# Brewer chapter 10

21. Mar 2015
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### Brewer chapter 10

• 1. PROBLEM 10-17B Return on Investment (ROI) and Residual Income (LO2, LO3) CHECK FIGURE (1) Total ROI: 22.0% “I know headquarters wants us to add that new product line,” said Mel Harrison, manager of Border Corporation’s Home Office Products Division. “But I want to see the numbers before I make any move. Our division’s return on investment (ROI) has led the company for three years, and I don’t want any letdown.” Border Corporation is a decentralized wholesaler with five autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the company’s Home Office Products Division for the most recent year are given below: Sales \$8,000,000 Less variable expenses 5,900,000 Contribution margin 2,100,000 Less fixed expenses 1,620,000 Net operating income \$ 480,000 Divisional operating assets \$2,000,000 The company had an overall return on investment (ROI) of 16% last year (considering all divisions). The Home Office Products Division has an opportunity to add a new product line that would require an additional investment in operating assets of \$1,000,000. The cost and revenue characteristics of the new product line per year would be: Sales \$2,000,000 Variable expenses 60% of sales Fixed expenses \$620,000 Required: 1. Compute the Home Office Products Division’s ROI for the most recent year; also compute the ROI as it will appear if the new product line is added. 2. If you were in Mel Harrison’s position, would you accept or reject the new product line? Explain. 3. Why do you suppose headquarters is anxious for the Home Office Products Division to add the new product line? 4. Suppose that the company’s minimum required rate of return on operating assets is 13% and that performance is evaluated by the residual income. a. Compute the Home Office Products Division’s residual income for the most recent year; also compute the residual income as it would appear if the new product line is added. b. Under these circumstances, if you were in Mel Harrison’s position, would you accept or reject the new product line? Explain. PROBLEM 10-18B Comparison of Performance Using Return on Investment (ROI) (LO2) CHECK FIGURE (2) Company A margin: 12.5% Comparative data on three companies in the same service industry are given below: Companies in the Same Industry A B C Sales \$680,00 0 \$496,000 ? Net operating income \$ 85,000 \$ 62,000 ? Average operating assets \$340,00 ? \$620,000
• 2. 0 Margin ? ? 4.0% Turnover ? ? 2.5 Return on investment (ROI) ? 10.0% ? Required: 1. What advantages are there to breaking down the ROI computation into two separate elements, margin and turnover? 2. Fill in the missing information above, and comment on the relative performance of the three companies in as much detail as the data permit. Make specific recommendations about how to improve the return on investment. (Adapted from National Association of Accountants, Research Report No. 35, p. 34) PROBLEM 10–19B Perverse Effects of Some Performance Measures (LO4) An alternate problem doesn’t exist. PROBLEM 10-20B Return on Investment (ROI) and Residual Income (LO2, LO3) CHECK FIGURE (1) ROI, 20.0% Financial data for France Inc., for last year follows: France Inc. Balance Sheet Ending Balance Beginning Balance Assets Cash \$ 135,000 \$ 205,000 Accounts receivable 540,000 455,000 Inventory 360,000 310,000 Plant and equipment, net 585,000 610,000 Investment in Paris, S.A. 270,000 245,000 Land (undeveloped) 190,000 180,000 Total assets \$2,080,000 \$2,005,000 Liabilities and Stockholders’ Equity Accounts payable \$ 285,000 \$ 370,000 Long-term debt 1,700,000 1,600,000 Stockholders’ equity 95,000 35,000 Total liabilities and stockholders’ equity \$2,080,000 \$2,005,000 France Inc. Income Statement Sales \$4,000,000 Less operating expenses 3,680,000 Net operating income 320,000 Less interest and taxes: Interest expense \$160,000
