True/False Questions

1. Allocating common fixed costs to segments on segmented income statements reduces

the usefulness of such statements.

Ans: True

2. A segment is any part or activity of an organization about which a manager seeks cost,
revenue, or profit data.

Ans: True

3. A responsibility center is a business segment whose manager has control over costs,
revenues, or investments in operating assets.

Ans: True

4. Residual income is used in the numerator to compute turnover in an ROI analysis.

Ans: False

5. Net operating income is earnings before interest and taxes.

Ans: True

6. Land held for possible plant expansion would be included as an operating asset in the
ROI calculation.

Ans: False

7. Margin equals Stockholders' Equity divided by Sales.

Ans: False
Segment Reporting and Decentralization

8. The use of return on investment (ROI) as a performance measure may lead managers
to reject a project that would be favorable for the company as a whole.

Ans: True

9. Residual income is equal to the difference between total revenues and operating
expenses.

Ans: False

10. When using residual income as a measure of performance, it is not meaningful to

compare the residual incomes of divisions of different sizes.

Ans: True

11. A cost center is also a responsibility center.

Ans: True

12. The basic objective of responsibility accounting is to charge each manager with those
costs and/or revenues over which he has control.

Ans: True

Multiple Choice Questions

13. The impact on net operating income of short-run changes in sales for a segment can be
most clearly predicted by analyzing:
A) the contribution margin ratio.
B) the segment margin.
C) the ratio of the segment margin to sales.
D) net sales less segment fixed costs.

Ans: A

14. In a segmented contribution format income statement, what is the best measure of the
long-run profitability of a segment?
A) its gross margin
B) its contribution margin
C) its segment margin
D) its segment margin minus an allocated portion of common fixed expenses
 Ans: C

15. In order to properly report segment margin as a guide to long-run segment profitability
and performance, fixed costs must be separated into two broad categories. One
category is common fixed costs. What is the other category?
A) discretionary fixed costs
B) committed fixed costs
C) traceable fixed costs
D) specialized fixed costs

Ans: C

16. Which of the following segment performance measures will decrease if there is an
increase in the interest expense for that segment?

Return on Investment Residual Income

A) Yes Yes
B) No Yes
C) Yes No
D) No No

Ans: D

17. Which of the following segment performance measures will increase if there is a
decrease in the selling expenses for that segment?

Return on Investment Residual Income

A) Yes Yes
B) No Yes
C) Yes No
D) No No

Ans: A

18. Some investment opportunities that should be accepted from the viewpoint of the
entire company may be rejected by a manager who is evaluated on the basis of:
A) return on investment.
B) residual income.
C) contribution margin.
D) segment margin.

Ans: A
Segment Reporting and Decentralization

19. Consider the following three conditions:

I. An increase in sales
II. An increase in operating assets
III. A reduction in expenses

Which of the above conditions provide a way in which a manager can improve return
on investment?
A) Only I
B) Only I and II
C) Only I and III
D) Only II and III

Ans: C

20. When calculating a segment's return on investment (ROI), which of the following
assets of that segment would be considered a part of average operating assets?
A) cash
B) accounts receivable
C) plant and equipment
D) all of the above

Ans: D

21. Which of the following measures of performance encourages continued expansion by

an investment center so long as it is able to earn a return in excess of the minimum
required return on average operating assets?
A) return on investment
B) transfer pricing
C) the contribution approach
D) residual income

Ans: D
 22. Residual income is:
A) Net operating income plus the minimum required return on average operating
assets.
B) Net operating income less the minimum required return on average operating
assets.
C) Contribution margin plus the minimum required return on average operating
assets.
D) Contribution margin less the minimum required return on average operating
assets.

Ans: B

23.A segment of a business responsible for both revenues and expenses would be called:
A) a cost center.
B) an investment center.
C) a profit center.
D) residual income.

