =
Sales
$16,000 + $3,200
=
$800,000
$19,200
= = 2.4%
$800,000
Sales
Turnover =
Average operating assets

$800,000
= =8
$100,000
ROI = Margin × Turnover

= 2.4% × 8 = 19.2%

4. Net operating income

Margin =
Sales
$16,000
= = 2%
$800,000
Sales
Turnover =
Average operating assets

$800,000
=
$100,000 - $20,000
$800,000
= = 10
$80,000
ROI = Margin × Turnover

= 2% × 10 = 20%

© The McGraw-Hill Companies, Inc., 2012. All rights reserved.

Solutions Manual, Appendix 11B 581