• 3. Tax expense 70,000 230,000 Net income \$ 90,000 The company paid dividends of \$30,000 last year. The “Investment in Paris, S.A.,” on the balance sheet represents an investment in the stock of another company. Required: 1. Compute the company’s margin, turnover, and return on investment (ROI) for last year. 2. The board of directors of France, Inc. has set a minimum required return of 14%. What was the company’s residual income last year? PROBLEM 10-21B Return on Investment (ROI) Analysis (LO2) CHECK FIGURE (3) ROI: 27.3% (6) ROI: 21.1% The contribution format income statement for Wayne Company for last year is given below: Total Unit Sales \$6,300,000 \$126.00 Less variable expenses 4,410,000 88.20 Contribution margin 1,890,000 37.80 Less fixed expenses 1,134,000 22.68 Net operating income 756,000 15.12 Less income taxes @ 40% 302,400 6.05 Net income \$ 453,600 \$ 9.07 The company had average operating assets of \$3,000,000 during the year. Required: 1. Compute the company’s return on investment (ROI) for the period using the ROI formula stated in terms of margin and turnover. For each of the following questions, indicate whether the margin and turnover will increase, decrease, or remain unchanged as a result of the events described, and then compute the new ROI figure. Consider each question separately, starting in each case from the data used to compute the original ROI in (1) above. 2. Using just-in-time (JIT), the company is able to reduce the average level of inventory by \$375,000. (The released funds are used to pay off short-term creditors.) 3. The company achieves a cost savings of \$63,000 per year by using less costly materials. 4. The company issues bonds and uses the proceeds to purchase \$150,000 in machinery and equipment at the beginning of the period. Interest on the bonds is \$18,000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by \$25,200 per year. 5. As a result of a more intense effort by salespeople, sales are increased by 25%; operating assets remain unchanged. 6. Obsolete items of inventory carried on the books at a cost of \$156,000 is scrapped and written off as a loss. 7. The company uses \$200,000 of cash (received on accounts receivable) to repurchase and retire some of its common stock. PROBLEM 10-22B Building a Balanced Scorecard (LO4) An alternate problem doesn’t exist.
• 4. PROBLEM 10–23B Segment Reporting and Decision-Making (LO1) CHECK FIGURE (a) Eastern segment margin: \$22,750 Vachon Corporation’s contribution format income statement for June is given below: Vachon Company Income Statement For the Month Ended June 30 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . \$975,000 Variable expenses . . . . . . . . . . . . . . . . . 436,800 Contribution margin . . . . . . . . . . . . . . . . 538,200 Fixed expenses . . . . . . . . . . . . . . . . . . . 491,400 Net operating income . . . . . . . . . . . . . . \$46,800 Management is disappointed with the company’s performance and is wondering what can be done to improve profits. By examining sales and cost records, you have determined the following: a. The company is divided into two sales territories—Eastern and Western. The Eastern territory recorded \$390,000 in sales and \$211,250 in variable expenses during June; the remaining sales and variable expenses were recorded in the Southern territory. Fixed expenses of \$156,000 and \$140,400 are traceable to the Eastern and Western territories, respectively. The rest of the fixed expenses are common to the two territories. b. The company is the exclusive distributor for two products—Paks and Tibs. Sales of Paks and Tibs totaled \$65,000 and \$325,000, respectively, in the Eastern territory during June. Variable expenses are 25% of the selling price for Paks and 60% for Tibs. Cost records show that \$42,000 of the Eastern territory’s fixed expenses are traceable to Paks and \$56,000 to Tibs, with the remainder common to the two products. Required: 1. Prepare contribution format segmented income statements first showing the total company broken down between sales territories and then showing the Eastern territory broken down by product line. In addition, for the company as a whole and for each segment, show each item on the segmented income statements as a percent of sales. 2. Look at the statement you have prepared showing the total company segmented by sales territory. What insights revealed by this statement should be brought to the attention of management? 3. Look at the statement you have prepared showing the Eastern territory segmented by product lines. What insights revealed by this statement should be brought to the attention of management? PROBLEM 10–24B Basic Segment Reporting; Activity-Based Cost Assignment (LO1) CHECK FIGURE (1) Cookbook segment margin: \$25,200 McHill Products has recently acquired a small publishing company that McHill Products intends to operate as one of its investment centers. The newly acquired company has three books that it offers for sale—a cookbook, a travel guide, and a handy speller. Each book sells for \$14. The publishing company’s most recent monthly income statement is given below:
• 5. Product Line Total Company Cookbook Travel Guide Handy Speller Sales . . . . . . . . . . . . . . . . . . . . . . . . . \$420,000 \$126,000 \$210,000 \$84,000 Expenses: Printing costs . . . . . . . . . . . . . . . . . 142,800 37,800 88,200 16,800 Advertising . . . . . . . . . . . . . . . . . . . 50,400 18,900 27,300 4,200 General sales . . . . . . . . . . . . . . . . . 25,200 7,560 12,600 5,040 Salaries . . . . . . . . . . . . . . . . . . . . . 46,200 25,200 12,600 8,400 Equipment depreciation . . . . . . . . . 12,600 4,200 4,200 4,200 Sales commissions . . . . . . . . . . . . 42,000 12,600 21,000 8,400 General administration . . . . . . . . . . 58,800 19,600 19,600 19,600 Warehouse rent . . . . . . . . . . . . . . . 16,800 5,040 8,400 3,360 Depreciation—office facilities . . . . . 4,200 1,400 1,400 1,400 Total expenses . . . . . . . . . . . . . . . . . . 399,000 132,300 195,300 71,400 Net operating income (loss) . . . . . . . . \$21,000 (\$6,300) \$14,700 \$12,600 The following additional information is available about the company: a. Only printing costs and sales commissions are variable; all other costs are fixed. The printing costs (which include materials, labor, and variable overhead) are traceable to the three product lines as shown in the statement above. Sales commissions are 10% of sales for any product. b. The same equipment is used to produce all three books, so the equipment depreciation cost has been allocated equally among the three product lines. An analysis of the company’s activities indicates that the equipment is used 30% of the time to produce cookbooks, 50% of the time to produce travel guides, and 20% of the time to produce handy spellers. c. The warehouse is used to store finished units of product, so the rental cost has been allocated to the product lines on the basis of sales dollars. The warehouse rental cost is \$3 per square foot per year. The warehouse contains 67,200 square feet of space, of which 10,080 square feet is used by the cookbook line, 33,600 square feet by the travel guide line, and 23,520 square feet by the handy speller line. d. The general sales cost above includes the salary of the sales manager and other sales costs not traceable to any specific product line. This cost has been allocated to the product lines on the basis of sales dollars. e. The general administration cost and depreciation of office facilities both relate to administration of the company as a whole. These costs have been allocated equally to the three product lines. f. All other costs are traceable to the three product lines in the amounts shown on the statement above. g. The management of McHill Products, Inc., is anxious to improve the new investment center’s 5% return on sales. Required: 1. Prepare a new contribution format segmented income statement for the month. Adjust allocations of equipment depreciation and of warehouse rent as indicated by the additional information provided. 2. After seeing the income statement in the main body of the problem, management has decided to eliminate the cookbook because it is not returning a profit, and to focus all available resources on promoting the travel guide. 3. Based on the statement you have prepared, do you agree with the decision to eliminate the cookbook? Explain. 4. Based on the statement you have prepared, do you agree with the decision to focus all available resources on promoting the travel guide? Assume that an ample market is available for all three product lines. (Hint: Compute the contribution margin ratio for each product.) PROBLEM 10–25B Creating Balanced Scorecards that Support Different Strategies (LO4) An alternate problem doesn’t exist.