Ans: C

24. Devlin Company has two divisions, C and D. The overall company contribution
margin ratio is 30%, with sales in the two divisions totaling $500,000. If variable expenses are
$300,000 in Division C, and if Division C's contribution margin ratio is 25%, then sales in
Division D must be:
A) $50,000
B) $100,000
C) $150,000
D) $200,000

Ans: B

Solution:

Total company contribution margin = $500,000 × 30% = $150,000

Total company variable expenses = $500,000 − $150,000 = $350,000

Division C contribution margin ratio = (Sales − $300,000) ÷ Sales = 0.25

Sales − $300,000 = 0.25 × Sales
(0.75 × Sales) ÷ 0.75 = $300,000 ÷ 0.75
Sales = $400,000

Division D sales = Total company sales − Division C sales

= $500,000 − $400,000 = $100,000

Divisions
Segment Reporting and Decentralization

Total
Company Division C Division D
Sales ................................... $500,000 $400,000 $100,000
Less variable expenses ....... 350,000 300,000 50,000
Contribution margin........... $150,000 $100,000 $ 50,000
Contribution margin ratio .. 0.30 0.25 0.50

25. Toxemia Salsa Company manufactures five flavors of salsa. Last year, Toxemia
generated net operating income of $40,000. The following information was taken from last
year's income statement segmented by flavor (brackets indicate a negative amount):

Wimpy Mild Medium Hot Atomic

Contribution margin . $(2,000) $45,000 $35,000 $50,000 $162,000
Segment margin ........ $(16,000) $(5,000) $7,000 $10,000 $94,000
Segment margin less
allocated common
fixed expenses ....... $(26,000) $(15,000) $(3,000) $0 $84,000

Toxemia expects similar operating results for the upcoming year. If Toxemia wants to
maximize its profitability in the upcoming year, which flavor or flavors should
Toxemia discontinue?
A) no flavors should be discontinued
B) Wimpy
C) Wimpy and Mild
D) Wimpy, Mild, and Medium

Ans: C

Solution:

The segment margin is a better indication of profitability of individual products than

the segment margin less allocated common fixed expenses. The products with
negative segment margins should be discontinued to maximize profit: Wimpy and
Mild.
 26. Uchimura Corporation has two divisions: the AFE Division and the GBI Division. The
corporation's net operating income is $42,000. The AFE Division's divisional segment
margin is $15,700 and the GBI Division's divisional segment margin is $175,400.
What is the amount of the common fixed expense not traceable to the individual
divisions?
A) $149,100
B) $57,700
C) $217,400
D) $191,100

Ans: A

Solution:
Total
Company
Divisional segment margin ..............................
$191,100 ($15,700 + $175,400)
Less common fixed costs not
traceable to the individual divisions............. X
Net operating income .......................................
$ 42,000

Common fixed costs not traceable to the individual divisions

= $191,100 − $42,000 = $149,100

27. Younie Corporation has two divisions: the South Division and the West Division. The
corporation's net operating income is $26,900. The South Division's divisional segment
margin is $42,800 and the West Division's divisional segment margin is $29,900. What is the
amount of the common fixed expense not traceable to the individual divisions?
A) $56,800
B) $69,700
C) $72,700
D) $45,800

Ans: D

Solution:
Total
Company
Divisional segment margin .............................. $72,700 ($42,800 + $29,900)
Less common fixed costs not
traceable to the individual divisions............. X
Net operating income .......................................
$26,900

Common fixed costs not traceable to the individual divisions

= $72,700 − $26,900 = $45,800
Segment Reporting and Decentralization

28. Dukelow Corporation has two divisions: the Governmental Products Division and the
Export Products Division. The Governmental Products Division's divisional segment
margin is $255,000 and the Export Products Division's divisional segment margin is
$59,800. The total amount of common fixed expenses not traceable to the individual
divisions is $163,700. What is the company's net operating income?
A) $314,800
B) ($314,800)
C) $151,100
D) $478,500

Ans: C

Solution:
Total
Company
Divisional segment margin ..............................
$314,800 *
Less common fixed costs not
traceable to the individual divisions ............ 163,700
Net operating income ......................................
$151,100

*$255,000 + $59,800 = $314,800

29. Miscavage Corporation has two divisions: the Beta Division and the Alpha Division.
The Beta Division has sales of $580,000, variable expenses of $301,600, and traceable fixed
expenses of $186,500. The Alpha Division has sales of $510,000, variable expenses of
$178,500, and traceable fixed expenses of $222,100. The total amount of common fixed
expenses not traceable to the individual divisions is $235,500. What is the company's net
operating income?
A) $374,400
B) $201,300
C) $609,900
D) ($34,200)

Ans: D

Solution:
Divisions
Total Alpha Beta
Company Division Division
Sales .............................................. $1,090,000 $510,000 $580,000
Less: variable expenses ................. 480,100 178,500 301,600
Contribution margin ...................... 609,900 331,500 278,400
Less: traceable fixed expenses ...... 408,600 222,100 186,500
 Divisional segment margin............ 201,300 $109,400 $91,900
Less common fixed expenses ........ 235,500
Net operating income .................... ($34,200)

30. J Corporation has two divisions. Division A has a contribution margin of $79,300 and
Division B has a contribution margin of $126,200. If total traceable fixed costs are $72,400
and total common fixed costs are $34,900, what is J Corporation's net operating income?
A) $168,000
B) $170,600
C) $133,100
D) $98,200

Ans: D

Solution:

Total Company
Contribution margin ...................... $205,500 *
Less: traceable fixed expenses ...... 72,400
Divisional segment margin............ 133,100
Less common fixed expenses ........ 34,900
Net operating income .................... $ 98,200

*$79,300 + $126,200 = $205,500

31. Kop Corporation has provided the following data:

Return on investment (ROI) ................ 15%

Sales..................................................... $120,000
Average operating assets ..................... $60,000
Minimum required rate of return ......... 12%
Margin on sales ................................... 7.5%

Kop Corporation's residual income is:

A) $1,800
B) $5,400
C) $2,700
D) $3,600

Ans: A
Solution:

Net operating income = Sales × Margin on sales = $120,000 × 7.5% = $9,000

Residual income = Net operating income − (Average operating assets × Minimum
required rate of return) = $9,000 − ($60,000 × 12%) = $9,000 − $7,200 = $1,800
Segment Reporting and Decentralization

32. Spar Company has calculated the following ratios for one of its investment centers:

Margin ................... 25%

Turnover ................ 0.5 times

What is Spar's return on investment for this investment center?

A) 50.0%
B) 12.5%
C) 15.0%
D) 25.0%

Ans: B

Solution:

Return on investment = Margin × Turnover = 25% × 0.5 times = 12.5%

33. Mike Corporation uses residual income to evaluate the performance of its divisions.
The company's minimum required rate of return is 14%. In January, the Commercial
Products Division had average operating assets of $970,000 and net operating income
of $143,700. What was the Commercial Products Division's residual income in
January?
A) $7,900
B) -$20,118
C) $20,118
D) -$7,900

Ans: A

Solution:

Residual income = Net operating income − (Average operating assets × Minimum

required rate of return) = $143,700 − ($970,000 × 14%) = $143,700 − $135,800 =
$7,900
 34. In November, the Universal Solutions Division of Keaffaber Corporation had average
operating assets of $480,000 and net operating income of $46,200. The company uses
residual income, with a minimum required rate of return of 11%, to evaluate the
performance of its divisions. What was the Universal Solutions Division's residual
income in November?
A) -$6,600
B) $5,082
C) $6,600
D) -$5,082

Ans: A

Solution:

Residual income = Net operating income − (Average operating assets × Minimum

required rate of return) = $46,200 − ($480,000 × 11%) = $46,200 − $52,800 = -$6,600

35. If operating income is $60,000, average operating assets are $240,000, and the
minimum required rate of return is 20%, what is the residual income?
A) 40%
B) 25%
C) $12,000
D) $48,000

Ans: C

Solution:

Residual income = Net operating income − (Average operating assets × Minimum

required rate of return) = $60,000 − ($240,000 × 20%) = $60,000 − $48,000 = $12,000

Use the following to answer questions 36-40:

O'Neill, Incorporated's income statement for the most recent month is given below.

Total Store A Store B

Sales ..................................... $300,000 $100,000 $200,000
Variable expenses ................. 192,000 72,000 120,000
Contribution margin ............. 108,000 28,000 80,000
Traceable fixed expenses ..... 76,000 21,000 55,000
Segment margin ................... 32,000 $ 7,000 $ 25,000
Common fixed expenses ...... 27,000
Net operating income ........... $ 5,000
Segment Reporting and Decentralization

For each of the following questions, refer back to the original data.