• 6. PROBLEM 10–26B Restructuring a Segmented Income Statement (LO1) CHECK FIGURE (3) West segment margin: \$79,650 Losses have been incurred at Scott Corporation for some time. In an effort to isolate the problem and improve the company’s performance, management has requested that the monthly income statement be segmented by sales region. The company’s first effort at preparing a segmented statement is given below. This statement is for May, the most recent month of activity. Sales Region West Central East Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \$540,000 \$960,000 \$860,000 Regional expenses (traceable): Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . 179,190 308,000 414,150 Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118,800 220,000 231,000 Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99,000 96,800 148,500 Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,850 13,200 16,500 Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,700 30,800 33,000 Shipping expense. . . . . . . . . . . . . . . . . . . . . . . . . 18,810 35,200 31,350 Total regional expenses . . . . . . . . . . . . . . . . . . . . . 460,350 704,000 874,500 Regional income (loss) before corporate expenses 79,650 256,000 -14,500 Corporate expenses: Advertising (general) . . . . . . . . . . . . . . . . . . . . . . 19,800 35,200 33,000 General administrative expense . . . . . . . . . . . . . 55,000 55,000 55,000 Total corporate expenses. . . . . . . . . . . . . . . . . . . . 74,800 90,200 88,000 Net operating income (loss) . . . . . . . . . . . .. . . . . . . \$4,850 \$165,800 (\$102,500) Cost of goods sold and shipping expense are both variable; other costs are all fixed. Scott Corporation is a wholesale distributor of office products. It purchases office products from manufacturers and distributes them in the three regions given above. The three regions are about the same size, and each has its own manager and sales staff. The products that the company distributes vary widely in profitability. Required: 1. List any disadvantages or weaknesses that you see to the statement format illustrated above. 2. Explain the basis that is apparently being used to allocate the corporate expenses to the regions. Do you agree with these allocations? Explain. 3. Prepare a new contribution format segmented income statement for May. Show a Total column as well as data for each region. In addition, for the company as a whole and for each sales region, show each item on the segmented income statement as a percent of sales. 4. Analyze the statement that you prepared in part (3) above. What points that might help to improve the company’s performance would you bring to management’s attention?
• 7. PROBLEM 10–26B Restructuring a Segmented Income Statement (LO1) CHECK FIGURE (3) West segment margin: \$79,650 Losses have been incurred at Scott Corporation for some time. In an effort to isolate the problem and improve the company’s performance, management has requested that the monthly income statement be segmented by sales region. The company’s first effort at preparing a segmented statement is given below. This statement is for May, the most recent month of activity. Sales Region West Central East Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \$540,000 \$960,000 \$860,000 Regional expenses (traceable): Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . 179,190 308,000 414,150 Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118,800 220,000 231,000 Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99,000 96,800 148,500 Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,850 13,200 16,500 Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,700 30,800 33,000 Shipping expense. . . . . . . . . . . . . . . . . . . . . . . . . 18,810 35,200 31,350 Total regional expenses . . . . . . . . . . . . . . . . . . . . . 460,350 704,000 874,500 Regional income (loss) before corporate expenses 79,650 256,000 -14,500 Corporate expenses: Advertising (general) . . . . . . . . . . . . . . . . . . . . . . 19,800 35,200 33,000 General administrative expense . . . . . . . . . . . . . 55,000 55,000 55,000 Total corporate expenses. . . . . . . . . . . . . . . . . . . . 74,800 90,200 88,000 Net operating income (loss) . . . . . . . . . . . .. . . . . . . \$4,850 \$165,800 (\$102,500) Cost of goods sold and shipping expense are both variable; other costs are all fixed. Scott Corporation is a wholesale distributor of office products. It purchases office products from manufacturers and distributes them in the three regions given above. The three regions are about the same size, and each has its own manager and sales staff. The products that the company distributes vary widely in profitability. Required: 1. List any disadvantages or weaknesses that you see to the statement format illustrated above. 2. Explain the basis that is apparently being used to allocate the corporate expenses to the regions. Do you agree with these allocations? Explain. 3. Prepare a new contribution format segmented income statement for May. Show a Total column as well as data for each region. In addition, for the company as a whole and for each sales region, show each item on the segmented income statement as a percent of sales. 4. Analyze the statement that you prepared in part (3) above. What points that might help to improve the company’s performance would you bring to management’s attention?