36. If Store B sales increase by $20,000 with no change in traceable fixed expenses, the
overall company net operating income should:
A) increase by $2,500
B) increase by $5,000
C) increase by $8,000
D) increase by $12,000

Ans: C

Solution:

Store B contribution margin ratio = $80,000 ÷ $200,000 = 40%

Additional net operating income = $20,000 × 40% = $8,000

37. The marketing department believes that a promotional campaign at Store A costing
$5,000 will increase sales by $15,000. If its plan is adopted, overall company net operating
income should:
A) decrease by $800
B) decrease by $5,800
C) increase by $5,800
D) increase by $10,000

Ans: A

Solution:

Store A contribution margin ratio = $28,000 ÷ $100,000 = 28%

Change in net operating income = ($15,000 × 28%) − $5,000
= $4,200 − $5,000 = $800 decrease

38. A proposal has been made that will lower variable expenses in Store A to 62% of
sales. However, this reduction can only be accomplished by an increase in fixed
expenses of $8,000. If this proposal is implemented and sales remain constant, overall
company net operating income should:
A) remain the same
B) decrease by $4,200
C) increase by $2,000
D) increase by $8,000

Ans: C
 Solution:

New amount for Store A variable expenses = $100,000 × 62% = $62,000

Change in net operating income = ($72,000 − $62,000) − $8,000
= $10,000 − $8,000 = $2,000 increase

39. If sales in Store B increase by $30,000 as a result of a $7,000 expenditure in fixed

expenses:
A) the contribution margin should increase by $18,000
B) the segment margin should increase by $12,000
C) the contribution margin should increase by $11,000
D) the segment margin should increase by $5,000

Ans: D

Solution:

Store B contribution margin ratio = $80,000 ÷ $200,000 = 40%

Change in segment margin = ($30,000 × 40%) − $7,000
= $12,000 − $7,000 = $5,000 increase

40. Currently the sales clerks receive a salary of $7,000 per month in Store B. A proposal
has been made to change from a fixed salary to a sales commission of 5%. Assume
that this proposal is adopted, and that as a result sales increase by $20,000. The new
segment margin for Store B should be:
A) $29,000
B) $32,000
C) $39,000
D) $45,000

Ans: A

Solution:

Sales ...................................... $220,000 ($200,000 + $20,000)

Sales commissions ................ 11,000 ($220,000 × 5%)
Other variable expenses ........ 132,000 ($220,000 × 60%*)
Contribution margin.............. 77,000
Traceable fixed expenses ...... 48,000 ($55,000 − $7,000)
Segment margin .................... $ 29,000

*Variable expenses ÷ Sales = $120,000 ÷ $200,000 = 60%

Segment Reporting and Decentralization

Use the following to answer questions 41-43:

Higgins Company sells three products, Product A, Product B, and Product C. Sales during
June totaled $1,500,000 in the company. The company's overall contribution margin ratio was
38%, and its fixed expenses totaled $525,000 for the year. Sales by product were: Product A,
$750,000; Product B, $450,000; and Product C, $300,000. Traceable fixed expenses were:
Product A, $180,000; Product B, $150,000; and Product C, $90,000. The variable expenses
were: Product A, $450,000; Product B, $270,000; and Product C, $___?___.

41. The net operating income for the company as a whole for June was:
A) $45,000
B) $105,000
C) $150,000
D) $570,000

Ans: A

Solution:

Sales ...................................... $1,500,000

Contribution margin ratio ..... × 38%
Contribution margin.............. $570,000
Fixed expenses ...................... 525,000
Net operating income ............ $ 45,000

42. The contribution margin ratio for Product C for June was:
A) 0%
B) 30%
C) 38%
D) 70%

Ans: B

Solution:

Company variable expenses = $1,500,000 × (100% − 38%)

= $1,500,000 × 62% = $930,000
Product C variable expenses = $930,000 − $450,000 − $270,000 = $210,000
Product C contribution margin = $300,000 − $210,000 = $90,000
Product C contribution margin ratio = $90,000 ÷ $300,000 = 30%
 43. Common fixed expenses for Higgins Company for June were:
A) $45,000
B) $420,000
C) $150,000
D) $105,000

Ans: D

Solution:

Common fixed expenses = Total fixed expenses – Traceable fixed expenses

= $525,000 – ($180,000 + $150,000 + $90,000)
= $525,000 – $420,000 = $105,000

Use the following to answer questions 44-46:

Azuki Corporation operates in two sales territories, urban and rural. Shown below is last
year's income statement segmented by territory:

Urban Rural
Sales .............................................. $320,000 $80,000
Variable expenses .......................... 208,000 56,000
Contribution margin ...................... 112,000 24,000
Traceable fixed expenses .............. 48,000 30,000
Segment margin ............................ $64,000 $(6,000)

Azuki's common fixed expenses were $25,000 last year.

44. What was Azuki Corporation's overall net operating income for last year?
A) $33,000
B) $45,000
C) $58,000
D) $83,000

Ans: A

Solution:

Segment margin ............................. $58,000 ($64,000 + -$6,000)

Common fixed expenses ................ 25,000
Net operating income ..................... $33,000
Segment Reporting and Decentralization

45. If urban sales were 10% higher last year, by approximately how much would Azuki's
net operating income have increased? (Assume no change in the revenue or cost
structure.)
A) $4,400
B) $6,400
C) $11,200
D) $32,000

Ans: C

Solution:

Urban contribution margin ratio = $112,000 ÷ $320,000 = 35%

Increase in net operating income = $320,000 × 10% × 35% = $11,200

46. If operations in rural areas would have been discontinued at the beginning of last year,
how would this have changed the net operating income of Azuki Company as a
whole?
A) $5,000 increase
B) $6,000 increase
C) $11,000 increase
D) $24,000 decrease

Ans: B

Solution:

Rural segment margin = Contribution margin − Traceable fixed expenses

= $24,000 − $30,000 = ($6,000)

Net operating income would have increased by $6,000 if operations in rural areas
would have been discontinued at the beginning of last year.

Use the following to answer questions 47-48:

The following data pertain to Turk Company's operations last year:

Sales .............................................. $900,000

Net operating income .................... $36,000
Contribution margin ...................... $150,000
Average operating assets ............... $180,000
Stockholders’ equity...................... $100,000
Plant, property, & equipment ........ $120,000
47. Turk's return on investment for the year was:
A) 4%
B) 15%
C) 36%
D) 20%

Ans: D

Solution:

ROI = Net operating income ÷ Average operating assets

= $36,000 ÷ $180,000 = 20%

48. If the residual income for the year was $9,000, the minimum required rate of return
must have been:
A) 15%
B) 4%
C) 20%
D) 36%

Ans: A

Solution:

Residual income = Net operating income − (Average operating assets × Minimum

required rate of return)
= $9,000 = $36,000 − ($180,000 × Minimum required rate of return)
= $27,000 ÷ $180,000
Minimum required rate of return = 15%
Segment Reporting and Decentralization

Use the following to answer questions 49-50:

The Hum Division of the Ho Company reported the following data for last year:

Sales .................................................... $800,000

Operating expenses ............................. $650,000
Interest expense ................................... $50,000
Tax expense ......................................... $30,000
Stockholders’ equity............................ $200,000
Average operating assets ..................... $600,000
Minimum required rate of return ......... 12%

49. The residual income for the Hum Division last year was:
A) $126,000
B) $46,000
C) $78,000
D) $22,000

Ans: C

Solution:

Sales..................................................... $800,000
Operating expenses.............................. 650,000
Net operating income .......................... $150,000

Residual income = Net operating income − (Average operating assets × Minimum

required rate of return) = $150,000 − ($600,000 × 12%) = $150,000 − $72,000 =
$78,000
50. The return on investment last year for the Hum Division was:
A) 75%
B) 25%
C) 35%
D) 12%

Ans: B

Solution:

ROI = Net operating income ÷ Average operating assets

= $150,000 ÷ $600,000 = 25%